Locking Bias

After the 10 year note auction produced strong demand yesterday, mortgage bonds were able to regain their losses in late afternoon trading. This put bonds back above their 25 day moving average and right in the middle of the sight trading range they have been in for more than two weeks. Bonds have traded within a 30 basis point range for more than two weeks, which is a rare event to experience. Although it has added a great deal of stability to mortgage rates, the longer bonds remain in this tight of a channel the greater the risk of a dramatic breakout. Similar to a spring being wound for an extended period of time, bonds build tension the longer they go without a strong move.

We are just one week away from the highly anticipated Federal Reserve meeting where many expect short term rates to be increased for the first time since 2006. This has many investors sitting on the sidelines waiting to make any significant bets on the market until they know the cards the Fed is holding. If the Fed chooses to raise rates, the stock market will see that as a headwind for further economic growth. However, the bond market at this point will likely view an increase as insurance against higher inflation. Therefore, mortgage interest rates could actually be driven lower as a result. Regardless of the outcome, most feel that a rate hike is due and that current economic conditions no longer justify near 0% interest rates.

Given the lackluster performance in the bond market, there remains little incentive to float an interest rate. Therefore, unless bonds are able to muster the strength to make a break higher, we will maintain our locking bias.

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