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Bond traders are not idiots.

I’ve blogged about this before.  People that invest in the bond and stock markets tend not to be completely stupid, in my experience.  They do listen to CNBC.  They do read the paper.  They’re not unaware of what’s going on in the markets.

Everyone knows, for instance, that the Fed is going to phase out its purchase of mortgage-backed securities (MBS – it is these securities that lenders use to set their mortgage interest rates).  Everyone knows that this phase-out is set to occur on or about the end of March.  Today, Fed Chairman Ben Bernanke announced that the phase-out would be dependent on “the markets”, by which he presumably meant the homebuying markets as well as the bond and stock markets.  In today’s testimony he gave no indication that there would be a dramatic, one-day-we’re-buying-the-next-we-aren’t cessation, and in fact he reaffirmed that the Fed would still be willing to buy MBS to keep interest rates low.  But he also left intact the plan to stop buying, and sooner rather than later.

So…why aren’t we seeing a dramatic selloff in bonds?  Are traders deaf?  Are they insane?  I mean, if Toyota were to have a huge recall of its cars (I know, like that would ever happen) and suddenly start bleeding money, its stock would fall like a rock.  Oh.  Wait.

Similarly, if one knew ahead of time that a dramatic decrease in the available purchase demand was in the offing, wouldn’t one be selling ahead of a price decline?  Well?

Unless something weird happened in the last five minutes while I’ve been writing this, I think we have three things at work here that are currently more powerful than anything the Fed does, at least as regards the bond market, and, by extension, mortgage interest rates.

  1. The homebuyer credits.  Uncle Sam has decided that handing over fistfuls of cash to people in exchange for them buying houses is a good idea.  At least, it’s a good idea for another couple of months (see full details on the homebuyer tax credits here).  That is, no question, stimulating demand for housing and for mortgages.  That is firming home prices, and that firming holds out hope that there won’t be an eventual half of all homes in foreclosure (the best predictor of impending foreclosure is home equity – the more, the better).  As fewer homes are in foreclosure, the mortgages that back those securities have more value, meaning that MBS are worth more.
  2. The economy sucks.  Yeah, yeah, GDP is roaring ahead by 6%.  Whatever.  Anyone believe that number?  Anyone?  Bueller?  Look, until people start being hired, and the hemorrhaging in the job market stops, no increase in nominal GDP – even assuming, for a moment, that the government figures didn’t begin with “once upon a time” – there is not going to be enough strength in the “recovery” to have any measurable impact on anything.  Bad economy=bad for stocks=good for bonds.
  3. And finally, the big one – we all know that Bernanke isn’t really in control of anything.  What year is this again?  Oh, right, it’s 2010.  Let’s see…even numbered year…ratcheting up of commercials…huge increase in bloviation from Washington…AH!  That’s it!  It’s an election year.  The party in power is reeling from a series of straight jabs to the jaw along the once-reliable East Coast, and that increases the pressure on the DC elites to make sure the economy isn’t getting observably worse coming into November.  Think the Fed will be increasing interest rates in the late summer?  Pardon me, I’m going to have to get some supplementary oxygen from laughing so hard.  Traders know who is really calling the shots in the financial system, and it isn’t Tim Geithner, nor is it Ben Bernanke.  Any serious fiscal responsibility will have to wait at least a year.

Result?  No big selloff in bonds at this point.  No big moves in any direction.  Traders are waiting for #3 to move before they do.  Another stimulus (this time, it’s Stimulus III – The Jobs Bill) is possible, even likely, and that will change things.  There is a gigantic overhaul of the entire financial system stalled in Congress right now, but it could get legs again now that health care appears too politically toxic.  That also would dramatically change things.

Not being a prophet, I can’t tell you what will happen in April.  Perhaps we’re in for a (long-overdue) spike in interest rates.  But me?  I’m not betting that way.  And neither is Wall Street.

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  • http://avcap.net/ Insurance

    hehehe.. really like the jack table pic

  • http://www.inman.com Matt Carter

    Uh, you need to read Bernanke’s testimony.

    He did say that a lot of the tightening the Fed is contemplating will depend on whether or not signs of inflation emerge.

    But Bernanke was clear that the Fed expects to wrap up $1.25 trillion in MBS purchases by the end of March, as scheduled.

    http://www.federalreserve.gov/newsevents/testimony/bernanke20100210a.htm

    The money that’s been allocated will run out, and the purchases will just stop.

    They Fed only needs to buy up $9 billion in MBS a week for the money to run out by the end of March, compared to the $23 billion in weekly purchases they were averaging most of last year.

    http://www.calculatedriskblog.com/2010/02/fed-mbs-purchase-program-95-complete.html

    Bernanke and NY Fed President William Dudley have said they might start the MBS purchases up again, but only if the SHTF.

    http://www.pbs.org/nbr/site/onair/transcripts/ny_fed_chief_william_dudley_100113/

    Bernanke also said one way the Fed will tighten monetary policy, when the time comes, is by SELLING MBS.

    Fannie and Freddie are about to buy up to $200 billion in 120+ delinquent loans out of MBS and pass-through pools, so that may cushion the impact of the Fed wrapping up its MBS purchses.

    http://business.theatlantic.com/2010/02/what_will_investors_do_with_200_billion_from_fannie_and_freddie.php

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  • http://www.lehilender.com Chris Jones

    Matt, thanks for the comments. You’ve done your homework, and that’s rare.

    I did read what Bernanke said. I just don’t believe any of it. Well, okay, I believe it in the sense that I believe that HE believes it, but I don’t believe, when push comes to shove, that he’s going to do what he said he will do. The money only runs out if Congress wants it to. If, when the money runs out, rates spike to 6%, what are the odds that Congress will allow that? There is always more money, as long as the printing press is still located in the very pretty building just to your left as you cross the 14th Street Bridge.

    I think rates will rise. I always think rates will rise. But I don’t think inflation is a problem as long as 20% of the country is out of meaningful work, and until that problem is fixed – and no jobs bill will fix it – then I continue to believe we’re going to be sitting pretty close to where we are now for a good long while.

    As always, I could be wrong. I often am.

  • http://www.inman.com Matt Carter

    Hmmm… you do understand that Congress doesn’t tell the Fed what to do? They can take away (or expand) the Fed’s power, but it’s the Fed’s board of directors that determines policy.

    You may have noticed that the Senate last month confirmed Bernanke to another four-year term as chairman of the board.

    Unless and until Congress strips the Fed of its considerable power, your claim that “Bernanke isn’t really in control of anything” (put forward in your original post) suggests a lack of understanding on these points.

    Congress DID authorize the Treasury to buy a smaller amount ($220 billion) of MBS in 2008 under the Housing and Economic Recovery Act (HERA). That program was completed at the end of the 2009.

    http://www.ustreas.gov/press/releases/2009122415345924543.htm

    If Congress wants to provide further support for mortgage markets, it could pass another bill like HERA directing Treasury to buy more MBS.

    The Fed, which likes to telegraph its actions in order to not take investors by surprise, has been saying for months that it will wind down its MBS program at the end of March.

    It would take a major crisis for the Fed to reverse itself at the March 16 meeeting of the Federal Open Market Committee.

    As noted above, the Fed could always restart its MBS purchases if needed.

    BTW, I agree with you that the Fed is in no hurry to raise short-term interest rates, but that is an entirely separate issue.

  • jacksmith

    This is great blog, huuuu i want to say that we have three things at work here that are currently more powerful than anything the Fed does, at least as regards the bond market, and, by extension, mortgage interest rates.
    jacksmith
    thanks
    ………………….
    Compare Mortgages

  • http://www.inman.com Matt Carter

    Bernanke, testifying to House Financial Services Committee today (Feb. 24):

    “It is true that we will stop buying new mortgage-backed securities at the end of this quarter but we will continue to hold $1.25 trillion dollars in agency mortgage-backed securities and taking that off the market in itself will keep mortgage rates below what they otherwise would be. So, we believe that there will still be stimulus coming from our holdings of those securities as well as our low interest rate. So, we think the economy, as opposed to the money markets for example, still requires support for recovery.”

    http://www.reuters.com/article/idUSTRE61N4IH20100224

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    you really add great contribution on the discussion Matt

  • http://www.inman.com Matt Carter

    Fed says it will wind up MBS purchases as planned.

    http://www.federalreserve.gov/newsevents/press/monetary/20100316a.htm

    Economists at the Mortgage Bankers Association are forecasting rates on 30-year fixed-rate mortgages will rise to an average of 5.4 percent during April, May and June and 5.8 percent in the final three months of the year. MBA economists expect the 30-year fixed-rate loan will average 6.2 percent in 2011 and 6.4 percent in 2012.

    http://www.mbaa.org/files/Bulletin/InternalResource/72219_.pdf

  • http://billeater.com/compare/mortgages Compare Mortgages

    Congrats to whoever photoshopped the BlackJack table! That’s exactly how some of us feel about the whole situation :) Love this blog for being a little bit irreverent…

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  • http://www.landscapingwithrocks.net/ Landscaping with rocks

    Uh, you should read the testimony of Bernanke. He said that much of the intensification of the Fed is contemplating will depend on whether or not there are signs of inflation. But Bernanke was clear that the Fed expects to conclude 1250000000000 dollars in purchases of MBS in late March as scheduled. ttp: Money has been allocated will be exhausted, and only stop shopping. Fed They only have to buy up to $ 9 billion in MBS to a week for the money runs out end of March, compared with $ 23 billion in average weekly purchases were more than last year. ttp: Chairman Bernanke and NY Fed, William Dudley has said he would begin buying MBS again, but only if the SHTF. ttp: Bernanke also said one way for the Fed to tighten monetary policy when the time comes, is through the sale of MBS. Fannie and Freddie are about to purchase up to $ 200 million in 120 + delinquent loans and MBS pass-through pool, so it can cushion the impact of the Fed ending their Purchse MBS. ttp: / / Business. I have never thought that surfing online can be so much beneficial and having found your blog, I feel really happy and grateful for providing me with such priceless information.

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    Uh, you should read the testimony of Bernanke. He said that much of the intensification of the Fed is contemplating will depend on whether or not there are signs of inflation. But Bernanke was clear that the Fed expects to conclude 1250000000000 dollars in purchases of MBS in late March as scheduled. ttp: Money has been allocated will be exhausted, and only stop shopping. Fed They only have to buy up to $ 9 billion in MBS to a week for the money runs out end of March, compared with $ 23 billion in average weekly purchases were more than last year. ttp: Chairman Bernanke and NY Fed, William Dudley has said he would begin buying MBS again, but only if the SHTF. ttp: Bernanke also said one way for the Fed to tighten monetary policy when the time comes, is through the sale of MBS. Fannie and Freddie are about to purchase up to $ 200 million in 120 + delinquent loans and MBS pass-through pool, so it can cushion the impact of the Fed ending their Purchse MBS. ttp: / / Business. Well, some people who understand a lot about film think the film is good enough to deserve the awards. Don’t be too narrowed when it comes to art.

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