Tuesday, December 16th Mortgage Market Update

Mortgage Market Update

Both stocks and Treasuries made strong gains following today's stronger than expected Fed action. In late trading, the 10-Year Treasury Note was up by 2-11/32, lowering its yield by 25 basis points to 2.27%; the Dow was up by 359.61 points to 8,924.14; and the Nasdaq was up by 81.55 points to 1,589.89.

The FOMC unanimously decided to cut its target for the fed funds rate (the overnight borrowing rate between banks) to between 0.0% and 0.25%, meaning a cut of 0.75% to as much as 1.00% from its previous reading of 1.00%. The committee also cut the discount rate by 0.75% to 0.25%.
The policy statement acknowledged the weak economy, tight credit conditions, but low inflation pressures. It also said that the fed funds rate is likely to remain exceptionally low for some time. The committee also noted that it is ready to buy more mortgage agency debt and mortgage-backed securities if necessary and may purchase longer-term Treasuries as well.

Other options are also possible; the statement concluded by saying, "The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity."(FOMC STATEMENT)

Before the announcement, the stock market had been trading in the green but was given a boost by the rate news. The early gains came on news of a record drop in the Consumer Price Index last month. The other news of the day was not as stock-friendly. The pace of housing starts declined by the largest amount since March of 1984 to the lowest level on record going back to 1959. The rate of building permit issuance also fell to a record low.

The bearish housing news and a drop in the value of the dollar tied to the rate cut news weighed against oil prices. Although futures traders are expecting a hefty cut in oil production to be announced tomorrow from the Organization of Petroleum Exporting Countries, the price of a barrel of crude oil for January delivery fell by $1.02 on the New York Mercantile Exchange to close at $43.49. This was a third consecutive session decline totaling $4.49. Today's close was the third lowest for a front-month contract in almost four years.

In the stock market, the Dow gained 4.20%, the S&P 500 gained 5.14%, and the Nasdaq gained 5.41%. The Dow closed higher on the 8th of this month but today's was the second highest since November 7th. The S&P 500 and Nasdaq posted their highest closing levels today in over a month.
The Fed rate cut and reiteration that the central bank may decide to buy long-term Treasuries gave strong support to the long end of the market. The benchmark 10-Year Note yield closed at a record low as did the yield of the 30-Year Bond. The long bond's price rose by over 5 points today (5-09/32).

Tomorrow, the only major release is the report on current account for the third quarter. The current account balance is the difference between dollars leaving and entering the country. In addition to regular imports and exports, the data includes investment income and unilateral transfers (foreign aid and government pensions sent abroad), so the report is broader than the monthly reports on international trade of goods and services.

In the second quarter, the balance was a deficit of $183.1 billion, the largest in four quarters. A similarly sized deficit is anticipated for the last quarter.

The inflation news of the day was a plus for both the stock and bond markets and both made gains in early trading. But stock traders are also facing more bad news about the economy and a weaker than expected earnings report for last quarter from Goldman Sachs.

Though the fundamentals seem to favor bonds, Treasuries are currently mixed with the long end of the maturity spectrum holding modest gains. Bond traders are taking a cautious position in front of today's conclusion of the Fed's monetary policy meeting.

In today's economic news, the Labor Department reported that its Consumer Price Index (CPI), a gauge of inflation at the retail level, fell by 1.7% last month. This was the largest decline in the history of the data series going back to 1947 and supersedes October's previous record decline of 1.0%. Another large drop was expected due to falling energy prices but the actual decline was larger than the 1.3% that forecasters had predicted.

The major contributor to the decline was indeed in the category of energy. Due to falling oil/gasoline prices, the energy index dropped by 17.0% in November. This was a fourth consecutive monthly decline and the largest in the history of this data series going back to 1957. Another especially volatile category is food and its index rose by 0.2%, the smallest increase in eight months.

Excluding energy and food prices, the so-called core index was virtually unchanged (0.0%) in November. But of the non-core components, the energy-related category of transportation saw the biggest decline, falling by 9.8%. This was also the largest decline in the history of the data series going back to 1947.

The only other decline in the non-core sectors was a 0.1% drop in the housing price index. The largest increase was in the apparel price index with a gain of 0.3% following a 1.0% decline in October. The category of education and communication saw a 0.2% index increase as did the category of medical care.

On a year-over-year basis, the CPI was up by 1.1%. But the increase was the smallest since June of 2002. The core index was up by 2.0%, the smallest Y/Y increase since September of 2005.
The other major news release of the day was the report on housing starts and it was much weaker than forecasters had expected. The Commerce Department said the seasonally adjusted, annualized pace of new home construction plunged by 18.9% in November to 625,000. October's originally reported rate of 791,000 was revised down to 771,000. Not only was November's figure lower than the 730,000 that analysts had predicted, it was the lowest starts rate in the history of the data series that began in January of 1959.

The weakness was broad-based. The rate fell by 34.6% in the Northeast, by 23.1% in the Midwest, by 16.8% in the West, and by 15.6% in the South.

The outlook for near-term starts is also bleak. Today's report said that the pace of building permit issuance fell by 15.6% in November to 616,000 -- the lowest in the history of this data series which began in January of 1960.

The major event of the day will be the release of the Fed's latest statement on monetary policy. The Federal Open Market Committee (FOMC), the Federal Reserve's policy committee, concludes a two-day meeting today and most Fed-watchers expect the meeting statement to reveal another round of rate cuts to stimulate the economy and keep credit flows moving.

Because of the credit crunch and economic downturn, the Fed has cut the discount rate (the interest rate charged for loans directly from the central bank) eleven times since August of last year from 6.25% to its current 1.25%. The central bank's target for the more influential federal funds rate (the overnight borrowing rate between banks) has been cut nine times since September of last year from 5.25% to its current 1.00%. The rate is actually determined by the banks on a daily basis, but the Fed can adjust reserve levels to bring the rate into line with the target.

The Fed has also instituted numerous emergency programs to keep money flowing though the financial system. But even with all of the measures taken, further action is anticipated. Most observers are anticipating a 0.50% cut to both the fed funds target and the discount rate, bringing them down to record lows. Some forecasters are even calling for larger cuts of 0.75%. The bolder the action is, the greater lift it would likely give the markets. A less-aggressive move might have a negative influence.

The results of the meeting will be posted here when they become available . . . .