Interest Rates Are Headed Lower

Interest rates are headed lower. That is a volatile statement with no caveats, but all signs point to it. Deflation in commodity prices, a weak housing sector, economies around the world dancing on cliffs, the dollar getting stronger - and the US stock market is increasingly vulnerable to more selling. Late yesterday Amazon blew the doors off forecasts showing a profit while expected to continue the quarterly losses. Today even the NASDAQ couldn’t hold up on that strong report. So far quarterly earnings and forward guidance haven’t lit any fires. Global equity markets declining; this week our key indexes took hits.

So why has not the bond market improved? Well it has, a nice decline in the 10yr this week, with MBSs following along but so far most of the movement has been into treasuries. The last three days have been light on volume - it is the FOMC meeting next week keeping some order in markets this week. No inflation, in fact it is slowing as prices fall, goes squarely against what the Fed wants to see. The Fed is scared to death, the markets too naive to understand the potential risks (at least based on what we hear constantly from those that are brought out in the media).

There is way too much faith being put on the Fed now. History is replete with its miss-cues. The most recent, Greenspan, a so-called business economist because he was employed by many large corporations, could not see the disaster coming with 100% mortgages, liar loans and subprime loans that would never have been made prior to 2001. Bernanke and Yellen hiding behind Fed speak. The Fed never has done a massive QE to take control of the economy, now with absolutely no historical guidance Fed officials think they know what to do? Not likely, and under the surface they realize it; increasing the FF rate is a huge gamble. Next week’s policy statement, always a critical commentary, will be even more so. If the Fed still wants to begin lifting off in Sept it better have an explanation why as deflationary pressures are building and any rate increase expected will only exacerbate the situation and add more headwinds for our economy as the dollar strengthens on any increase while the rest of the world is increasing QEs.

In summary, it has been a nice week for bonds and borrowers.  Right now, I am still letting people know that unless you are closing in the next 15 days, keep floating, but remember to keep your hand on the trigger as we are still in a volatile state.  With the FOMC next week Monday may see selling in the bond and MBS markets, although that would not change my current bullish view. The Wednesday afternoon policy statement should keep things relatively quiet until then.