THE BASIS POINT

WeeklyBasis 1/29: Rate Bottom Is Here

Rates again dipped to record lows last week: 30yr single family home loans to $417k closed at 3.75%. Here are Friday’s rates for all loan tiers.

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.
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