If you look at the most recent U.S. jobs and manufacturing data summarized below as well as better retail earnings this morning (WSJ, IBD), it’s a picture of modest improvement. Normally this would mean higher rates as investors shift out of safe bets into riskier assets. But the overhang of the Eurozone debt crisis proves to be too much.

It doesn’t help that Bernanke implied the U.S. could be Greece in his testimony this morning. Read the link for why it’s really not, but that doesn’t matter on short-term sentiment. The bond rally continues on this, and of course the week’s hot Eurozone topic: Greece, which is still trying to get private investors to agree on a debt deal.

The deal calls for Greek bond investors to exchange outstanding bonds for new ones with coupons as low as 3.6-3.75%, and take losses of about 70% in the process. If most private investors don’t agree, it could trigger credit default swaps (CDS) on these securities, leading a European bank liquidity issue, which is really a global issue.

That plus the fact that the deal may not save Greece is why investors are seeking refuge in MBS and Treasuries (which are yielding 1.84 right now, also staggeringly low).

And now for the stat/chart rundown…

Jobless Claims
-367,000 for week ended January 28, seasonally adjusted
-Down 12,000 from previous week’s revised 379,000 (was 377k)
-4-week moving average was 375,750, down 2,000
-The 4-week average translates into 1,637,000 Jobless Claims/month
-While this week’s data is modestly better, this is not an indication of a healthy jobs market. It is healthier that it was but still not well. Tomorrow’s BLS Employment Situation Report will give another look.

Challenger Job-Cut Report
-Announced layoffs for January were 53,486 up from previous month’s 41,785

ISM Manufacturing Index (January 2012)
-ISM Manufacturing Index 54.1. Previous was 53.9.
-50 is dividing line between expansion and contraction
-This is the 30th straight month of (albeit modest) expansion
-The data are consistent. The wholesale part of the economy seems unaware that consumer spending had flattened. Either Consumer Spending will increase or manufacturing will decrease. The last GDP report showed significant growth in inventories.

The point is that this is perilous for 1Q2012 GDP. If Consumer Spending is flat and Government Spending is down and the Investment part of GDPis down because inventories are too large then GDP will be flat or even negative.

Here’s a summary of all ISM Manufacturing trends:

Worker Productivity and Costs (4thQ2011)
-Nonfarm productivity – Quarter/Quarter change +0.7%
-Unit labor costs – Quarter/Quarter change (seasonally adjusted, annualized) – +1.2%
-Productivity growth slowed (it was +2.3% in the previous Q/Q comparison) while compensation rose 1.9% after falling 0.3% in 3rdQ2011.

ADP January 2010 Jobs Report
-ADP showed +170,000 new private jobs
-Previous was +325,000, Consensus was +172,000
-These are private sector jobs only: +170,000 private jobs is not an indication of economic growth and just barely keeps pace with population growth.

Mortgage Applications Week Ended January 27
-Purchase Index, Week/Week -1.7%
-Refinance Index, Week/Week -3.6%
-Composite Index, Week/Week -2.9%

- Purchase Index, 4-week Moving Average +4.11%
- Refinance Index, 4-week Moving Average +4.22%
- Composite Index, 4-week Moving Average -2.9%

-Full mortgage app report.

Construction Spending (December 2011)
-Construction Spending, Month/Month +1.5%
-Construction Spending, Year/Year +4.3%
-New single-family construction was 1.5%

by Julian Hebron & Dick Lepre

Rates dropped as mortgage bonds rallied big and stocks were flat on a Fed pledge to keep overnight rates near zero through 2014, iffy New and Pending Home Sales, weak GDP, and doubts about investors in Greek debt to agreeing on losses they’ll take.

Greek debt negotiations will dominate market action early this week.

The latest looks like a deal where Greek bond investors exchange outstanding bonds for new ones with coupons as low as 3.6-3.75%, and take 50-70% losses in the process. If most private investors don’t agree, it could trigger credit default swaps (CDS) on these securities, leading a European bank liquidity issue, which is really a global issue, and U.S. rates could drop further in this scenario.

The week also begins with an EU summit that will focus on tighter fiscal union across Europe. But short-term, most sentiment hangs on the Greece deal.

Volatility will reign, with most probable scenario being low rates hold as investors focus on U.S. mortgage and Treasury bonds.

The week’s data breaks down like this:

Monday we’ll see the Fed’s preferred inflation measure, the Personal Consumption Expenditures Index (PCE), which is likely to be flat. Tuesday brings November’s Case Shiller home price report where we’ll find out if a losing streak extends into a third month or turns positive. Wednesday and Friday bring ADP and BLS jobs reports for January. Expectations are wide for both after blowout ADP (+325k private jobs created) and much better BLS (+200 nonfarm jobs created) for December. Also Wednesday is ISM Manufacturing for January which may show an improving trend extending into its 30th month. Plus 4Q earnings season rolls on all week.

Here I preview each item for those who want more details.

Looking at stocks, the S&P 500 closed last week at at 1316, flat on the week and well above its 200-day and 50-day moving averages of 1257 and 1255. Seems stock investors are awaiting signals out of Greece before committing further or pulling back. A possible deal impasse and/or CDS spiral on Greek debt could push the S&P 500 down to its 50 and 200-day averages. But given this unpredictable macro environment, analyst Robert Sinn put it best in his 1/28 Weekly Letter:

You can expect to hear people mention S&P 500 levels less often as they speak more in terms of individual names and in which sectors they want to be invested.

Looking at mortgage bonds (MBS), the 3.5% Fannie Mae coupon – a key benchmark lenders use to price consumer rates – rose a whopping 103 basis points last week to close at 103.69. MBS are now a comfortable 88 basis points above 25-day moving average and 125 basis points above their 50-day moving average.

Rates drop when bond prices rise like this, but rates only dropped .125% because lenders didn’t price all these gains into rate sheets until they see whether the rally holds—which again, is dependent largely on Greece to start the week.

The tricky balance is that U.S. data could continue its modest improvement this week, so if the EU situation stabilized even slightly, MBS would sell, pushing rates up. And lenders don’t want to get caught in that reversal so they price conservatively.

I’ll repeat my outlook for last week since the Greek deal is dragging on:

MBS and rates will hold or improve slightly if the Greek debt deal goes sideways. But if it’s reasonably clean -meaning there’s no event that triggers claims on credit default swaps and squeezes banks – then we could see U.S. rates rise short-term as investors shift out of MBS and Treasury safe havens into riskier assets.

BOTTOM LINE: Rates are absurdly low. Only a meltdown in Europe will cause U.S. rates to go lower near-term.

If you’ve been waiting for a rate bottom, this could be your week.
___
Related:
-Refi Roadmap: A Locked Rate Isn’t A Closed Loan
-Stat by Stat: Recap Jan 23-27, Preview Jan 30-Feb 3

Could this relative price movement change direction?

Sure. Some broker-dealers believe that a sustained selloff in the rates market that will take the 10-year Treasury to 2.5% or above would be the most likely scenario in which MBS spreads would widen significantly. This is due to a number of factors, including a prediction that, assuming a selloff is caused by improving fundamentals of the US economy, the probability of Fed’s QE 3 involving agency MBS should diminish significantly in a rates backup scenario.

On top of that, IF rates were to see that big of a move, it would mean that volatility has increased – rarely a good thing for MBS’s. And when that happens, “convexity hedging” related selling from servicers and originators would probably lead to a sudden increase in the supply of agency MBS in this scenario, resulting in even more selling.

Lastly, domestic banks have been providing a very strong bid for agency MBS over the past 5-6 months, and in a rates backup scenario, their deposit growth is likely to be lower, meaning that banks would be unlikely to grow their holdings until rates stabilize again. Simple!

Rates held lows on weaker U.S. retail sales and jobs data, and S&P’s broad EU credit downgrades.

The downgrades now raise a new issue: the possible downgrade and reduction in size of the EFSF, EU’s bailout fund. Also Greece will resume trying to get Greek bond investors to agree on losses this week. Those talks stalled last week.

Plus there’s lots of 4Q earnings and key housing data next week. Here I preview each item.

As for stocks, the S&P 500 closed last week at at 1289, up .86% on the week and well above its 200-day moving average of 1259. While this is slightly overbought territory, the 200 DMA and the 50 DMA at 1244 both provide some downside support if earnings disappoint and the EU situation, especially Greece, grows more dire this week.

Looking at mortgage bonds (MBS), the 3.5% Fannie Mae coupon—a key benchmark lenders use to price consumer rates—rose 11 basis points last week to close at 103.20.

Rates drop when bond prices rise, but this isn’t enough of a rise for lenders to adjust consumer rates down, which is why rates held.

Another reason for lender hesitation is that MBS closed last week a hair below record highs set in September when the Fed renewed their low rate commitment by saying they’d keep buying MBS.

MBS are a comfortable 62 basis points above their 25-day moving average, and have several layers of support below that at the 50, 100, and 200 day moving averages.

These MBS technical signals continue to suggest rates will hold in their current record low range or .125% higher near-term.

People in contract to buy homes must lock rates in order to stay on target with loan approvals and closing, but refinancers have two choices: (1) hold for better, or (2) lock record lows now.

Option two is advisable since mortgage bonds are now at record levels. Even if they rise a bit, lenders are still unlikely to lower rates. We’d need MBS prices to spike for that to happen.

With EU problems driving our rates down for so long, it’s easy to get complacent, but if U.S. economic data improves next week and beyond, MBS can reverse quickly.

Remember, rates change all day everyday as mortgages trade, so the best thing to do is give your mortgage lender a rate target you can’t or won’t go above and give them a standing order to lock it when it comes.
___
Economic Data Roundup:
-Recap Last Week, Preview Next Week

“Although dollar prices of Fannie 3.0′s (these securities would include 3.25% and higher mortgages) have skyrocketed over the past few days, there has been very limited originator selling of this coupon. Below we try to estimate at what price spread level of Fannie 3.5s/3.0s swap, originators should have an economic incentive to move new issuance into Fannie 3.0s from Fannie 3.5s.

Let us say that a lender has originated $100 mortgages at 3.9% mortgage rate and is deciding between securitizing them in FN 3.0s or FN 3.5s. He has got two options:

(A) Create $100 FN 3.0s and retain 90bp servicing spread, or

(B) Create $100 FN 3.5s and retain 40bp servicing spread.

At Friday’s closing price levels, in Option A, he gets $101 cash and retains 90bp servicing spread. In Option B, he gets $103.1 cash and retains 40bp servicing spread.

Which one of these options is better for him?

Right now, 2010 FN 3.5s IOS is trading at 17-02. Since the 2011 IOS should trade somewhat better than 2010 IOS, let us assume that the 2011 3.5s IOS is worth $19 and also that the servicing asset trades at about 15% discount to IOS (fairly realistic assumptions).

In this case, the 50bp additional servicing in Option A versus Option B is worth: (0.5/3.5)*(19*0.85) = $2.31.

Thus, the originator gains $103.31 ($101+$2.31) by following Option A versus $103.1 by following Option B in a completely liquid market with no barriers to trading.

In other words, as long as the FN 3.5s/3.0s swap is below $2.31 (2-10), the originator should create FN 3.0s instead of FN 3.5s (from a purely economic perspective) while this swap was trading at about 2-04 at Friday’s closes.

Of course, originators need to set aside capital if they retain excess servicing – so they may need some premium over what is indicated by economics to move into FN 3.0s instead of FN 3.5s.

And the Basel III constraints on the contribution of MSRs to bank capital are also possibly making originators reluctant to keep excess servicing spread on their balance sheets at the moment.

-Bernanke’s Mortgage/Housing Bet—great summary of QE (Jody Shenn, Bloomberg)

-Housing Forecasts: Goldman, Merrill, Fannie, Wells, more (CalculatedRisk)

-A new duality of credit & zero-bound rate risk defines 2012 markets (Bill Gross, PIMCO)

-Profound & Pervasive Misconduct In Mortgage Servicing (Ritholtz on Raskin)

-Survey shows wide support for mortgage interest deduction (HousingWire)

-One Fed president explains how FOMC meetings work (Michael Derby, WSJ)

This drop came despite improving jobs, retail sales, and manufacturing data. Below I recap, preview the rate and stock week ahead, and explain why rates are holding lows despite better economic data. Scroll to ‘Bottom Line’ if you’re on the run.

RECAP JANUARY 3-6 MARKET WEEK

Manufacturing Better Again: The Institute for Supply Management’s December manufacturing report was 53.9, up from 52.7 in November, with 50 as dividing line between between expansion and contraction. This was the 29th month of growth and a 6 month high. It’s slim growth, but a resilient streak. And of course consumers must still buy what’s being manufactured for this to translate into real economic growth.

Blowout ADP Jobs Report: Payroll provider ADP’s December jobs report showed 325,000 private jobs created, blowing away estimates of 178,000 and November’s 204,000 figure. Still rates didn’t rise. More in BLS jobs report below.

Jobless Claims Down-Trend Continues: Claims for unemployment insurance resumed their down trend the week of 12/31 after rising the week before—they’re now down four of the last five weeks. Jobless claims were 372,000 for week ended December 31, down 15,000 from previous week, and the 4-week moving average was 373,250, down 3,250. Average claims since 2000 are 390k, so so 1-week and 4-week numbers are better than long-term trend. More good U.S. economic news.

Holiday Retail Sales Looking Better: The Commerce Department’s December retail sales report is due next Thursday, and previewed below. But the ICSC-Goldman Sachs and Redbook Research chain store sales numbers each week give a more frequent pulse. Last week’s ICSC-Goldman and Redbook numbers continued the positive holiday shopping trend (driven by deep retailer discounts) for the week ended 12/31: ICSC +5.3 and Redbook +4.9 versus same week in 2010.

Better BLS Jobs Report: The Bureau of Labor Statistics December jobs report showed 200k new non-farm jobs created vs. the 100k created in November, and unemployment dropped from 8.6% to 8.5%. Encouraging news since people need jobs to spend, but this chart shows just how much ground there is to regain from the recession depths. And here’s a good explanation of how jobs are counted.

PREVIEW JANUARY 9-13 MARKET WEEK

Next week’s economic calendar is pretty light, but there are still many factors impacting markets. Highlights below with rate impacts.

Retail Sales: November’s retail sales were 0.2%, confirming that early reports of strong post-Thanksgiving Black Friday sales were overblown. Estimates call for a 0.4% rise in December’s retail sales report Thursday. The ICSC-Goldman and Redbook weekly sales reports discussed above were better year-over-year, but Thursday’s Commerce Dept. report still isn’t likely to be a blowout number. Rates even.

Treasury Debt Auctions: $66n in new Treasury debt will be auctioned as follows: $32 in 3yr Notes Tuesday, $21 in 10yr Notes Wednesday, $13 in 30yr Bonds Thursday. These auctions (not always same coupons) happen every other week. Overall, demand for this new Treasury debt has been strong the past couple rounds, helping mortgage bond (MBS) demand, which keeps rates low. Sentiment is cautious so bonds are in favor, but MBS are priced for perfection. So rates steady, even if strong auction demand.

Europe Front & Center Again: German and French leaders Angela Merkel and Nicolas Sarkozy meet Monday with some brief public comments after. This is likely be reiteration of previously announced debt crisis plans to centralize fiscal authority (which is inevitable and a long slog). They may also preview the agenda for the January 30 EU summit. Additionally, the first ECB meeting of 2012 is is Thursday where no rate changes are expected. And finally, markets expect ratings agency Fitch to downgrade EU credit outlook on Thursday. Such action would cause investors move into U.S. Treasuries and mortgage bonds, keeping rates low.

Lots of Fed Chatter: There are nine senior Fed officials making public speeches everyday but Thursday next week. Traders will be looking for signals about more government buying of mortgage bonds to keep rates low. On Friday 1/6, we got two such signals that stoked mortgage bond markets and brought rates down: (1) NY Fed president William Dudley said he thinks the Fed should continue accommodative policy to help housing, and (2) Boston Fed president Eric Rosengren was more explicit, saying “Further purchases of mortgage-backed securities would in my view help provide a more rapid recovery in housing.”

Stock & Bond Technicals: Looking at stocks, the S&P 500 closed at at 1278, up 1.61% on the week, ending in slightly overbought territory, and above its 200-day moving average of 1259. Earnings season kicks off next week but doesn’t hit full steam until the week after, so headline factors like Fed and EU issues noted above will drive sentiment. As for mortgage bonds (MBS), the 3.5% Fannie Mae coupon—a key benchmark lenders use to price consumer rates—rose 26 basis points on the week to close at 103.09. Rates dropped .125% as a result. MBS are now a comfortable 70 basis points above their 25-day moving average.

Bottom Line: I said rates would be even to up .125% last week on expectations of a stronger jobs report. We got the better jobs data but rates actually dropped .125%, mostly on Friday’s rather surprising comments from NY and Boston Fed presidents signaling more mortgage bond buying. Boston’s Fed president was especially explicit (excerpt above). Mortgage bonds are now priced for perfection, meaning any positive news would cause them to sell, pushing rates up a bit. But there’s not a lot of economic news next week. Only an impending ratings downgrade in Europe, more Fed speeches, and a rather light entry into earnings season. So rates will hold this range they’ve been in for weeks, and I expect them to be even to up .125%.

Rates rise when mortgage bonds (MBS) sell, and today’s trend continues a two month-theme: Mortgages sell right after better economic releases and EU aid news, then recover. The 3.5% Fannie Mae coupon—a key benchmark lenders use to price consumer rates—was down 30 basis points in early trading and is now up 23 basis points. Impending EU trouble (and MBS-focused QE3 rumors) have tempered—and reversed—selloffs to keep rates from spiking from current record-low levels.

More in WeeklyBasis recap/outlook tomorrow, and here’s a deeper dive on today’s numbers.

The two firms said in May they would be targeting a $250 million RMBS deal using a warehouse line to gather the jumbo mortgages.

Assuming this goes through, however, it would only be the fourth private-label (aka jumbo, aka non-Fannie/Freddie) RMBS offering since 2007. The other three were done by Redwood.

Reportedly should Two Harbors, the seller in its deal, fail to deliver the security before May 17, Barclays, which is the initial purchaser, would agree to buy the assets. Two Harbors must obtain an AAA rating on the security from at least one ratings agency.

Don’t forget about possible risk retention rules—if they exist by then!

AOT stands for “assignment of trade.”

An assignment of trade is a tri-party agreement between an Assignor (like a mortgage lender’s lock desk), an Assignee (an investor who the mortgage lender sells to like Wells or GMAC) and a broker/dealer (like Goldman Sachs or Cantor Fitzgerald).

Often a lender will sell a mortgage-backed security (MBS) to a dealer to hedge (protect) its interest rate risk. At some point in the future the dealer is expecting this security to be delivered to it, and the seller is obligated to deliver it unless it buys back the security (“pair it off”).

But a third option exists whereby the lender sends the loans to an assignee like Wells, and assigns the trade to them as well. At that point Wells is obligated to deliver a security to the dealer.

Put another way, after the MBS is sold to the dealer, when the loans are closed and ready to be delivered, the mortgage lender (assignor) sends the files to the investor (assignee) who then delivers the MBS to the broker/dealer, at which time the mortgage lender lock desk has fulfilled its delivery agreement while avoiding pair-off fees.

Avoiding expenses is the name of the game, whether it is the lender not paying the bid/ask spread to the dealer, or not paying the assignee for failing to deliver any loans.

In theory saving these expenses leads to better rate pricing to loan agents and their consumer clients.

To take this a little further, the lender is essentially investing in the servicing strip (sometimes there’s excess servicing too) while the lock desk is executing at TBA prices instead of the lender’s marked-up rate sheet. AOTs are generally more profitable when servicing released premiums are rich, which is not the case at the moment. That is why so many originators are setting up relationships with sub-servicers.