Current Trend Direction: Higher

Risks favor: Floating

Current Price of FNMA 3.5% Bond: $101.59, +19bp

The Bond market continues to push higher in anticipation of another round of Quantitative Easing (QE2) by the Fed – with Mortgage Bonds hitting their best levels on record. The yield on the 10-Year Treasury Note was as low as 2.39%, it’s lowest level since January 2009, during the heart of the financial crisis.

After closing above key technical resistance levels yesterday, Mortgage Bonds are moving higher despite the slightly better than expected reading on weekly Initial Jobless Claims, as they fell 11,000 in the latest week to 445,000, and below the 455,000 that was expected. The 4-week moving average was 456,000, a decrease of 3,000 from the previous week. Continuing Jobless Claims fell 48K to 4.46 Million, but 4.12 Million people are claiming EUC (Emergency Unemployment Compensation) benefits for the week ending September 18th, which was an increase of 157K from the prior week…and more than erases the drop in Continuing Claims.

While the Initial Claims report was less than inspiring, and shows continued weakness after accounting for the EUC portion, it was better than expected. Additionally – the recent string of reports hints at stabilization within the labor market. This could mean that things are improving, albeit slowly. But it’s likely that the Fed will turn a deaf ear to any notions of potential improvement, as it appears they have their mind made up, and their hearts set on another trip to the printing press for more QE.

President Obama has signed HR 3081, the bill that extends the higher loan amounts for Fannie Mae, Freddie Mac and the Federal Housing Administration’s (FHA) multifamily programs to $729,750. These higher loan amounts will continue through 2011.

Alcoa unofficially kicks off earnings season for the 3rd quarter after the close of trading today. Stocks are trading near unchanged after the better than expected Claims report, and on expectations for another round of QE.

At 11:00am ET today, the Treasury will announce next week's size for the 2, 5 and 7-Year Note auctions scheduled for next Tuesday, Wednesday and Thursday.

Jobs Report Strategy

The momentum and direction of the Bond market is clearly with an upward bias for prices – and you don’t want to fight the momentum, whether it is right or wrong. In addition, tomorrow’s Jobs Report is very important – but the Fed seems to think this report is even more important than normal, with the report delayed a week to ensure greater accuracy. And let’s remember this is the last report before the next Fed meeting. There’s so much at stake with QE, and the Fed wants to have the most up to date information – as this report will have a lot of weight on their QE decision. That said and as previously mentioned, the Fed appears to be marching towards another round of QE, and will likely do so unless tomorrow’s Jobs number is a blockbuster.

One of the most outspoken and visible proponents for another round of QE is James “Raging” Bullard. Bullard will be on CNBC tomorrow morning upon the release of the Jobs Report, giving his commentary on the numbers. We already know that Bullard will try to color the results in such a way that supports his case for more QE. And Raging Bullard will also discuss his plan for less transparency in the amount of QE, as he would prefer to leave the amount “open ended.” Reading between the lines here – it’s clear to us that Bullard’s already on step two. In other words, the decision has been made for more QE already in his mind, and now he is attempting to push his agenda for an open ended amount of QE.

As you know – I have expressed reservations over and over about this, and feel that Mr. Bullard as well as others in the Fed may be taking some excessive risks that could manifest themselves into long term inflationary problems. Only time will tell how this all plays out.

When deciding whether to lock or float heading into the jobs report, we typically look at the more scientific approach, with Initial Jobless Claims, Payroll taxes, ADP figures, as well as technical factors. But this time we feel that the deck is already stacked. QE2 is coming, whether it is warranted or not, and whether we like it or not. And so our advice is going to be to accept this trend, with a bias towards Floating.

And while it is likely that we’ll see some price improvement, we must remind you of the old saying “Buy on the rumor, sell on the news.” I am growing more and more convinced that the next bubble to burst will be the Bond market. But just like previous bubbles that we’ve seen in Stocks and real estate…the ride higher isn’t over when it should be, or when it’s logical for it to take place. So for now – we’ll ride the roller coaster up in price…but be mindful that when this ends – and it will – it will end quickly and decisively.


Information provided by:
David Foley
Bank of America
david.foley@bankofamerica.com