May 19

Mortgage bonds broke beneath an important floor of support this morning, as they seem to have stalled at current levels.  With next week being a four day week, many bond investors will be away from their trading desks and on vacation this week and next.  Therefore, we can anticipate volatility as the week progresses.  Further, outside of the standard weekly reports, we have a relatively quiet news week.  This makes the technical picture more important, as investors will rely on the charts to set the direction of trading.

John Williams of the Federal Reserve spoke this morning, stating that a lack of inflation is currently a larger threat than excess inflation.  In a healthy economy, they hope to see 2 – 2.5% inflation, which is much higher than recent years’ increases.  In a low inflationary environment, consumers become reluctant to make purchases, as they hope for downward pressure on prices to make goods and services more affordable.  In turn, this causes our economy to contract, which has a rippling impact to housing, employment and most significant economic indicators.  With QE3 coming to a close, that will add further deflationary pressure, which may cause the Fed to step back in with  new and improved QE4.

With mortgage bonds currently beneath support, we will suggest a locking bias.  Continued strength in the stock market will add further downward pressure to bond prices as well.  It is interesting to watch the stock market continue its climb higher in spite of current economic data and indicators.  Either the stock market knows something the bond market is ignoring, or there is an irrational momentum in stocks that can’t continue forever.  Either way, since the two markets tend to move in opposition of each other, watch the stock market closely, as it will likely provide hints as to the direction of interest rates.