MBS being hit very hard this morning

Friday, December 21, 2007

ECONOMIC DATA / NEWS

Consumer spending in November rose by 1.1%, its biggest monthly gain in 3 ½ years.  But how will the markets receive this data.  The first thought that comes to mind is that it is one more reason for the Fed not to change their rate in January.  That has been the biggest fear of investors, and it could actually cause a sell off in stocks.

The other major report today is the core PCE price index, which is the Fed’s preferred measure of inflation.  It rose by .2% in November, matching economists’ forecasts.  Although not an overwhelmingly high increase month-over-month, it pushes the rate over the last year to 2.2%.  Inflation has come back into focus, since a flare up in consumer prices would be grounds for the Fed to pause their rate cuts.

Aside from the economic conditions that might prompt stock market selling, we also believe that traders will be closing stock positions as we head into Christmas week.  It is also common for traders to want to start fresh in the new year, so we anticipate a decline in the stock indices over the next week.

And Merrill Lynch is the latest financial firm to consider a partial sale to a foreign investor.  They could get $5 billion from Temasek Holdings in Singapore.  The deal has not gone through yet, and there is limited information on the discussions between the two firms.  The story was leaked by an inside party, and spokespeople from the two groups have declined comment.  It would certainly help subsidize the $8.4 billion in writedowns that Merrill has already taken, but the company is expected to sustain heavier losses due to their $27.2 billion exposure to subprime loans.

TECHNICAL ANALYSIS

It’s not the ideal start to MBS trading, but at least the decline has been muted.  The FNMA 30-year 6.0% is only down 9bp at 101.28.  They are within 7bp of the 25-day moving average, but that has only served as a moderate support level at best.  In the face of a strong stock market though, the dip is not too bad, and it could lead to a solid rally if the stock market does pull back as we expect.

The Treasury bond change is actually rather encouraging.  Although it jumped to 4.08% almost immediately after trading opened, the yield has not moved much in response to the stock market gains.  Presumably, most of the Treasury losses came in anticipation of the stock market surge.  Like MBS, if stocks fall later in the day, there should be a significant improvement in the yield.

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