Fed rate cut to come

Wednesday, December 05, 2007

ECONOMIC DATA / NEWS

Economists are now speculating that the Federal Reserve may cut their discount rate, the rate they charge to lend to banks directly, by even more than the Fed funds rate when they meet next Tuesday.  Vice Chairman Kohn and San Francisco Fed President Yellen recently gave speeches advocating more assistance by the Fed to the credit markets.  A .25% to .50% cut is already assumed, but the markets are starting to factor in an extra .25% cut in the discount rate.  For instance, if the Fed cuts the Fed funds rate by .25%, they would cut the discount rate by .50%.  The gap between Fed funds and discount rates are usually one percent, but that difference was chopped in half back in August.  This could be not just a catalyst allowing lenders to lower their rates more, which have already improved quite a bit over the last three months, but to possibly consider easing requirements on certain loans.

The ISM index for the services sector was slightly below forecasts, but not enough to shake up the markets.  The index came in at 54.1 last month versus 55.8 in October.  Job growth in the services sector was slower, which is congruent with economists’ forecasts that job growth slowed in November.

However, the ADP employment estimate is contradicting those predictions.  They have pegged job growth at 189,000 last month, which would beat other estimates by about 100,000.  ADP has been known to be ridiculously wrong in the past, so we’ll take it for what it’s worth.  When all the other indexes are showing slower job growth, this projection seems a little far fetched.  Nevertheless, it does put that shadow of doubt in traders’ minds that maybe the economy isn’t as weak as everyone has been saying.  This has be a partial reason for the stock market rally, adding to the excitement of expected rate cuts, which are also expected to boost the economy in the long run.

Other news putting confidence back into stocks is Fannie Mae’s announcement that they are going to issue $7 billion in preferred stock to raise capital to keep the company liquid.  This should free up money for other lenders as well, now that Fannie Mae will have additional funds to buy mortgages from other banks.  Fannie Mae will also slash their dividend, thereby preserving more money.  Both of these moves have also boosted the companies stock due to the perception that it will create more opportunities to increase profits.

TECHNICAL ANALYSIS

MBS prices made some very late gains yesterday, but they dipped early this morning.  The FNMA 30-year 6.0% is only down 3bp at 101.72, which keeps it above the sharp upward trend line.  However, the stochastics have soared deep into overbought territory, and they are on the brink of crossing downward, indicating that upward momentum is decreasing.  Prices will probably get pulled back to the 10-day moving average, and that could create a drop of 30bp.  The short-term upward trend line generally becomes much more susceptible to breaks after a couple of weeks.  We’re just reaching that time frame, so we do need to watch out for sudden price declines.

Treasuries are not up too much, relative to some of the wild trading that we’ve seen recently, but the 10-year yield did pop up to 3.94% at the market’s open.  Fortunately, it has not climbed much beyond that and has flirted with dipping back under 3.92%.  The 10-day moving average remains a strong resistance.  But, we do have to be cautious since the stochastics have lingered in overbought territory for close to two months.  If resistance holds though, the yield could see late day downward movement, which would probably carry through to tomorrow.

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