Lock at the top, Float at the bottom

Although showing signs of weakening at times, mortgage bonds have continued to hold on to highs not seen in nearly one year.  This has pushed interest rates down to match the lows of this same time period.  Considering that this has happened while the stock market has been riding along near all-time highs, as well as with the Federal Reserve Tapering process of QE3 well underway, this has come as a shock to many financial analysts.  We believe the market isn’t yet prepared for higher interest rates, and this occurrence puts rates more in line with where they should have been all along.

Weekly Unemployment Claims for the week were reported at 319,000.  This is well below 345,000 reported last week, and puts us back in the trend of falling new claims.  The report caused an initial drop in bond prices.  However, the market has already move past the news and quickly regained its losses.

Mortgage bonds have had a run up in price of 140 basis points in the past three weeks.  Even in a healthy upward market, you would expect to have times when you pull back, regroup, and then make another attempt to move higher.  We feel there is weakness developing that could cause at least a 40-50 basis point correction.  However, it is difficult to predict at what point this will happen.  As you can clearly see in the stock market, although the overall run seems to have been nearly a straight line up, stocks prices have had periods where they correct downward, regroup, and then push up again.

The Federal Reserve President, Janet Yellen, gave an impressive speech yesterday, showing the world that she truly understands the reality of our economic condition.  She reiterated that they plan to keep short term interest rates low for a while.  Further, she has done a great job detaching bond investors from tapering of QE3.  If you remember, it was the fear of tapering last May that initially drove interest rates on their sharpest increase that we had seen in years.  Now that the taper process is well underway, mortgage rates are actually lower than they were when they started the process.  The massive panic that spread throughout the bond market has seemed to calm, and now the bond market is functioning more rationally.

There is too much risk for us to suggest a floating bias.  At this point, we are still at the top of our trading range.  The general rule is to lock when at the top and float when at the bottom.  We will therefore have a lean towards locking.  However, if you choose to float, watch the market closely.  When at lofty levels, a correction can happen quickly.