No matter what the reason, traders respected chart patterns which projected good support, allowing for a nice little rally this morning.  Buyers started the party in Tokyo and quickly transfered power to stateside traders, interested in buying 30 year bonds.  Since the early gains, the market has been back and forth on light volume yet holding most of today’s gains.  However, the caution flag is still out as the market has not been able to trade above the 8 day moving average.  We really need a close above this level to find our comfort zone.

We see the set up as neutral, given a multitude of bearish divergences on one side and Fed Chief Bernanke and his dollar printing press on the other.  Throw all the factors together and you can make a good case for the market and Austin mortgage pricing to stall unit early November’s elections and FOMC meeting.

Retail Sales and strong manufacturing results out of the Empire State didn’t help either.  Mortgage backs performed better than treasuries as spreads tightened.  Technically, it is time to pay attention.  Weak day structure on the 10 year note chart is reinforced by a second consecutive day close below the 8 day moving average.  That’s the bad news.  Good news is that intraday studies are very oversold and the market has good support close by.  So to speak, we are at that line in the sand.

Next week will be the true test, one that we would expect will see the market trade sideways to a little better (slightly improving mortgage pricing). Overall, we think this is the low probability trade as QE2, even though it is fully priced in, is a force to be reckoned with.  When the Government is the buyer of choice, most follow the ant age, “Don’t fight the Fed.”

Call it neutral/bearish and not a market to throw caution to the wind.  Next week’s data is light with Housing numbers, Leading Economic Indicators, Philly Fed Survey, and the Fed’s Beige Book.  Have a great weekend.

Tomorrow will be “the day” as the monster Employment Report for August will be released (7:30 am cst).  Not only is it the highest profile report of the month, but given the mixed economic data and volatile trading of late, everyone will be focused like a laser on this one.  I would not be surprised to see a 250 to 300 point swing on the Dow tomorrow.  Trouble is, which way?  Tactical bias points to soft numbers, something in the neighborhood of minus 100K jobs and the unemployment rate to print 9.7%.

Today’s trade is a continuation of yesterday’s selling, albeit at a slower pace.  10 year note off 11/32’s, mortgage backs off 11/32’s in low note rate conventional, and stocks up a few points on the day.  Expect the day to be one of “squaring up” for traders in both bonds and stocks, with not much movement seen from current levels.  Best bet for Austin mortgage borrowers is to lock in their interest rate.  It just makes cents (and dollars too).

Bonds, notes, and mortgage backs are or were at historic lows.  That said, my bias above provides traders with sticker shock as they look at pricing.  Therefore the fade and/or consolidation trade is in vogue.  As we speak, the 10 year note is off 16/32’s.  Mortgage backs are off nearly a quarter.  English translation is a high probability of a worsening Austin mortgage price change.  We see the tactical bias as being defensive with conditions and chart work pointing to a more bearish outcome.  Borrowers are advised to stay with this market and don’t let it put you to sleep.  It could be costly.

“ I met them at the Treasury store, they told me that they were bad, but I knew they were really glad, that’s why I fell for the Leader of the Pack”.

Treasuries are the big dog on the global market with traders from all corners of world running to them for safety.  Take for example the Treasury International Capital Flows (TIC Index) which measures the purchases of our Treasuries by foreign entities.  In March alone, 108.4 billion were bought, making it the instrument of choice as global debt issues and stock market roller coasters rule the day.  PPI, a measure of inflation at the wholesale level, hit the tape with a benign reading of minus .1% headline and a core print (ex-food and energy) of plus .2%.  Nothing to be scared of here and if anything, a deflationary trend may be setting up due to the global slowdown in Europe.

April Housing Starts also hit the tape, up 5.8% to 672K units.  Not bad except when you look at new Building Permits which dropped 11%.  Still tough sledding for the builders out there.  10 year trading has been volatile this morning as we opened in the red (down 12/32’s) with mortgage backs off 5/32’s.  Stocks have worked their way off the early morning highs ( opened up 80 now up 47), helping treasuries and mortgage backs to boot strap themselves back to unchanged.

USDA UPDATE: In a nut shell, the USDA program is out of money (except for disaster funds in a few areas).  The Senate now has three competing bills so the work out process has begun.  Nothing scheduled on the Senate floor so this could take some time.  USDA issued guidance stating that they would issue condition commitments so we could proceed with the loan process but not close until the program was funded.  USDA has now pulled that guidance to issue conditional commitments.  As you can see, this is a mess.  Investors such as Chase, etc. will not take locks unless you have a conditional commitment or are in a county that has adequate disaster funds available as they see this as hedging a “phantom” pipeline.

Have questions about USDA funds? Call me (512) 293-1239.

Durable Goods greeted stateside traders at plus .5% while the ex-transportation component was plus .9%.  Both were a touch below consensus.  Weakness in Durables can be traced to New Home Sales which fell 2.2%, setting a new record low (308K units annually).  All of the above has pushed the 10 year note towards the bottom of the range, down 22/32’s to yield 3.77%.  Mortgage backs have fared better with spreads tightening (Fed taking 1.25 billion out of the market) but are still off a smooth 11/32’s.  Stocks complete the sea of red hat trick, off 20 points on the big board.

While the economic data is seen a net neutral, the technical set up on the chart looks more like a pit bull.  Reason being is that the selling today has sliced through the trend line that has restricted the downside (acted as support) since December 2009.  Couple that with bearish oscillators kicking in and a breach of the 40 day moving average and you have the makings of the “perfect storm”.

Today’s day-end close will be very important.  We need to hold 116 22/64^th on the futures chart (yield equivalent is 3.75%) to feel better about the range trade continuing.  With current levels at 3.77%, the market needs to boot strap itself back together or further downside (worsening mortgage pricing) will occur.  42 billion in 5 year notes (today’s auction) could be the key.  Yesterday’s 2 year auction was a dog, giving traders suspicious minds about the outcome of today’s 5’s and tomorrow’s 7’s.  Good participation will go a long way to helping our cause.  Given the way we ticked off the Chinese lately, that is not a given.  Keep both hands on the wheel.  We’ll update you on the auction results (12:00 cst).

Weekly Unemployment Claims fell 27K to 469K as seasonal factors and the weather related snafu has everyone guessing is this real or Memorex.  The big picture points to the percentage of eligible people receiving unemployment benefits being 3.5%, well above the reading that creates jobs.  Seems to us that unemployment is stabilizing albeit at higher levels.  Not the makings of a vibrant economy.

Pending Home Sales looked like a Rottweiler as well, falling 7.6% in January.  Economists were looking for a plus 1.0% print.  Once again, the NAR Chief Lawrence Yun blames the weather for affecting home shopping.  Maybe we’ll get a clear read in July.  For the record, all regions were in the red with the West falling 13.2%.  Did it snow in California?

Factory Orders were up 1.7% with the ex-transportation up .1%.  A 15% gain in transportation orders did this trick for this number.  Maybe new accelerator parts for Toyota.  Productivity gains were off the chart, rising 6.9%.  The flip side was a drop in labor costs of 5.9%.  We are putting computers to work, not Joe the Plumber.  All of the above has flattened the yield curve with the 10 year note up 4/32’s and the bond plus 13/32’s.

One positive here is that until we work through this massive off sides market position in MBS, mortgage pricing will be supported, helping to keep pricing stable.  I’m going to give you our best guess on tomorrow’s jobs data.

Expectations for the February Employment Report are as follows;

1)      Non-Farm Payrolls – Minus 50K

2)      Unemployment – Rate 9.8%

3)      Hourly Earning – Plus .2 month on month

4)      Average Work Week – Minus .2

As we have been talking about, the weather is going to make a mess of the numbers.  We expect continued job losses in manufacturing, construction, and private services payrolls.  Construction should be hit the hardest, probably losing another 50K.  Consensus workers are a wild card as the government is expected to ramp up hiring, adding 1.2 million short term workers over time.

Using one standard deviation and a dart board, our bias is for 100k in job losses and a 9.9% unemployment rate.  JPMorgan has the call at minus 90K and 9.9%, Barclays at Minus 75K and 9.8%, Wells Fargo at minus 80k and 9.7%, and Credit Suisse the outlier at minus 125K and 9.9%.  If there is a miss, it will be towards more job losses than less.  You may recall that I wrote about John Ryding call that job losses would be minus 250K.  Don’t know if he is right but I do know he’s a pretty sharp dude.  What will the market do?  Most likely blow the numbers off due to distortions in the weather but trade nonetheless in a volatile fashion.  Once the dust settles, we would expect that pricing will be close to today’s levels “unless” the number is below expectations.

Let’s say we see a -25K or unchanged print.  We feel the market would interpret that to be much better than expected once you factor in the weather distortion.  Really, this one is a crap shoot.  Technically, we’re not getting much help as the 10 year note chart has formed a triangle pattern on the daily time frame.  We would need to close below 3.45% to turn this into a raging  bull (currently 3.61%) so not much help there.  Triangle patterns typically wind themselves up, tighter and tighter before a break out occurs.  Given the distance in basis points for a bullish outcome, we would side with a break out to higher yields/ worsening mortgage pricing to coincide with the ending of the short squeeze in the MBS market.  To put this in English and cut to the chase, be careful out in the days ahead.

The market was doing just fine until the headlines broke the minutes of last month’s FOMC meeting (Fed Open Market Committee).  The “Street” didn’t take kindly to comments regarding treasury asset sales, consideration of a .25 bps hike in the Discount Rate, and a general hawkish tone once they can determine that a recovery is “self sustaining”.  The “headlines” unnerved traders, causing the 10 year note to drop ½ point in minutes.  Although the 10 year and mortgage backs are set to close on the weak side, major support held.  We are closing below the 21 day moving average for the first time since January 12^th, a not so good sign.  We need to be careful here as any close above 3.79% on the 10 year note will set a bearish trend in motion (currently 3.74%).  For now, we are just testing the bottom of the range with sellers holding an edge.  Best to stay defensive into tomorrow morning’s Weekly Claims release and PPI (inflation at the wholesale level).

Related articles

• FOMC Minutes: Market Watchers React (blogs.wsj.com)

Earlier today, Personal Income/Spending hit the tape plus .4% and plus .2%, slightly better than economists had predicted yet not anything to write home about.  Construction Spending was another story, falling 1.2% versus the minus .5% many were looking for.  Cold weather and competition from a heavy inventory of distressed/foreclosure sales has done the trick once again.

The ISM Index (Manufacturing) surprised to the upside, putting it its best number since August 2004 (plus 3.5 points to 58.4).  Digging deeper into the numbers, most of the gains came from new orders as inventories need to be rebuilt.  The question now becomes, will buyers step up to take the newly produced goods off the shelf?  Time will tell.

President Obama’s projected budget sets a new record deficit (1.516 trillion in 2010) as the new budget looks to be 3.8 trillion.  Bailout costs for FNMA and FHLMC alone will be 153 billion.  Wow.

Technically, note, bond, and MBS structure are in neutral as follow through to the upside (rally) is not in the cards.  Bulls need the 8 day moving average (currently we’re sitting on it) at 3.65% to hold.  We expect that area to hang in there into tomorrow.  Traders will then make a move, one way or the other, on Wednesday and Thursday to hedge positions up for Friday’s Employment Report.  Tough one to handicap as predictions on Nonfarm Payrolls and the Unemployment Rate are all over the map.  Cautiously optimistic is the best we can come up with.

Traders were expecting the same old, same old and got sideswiped by the hawkish detail I just mentioned.  This one is a tough call, trying to figure out if it’s the beginning of a tightening cycle or the Fed’s way of testing the market towards removal of accommodation (stopping the Treasury/MBS purchase program, etc.)  With so many cross currents it’s tough to remember who’s on first.

I can tell you from a technical stand point that the market put in an outside day down, including a test of the best levels we’ve seen since November and then failing.  The rejection from the top and outside day down are strong indicators of a market top in the making.  This does not mean that the consolidation we expect will be huge, just that it has a very high probability.  Given the fact that the 8 day moving average held, sellers will need to trade the market above 3.65% for a sustained period of time to do any real damage.

For now, the brackets to watch are 3.65% to 3.57% (we are set to close right at 3.65%).  Anything outside these parameters to the high side is bearish for interest rates and below 3.57% is bullish.  Given the uncertainties on so many fronts, you should expect the unexpected right along with volatile trading and mortgage pricing.  Hopefully, the State of the Union Speech will give us a little help.