Rate Spike On EU News. Will It Continue?

Rates are up .25% today as mortgage bonds drop and stocks rise sharply on perceptions of progress with Europe’s debt crisis.

EU leaders demanded that private investors in Greek bonds take a 50% writedown, and also said they’d increase Europe’s TARP-like bailout fund—the European Financial Stability Facility (EFSF)—to $1.4t.

EU leaders also said banks would have to increase capital ratios from 6% to 9% by June 30, 2012 after writing down sovereign debt holdings. This means banks will be reluctant to lend, which will hurt Europe’s already hurting economy, which will make the writedowns hard to peg.

Today’s EU plan is progress, but questions remain:

Will banks recapitalize using EFSF or are they on their own? Is a 50% writedown on Greek debt enough? What about writedowns on debt of other Eurozone countries?

These questions aren’t answered yet, but U.S. stocks like the news and bonds (that rates are tied to) don’t like it.

On top of this we had decent 3Q GDP of +2.5% here in the U.S. this morning. While it’s promising to see some U.S. economic strength, it further hurts bonds, pushing rates up.

Market reaction has pushed the S&P 500 above its 200 day moving average, a critical overhead resistance level. And it’s caused mortgage bonds—as measured by the 3.5% Fannie Mae coupon that most lenders use to price consumer rate sheets—to drop definitively below the 50 day moving average it’s been clinging to since October 7.

Rates rise when bonds drop like this.

Rates hit record lows October 3 following a two-tier rally: (1) rates dropped after the Fed said on September 21 they’d support rate markets by buying more mortgage bonds, and (2) rates dropped from September 27 to October 3 as markets grew fearful EU leaders weren’t doing enough to address their debt crisis.

Rates and stocks have been rising and falling on each little development in Europe, and the next likely updates come when these leaders are gathered again at the G20 Summit next week on November 3-4.

But today’s developments are important because it shows the EU is taking bolder steps to fix the crisis.

Bottom Line For Rate Shoppers: A meaningful rate drop from today’s +.25% spike feels unlikely by Friday because the EU news is substitutive enough to keep bonds and stocks at current levels short-term. Mortgage bonds have dropped so sharply today that it will take a few days before new trendlines emerge. Then we can determine if rates drop a bit, or if they’re entering into a new, higher range medium-term.

I’ll do some daily updates from here, and my next big update will be this Saturday’s WeeklyBasis market recap/outlook.
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Further Reference:
-Euro Summit Statements (CalculatedRisk)
-How Today’s EU Summit Addresses The Crisis (CreditWritedowns)
-EU Sets 50% Greek Writedown, $1.4t In Fund (Bloomberg)