THE BASIS POINT

Even Lower Rates Coming?

We may be moving to record low Treasury yields and mortgage rates as bonds rally even further. If and when this move occurs please remember that (1) mortgage rates take as long as two days to move downward from the time Treasury yields move down and (2) because the situation is novel it is difficult to forecast just how mortgage rates will track Treasuries. The fact, however, is that Fannie and Freddie mortgage backed securities (aka MBS or mortgage bonds) are still guaranteed by Treasury.

The following Technical commentary is by Jim Grauer.

This week has provided perhaps one of the most extraordinary experiences in my long technical analysis career. Recall from last week (08/12/11) that the breakout from the 10 year note H&S formation on 07/28/11 was at a price of 125^05. Exceeding all expectations for that pattern, prices exploded 5^ 28 points to 131^01 on 08/09/11.

Looking at a Daily chart for graphical illustration on the analogous 30 year bond), the vertical line chart formed what looks like a flagpole and in fact, this formation is called a high pole. Now, a very rare subsequent affiliated pattern occurs when the daily price range contracts for 4 or 5 days, forming a flag, or pennant on the top of this high pole. In the instant case, a pennant was formed.

A long history of this rare pattern holds that should prices aggressively breakout to the upside from the pennant, especially with a price gap (which did happen), the measured move to the next price objective is equal to the distance from the base of the pole (i.e. the neckline of the H&S formation back on 07/28/11) to the top of the high pole, or in this instance 5^28 points. Adding this number to where the breakout from the pennant embarked (i.e.129^31 on 08/17/11), our measured move, or count objective is 135^27.

Today, 08/18/11, the 10 year note closed at 130^25, therefore leaving another 5^02 points to go in order to meet the objective. Such a move would drop the 10 year yield approximately 60 bps from today’s close of 2^06% to a stunningly low 1.46%. Japan, here we come!!

Postscript: Even if we don’t make that objective, after all, nothing in life is guaranteed, suffice to say that the note price is slated to move considerably higher from current levels.

(End of Grauer commentary.)

Not Sure If We Have Been Here Before
We appear to be at a time when the U.S. consumer has completely lost confidence in the economy and the ability of anyone in government to do anything about it. If you read Jim Grauer’s content you will see that we may be preparing to move to a time when wealth holders choose to hold cash, U.S Treasuries and perhaps gold. If 10-year Treasury yields fall well under 2% folks may look to MBS for yield.

This is not merely about people getting into a funk. This is about the fact that fiscal policy has failed, monetary policy has failed and no politician has anything real to offer. The consumer and the investor are about to shed what hope they have left.

This could result in massive losses to equities as folks move from risk assets and park their wealth in cash, gold, Treasuries and MBS. The speed and depth of this could be frightening. If what Grauer forecasts or even if half the move he forecasts happens, we will see record low mortgage rates.