WeeklyBasis 2/19/10: Is The Rate Party Over?, Preview of Wild Market Week Coming

Extreme rate volatility discussed in this WeeklyBasis report two weeks ago still holds. Rates traded up and down about .375% this week on fears about business inflation and Fed rate hikes. Today’s tame consumer inflation contributed to rates dropping again, and rates end the week roughly .25% above all time record lows. But this record low rate window looks to be closing. Rates could rise by about 0.5% by summer for three reasons:

(1) The Fed will end it’s $1.25t mortgage bond buying program March 31 (they’re 95.8% into their MBS buying budget as of today), and then we’ll likely see profit taking on mortgage bonds as private investors sell, which pushes prices down and yields—or rates—up. The San Francisco Chronicle published a very good consumer-friendly story on this topic Monday, and my quote in that story explains other factors affecting rates after March 31.

(2) An improving economy and resulting inflationary fear will cause mortgage bonds to sell off because inflation eats up bond returns, so this would also push bond prices down and rates up. This happened yesterday when business inflation numbers came out hotter than expected, and we may see more of this in the coming months.

(3) Inflation will cause the Fed to start hiking short rates from current near-zero levels. Global investors currently borrow on these short-term rates to buy long-term securities with higher returns. When short rates rise, it will erode the benefit of this interest rate trade and force selling of long-term securities—including mortgage bonds—to repay short-term loans. That selling will also push rates higher. The Fed hiked the overnight Fed-to-bank Discount Rate by .25% (to .75%) last night and this is the first sign that the Fed is starting to move toward a short-rate hiking bias.

Volatility will continue next week with a packed economic calendar as follows:

Tuesday: S&P Case Shiller December Home Price report, Consumer Confidence, House Financial Services Committee debate whether more stimulus is needed

Wednesday: New Home Sales, Treasury Secretary testifies to Congress on budget, Ben Bernanke testifies to Congress on Fed policy and economic outlook

Thursday: Bernanke Congressional testimony continues

Friday: 4Q09 GDP revision 2 of 3, Existing Home Sales, 4Q09 Consumer Inflation (PCE)

All week: Five senior Fed policy makers will be making public speeches on the economy.

All week: Various Treasury auctions totaling $126b. These securities compete with mortgage bonds, so we may see more selling pressure on mortgage bonds as a result.

CONFORMING RATES ($200,000 – $417,000) – 1 POINT
30 Year: 4.875% (4.99% APR)
FHA 30 Year: 5.0% (5.13% APR)
5/1 ARM: 3.625% (3.74% APR)

SUPER-CONFORMING RATES ($417,001 to $729,750 cap by county) – 1 POINT
30 Year: 5.125% (5.24% APR)
FHA 30 Year: 5.125% (5.28% APR)
5/1 ARM: 4.5% (4.64% APR)

JUMBO RATES ($625,500 – $3,500,000) – 1 POINT
30 Year: 5.875% to 6.25% (6.02% to 6.37% APR)
5/1 ARM: 5.25% (5.43% APR)