Monday Market Commentary: Supply, Fed to Drive Rates this Week

by Alex Stenback on August 4, 2008

Last Week:
Mixed economic news caused mortgage bonds to trade sloppy and mostly sideways for the balance of the week, though mortgage rates did manage an improvement of .125% by Friday’s close.

Specifically:

  • The economy shed 51,000 jobs, according to the BLS. This was somewhat better than the 75K most expected, but the unemployment rate ticked up to 5.7%. 
  • The markets were encouraged at times by a dip in oil prices and an up-tick in consumer confidence.
  • Fed to extend the emergency lending facilities, credit crunch not over.
  • And, of course, the 698 PAGE housing "stimulus" bill was signed into law last week.  See our comments on this here, and here.

This Week:
The bond market (read, interest rate) activity this week will be framed by the Fed meeting (Tue) and a tremendous amount of supply (newly issued bonds) coming to market. 

As for supply – any time there is a lot of supply in the bond markets, it can hurt mortgage rates by taking money that might otherwise be invested in mortgage bonds elsewhere.  This week, a horse-choking $27 Billion dollars worth of Treasury notes and bonds will be sold, which may sap demand for mortgage bonds and push rates higher.

The Fed meets Tuesday and will announce a rate decision along with a policy statement.  The market is eager to know which front the Fed will be fighting on – the economy, or inflation. If the Fed statement suggests that inflation is public enemy number one (a point of view we would disagree with) then we can expect suggestive language about future rate hikes.  Note that in the short term, a return to rate hikes may help mortgage rates improve by soothing inflation spooked bond investors.

However, don’t bet on the Fed getting overly hawkish on inflation just yet.

As we mentioned last week, despite the higher prices for nearly everything, notably absent is the presence of any wage inflation (though personal income and spending both printed higher than expected this AM). 

This is important, because as painful as higher prices at the pump and at the cash register can be, inflation without wage inflation is not the sort of thing that will inspire the Fed to launch a shock-and-awe campaign to fight.  Especially when our economy looks more fragile by the day and the credit crunch remains in full-throated roar.

We expect the Fed will mention (but soft-pedal) the threat that inflation poses, and highlight ever so slightly the other threats and downside risks to the economy.  A statement like that won’t do much to improve mortgage rates, which would benefit from a hawkish, anti-inflation statement, so risks are tilting to the upside this week, in our view.

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