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Interest Rates Today

Current Trend Direction: Sideways to Higher

Risks favor: Carefully Floating into the Fed

Current Price of FNMA 3.5% Bond: $101.06, +31bp

The votes are in, and the Republicans have taken control of the House of Representatives, while the Democrats have retained control of the Senate.  And this could spell a very interesting “lame duck” session over the next few months, and even more interesting term ahead for the new balance of power.  Businesses and consumers alike have been feeling a great deal of uncertainty about legislation – both already passed and pending – and the corresponding impact on the economy.  And the anticipated gridlock that may occur over the next several years doesn’t necessary inspire confidence on either side of the ticket, in terms of what it will mean for Wall Street and Main Street alike.  We also think it’s likely that some of the ousted politicians will attempt to be quite active over the next few months during their “lame duck” session, while the Democrats still retain control over both the House and Senate.

But don’t relax yet, the heavyweight news week is far from over!  It’s Fed Day once again – and the Fed is expected to announce the details on their next round of Quantitative Easing.  While the details will become more clear – the debate over the wisdom of QE2 is likely to continue, with widespread dissention of opinion in the market at large, and even within the Fed chambers.

So what is the market anticipating as far as the announcement?  The Fed doesn’t like “shocking” the market, so in various comments and speeches over recent weeks, Fed members have led the market to believe that they will purchase around $500B in Treasury Securities over the span of six to eight months, but will likely leave the possibility open for tweaking of this purchase plan as needed.  Remember Bernanke’s comment about a golfer trying to learn how to use a new putter?  They’ll definitely want to leave the door open for some flexibility – but it reeks a bit of some uncertainty as well.

If $500B over 6 to 8 months is indeed announced, the Bond market may breathe a sigh of relief for getting what was anticipated, and we could see Bond prices push higher short-term and attempt to test the all-time highs.  Now remember, the Fed does read the paper and watch the news – and most certainly knows that the market is expecting $500B – so it is quite likely the Fed would have made comments to correct that assumption if it was off-base.  It’s kind of like playing that old game as a kid – when you hide something, but help the seeker find it by saying “warmer, warmer, no, now colder….OK, warmer, warmer….hot, hot, HOT!”  The Fed can’t leak the news, but they sure have broadcasted enough hints…and their recent silence indicates to us that they think the market has speculated correctly indeed, and we see Bonds getting a temporary lift on the news.

But longer-term, it is tough to gauge the negative unintended consequences that could come with another round of QE – and let’s not forget about the accumulation of more government debt.  The threat of serious inflation and further devaluation of the US Dollar could prove to be headwinds for long-term rates – including home loan rates – down the road.

So why do QE2?  Advocates of QE2 expect lower interest rates to help areas of the economy that are interest rate sensitive, like refinances, home purchases and business expenditures.  We agree that lower rates can stimulate some activity in these areas – but we also believe that consumer and business demand would be more positively influenced by a boost in confidence, which can only come from a greater degree of certainty in the economy and labor market…something that has been sorely lacking for quite some time.  And it remains to be seen how the brand new political mix will be able to boost confidence.

A big immediate benefit of QE2 could be further devaluation of the US Dollar, which would help boost exports and thereby raise our Gross Domestic Product (GDP).  GDP in the most recent Quarter is running at 2%, and is expected to run near that level for the next couple of Quarters.  This means that unless GDP does get a boost, we will not see any significant decline in the unemployment rate in the near future…as GDP needs to run at 3.5% or better to create a meaningful amount of jobs.

Last but certainly not least – we got a look into the labor market this morning, when the not-always-reliable ADP Report showed 43,000 private jobs created in October, above the 23,000 that was expected.  ADP also revised September’s number of -39,000 to only -2000.  This was a modestly positive report that is somewhat inline with the 60,000 private job creations expected to be reported within the official Jobs Report this Friday…but more on Jobs tomorrow as we lay out our strategy headed into Friday’s release.

We will continue to Float and would like to do so into the Fed announcement, given our expectations.  Once the Statement is released, we will follow the knee-jerk reaction in Bonds, and will Alert you of any significant changes.

Mike Harper
Private Mortgage Banker
Bankers Funding Company, LLC


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