I know its a bit long...but read this post top to bottom.

Vic provided a pretty good outlook on mortgage rates heading into tomorrow's ADP report and Friday's NFP release. We are indeed at a crossroads....a strong employment situation report would essentially confirm a month's worth of weakness in the bond market, thus putting a firm layer of resistance under the rates market, making mortgage rates under 5.00% a thing of the past.

MG and I have had a few debates about this outlook today. What's funny is, it turns out that we actually didn't disagree on anything, we just didn't understand each others point. I blame him...(haha joke!)

We were finally able to come to the realization that we were on the same page after revisiting a post written on Victor's blog in late December: ATTENTION FLOATERS AND FENCE SITTERS: MND MORTGAGE RATE OUTLOOK

Basically what we did is put percentage chances on events in the rates market. Note: these are forecasts for Q1 2010. Not beyond.

Here is the outlook:

  1. HOLD STEADY OR MOVE HIGHER: Rates could fall briefly only to rebound back to current levels or even higher. Either way, mortgage rates would bounce around a new, higher costing range. This would occur because economic perceptions were optimistic. This is a favorite for early 2010. After several months of choppy growth, the market is beginning to believe "the worst really has been avoided". If economic activity continues to show signs of improvement (even if its scattered), the bond market will take the "better than expected" side of the trade and mortgage rates would creep into the 5's and maybe even test the 5.50 level (at best). This is if the OPTIMISTIC perception grabs hold of headlines. This category also includes an outlook with no brief recovery. 55% chance in short run.  75% in Q1 2010*
  2. CORRECTION BACK INTO RECENT RANGE: Rates could move back into the range we enjoyed from August to December, and stay there (4.50 and 5.00 at best). If this occurs, it will likely be a function of continued economic uncertainties. In the short term, a few more New Home Sales like reports would help rates fall at least towards six month averages. After that, in order for the recent rates range to be revisited for an extended period, we would expect to see mixed economic messages via volatility in monthly economic reports. Very similar to what we've experienced over the past five months. The Fed also plays a huge role in this theory. Their rhetoric must continue to fight off inflation hawks with strong dovish verbiage (dovish = low rates), or number #1 will be even more likely. If you are looking to close in January, this outlook is viable, especially if the recent rates sell off was over dramatized by very light trading conditions. 45% chance in short run. 25% in Q1 2010*
  3. A DOUBLE DIP FLIGHT TO SAFETY. This is very unlikely early on in 2010, so don't get your hopes up for an immediate recovery rally that sets new all time lows. In 2010, it is possible that rates could completely recover all lost progress and move back towards record lows, but only if the economy takes a major turn for the worse. This is not something we expect to see early in 2010. This outlook is less likely to occur if the market is focused on short term growth spurts. Over the long haul, most economic activity is just now stabilizing, right above record low levels. <1% chance in short run. <1% chance in Q1 2010* 

*Read  "% chance in Q1 2010" as the likelihood of the scenario being the dominate theme of Q1 2010.

This commentary is still very relevant.

In the short run....for almost the entire month of December, the bond market  reflected the "worst is behind us" perception. Long term Treasury yields moved considerably higher in a very short time frame all while stocks  set new 2009 index highs (after the November NFP report). This bias towards higher rates was however not confirmed by any strength in the market because price action was distorted by light (thin) trading conditions. Thus, the market did not provided a clear outlook for rates heading into 2010....it only provided hints.

That is why the short term (early 2010) chances of rates holding steady at recent highs (or rising) and rates returning to the 5-month range were so close. 55% chance of holding steady or moving higher. 45% chance of rates moving back into the 3.27-3.50 range that moderated directionality from August to December.

This is where the crossroads that Vic wrote about comes into play.


We will get some serious feedback on that question throughout the course of this week. The "better than expected" perception will be put to test starting tomorrow morning when ADP Employment data is released at 830am. After that FOMC minutes, ISM Non-Manufacturing, Jobless Claims....and then

The grand poohba of 'em all on Friday morning: NON-FARM PAYROLLS!

Plain and Simple: in the short term, no bias has been confirmed. There is a 55% chance that rates hold near current levels or move higher. There is a 45% chance that 10s rally back towards 3.50% (with 3.62% being a KEY pivot point). This week's econ calendar will either confirm or reverse the recent bearish bias in the bond market.

As for later in the quarter...we still both agree that rates will be moving higher. We were 75% sure of that....

Looking past Q1 2010...there are a TON of uncertainties that might make us extremely WRONG.  The devil (logic) on my shoulder can't help but call attention to WEAKNESS IN HOUSING though.

My trader side has been battling my economist side over this dilemma for the past month. I KNOW that housing is in trouble, but I also KNOW that the US government has super-sized borrowing needs which might eventually crowd out private borrowing. I also know that the marketplace has proven itself more than happy to trade the PERCEPTION of stabilization. While I do not believe a 'double dip' is possible in Q1 2010....I do think weakness in housing could lead the markets into another downturn later in the year. Structural inefficiencies have not been appropriately dealt with...there are many "issues" the market may have to discount (price in) down the road. 

I just need to get that off my chest because I dont think I made that sentiment clear. For the time being, we need to see if the past month of bearish behavior in the bond market will be confirmed by data and events this week.