Decoding Bernanke

Friday, August 31, 2007

ECONOMIC DATA / NEWS

There were a number of economic reports this morning, but the speech by Fed Chairman Bernanke topped any of that data.  Bernanke spoke on “Housing, Housing Finance, and Monetary Policy.”  It was essentially a history lesson on how the housing market has fluctuated and evolved over the decades, and how cyclical periods have affected monetary policy over the years.  One comment he made was that “It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions.”  But then he went on to say, “But developments in financial markets and have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining monetary policy.”  Those two statements seem contradictory to one another, because the problems that may (and probably will) arise in the economy are at this point going to be directly related to the issues in the housing market.  If we try to read between the lines, what he is really saying (whether he intended to or not) is that the Fed should not have to clean up people’s mistakes, but they are probably going to have to this time.

The immediate impact of his speech was a drop in bond prices, because at first glance it sounds like he is saying that the Fed is not going to help the mortgage market.  This was also compounded by the .4% increase in consumer spending, which was decent although by no means exceptional.  It was also in line with expectations, so traders should not have reacted too strongly to the report.  It is more likely that traders were reacting to the .5% gain in personal incomes, since it has been unusual for incomes to outpace spending over the last several years.  That could have filled people’s heads with the notion that the economy might have more staying power than many believe.

Inflation was also low in July according to the core PCE price index.  It clicked up just .1%, which was the same change we got in July.  However, with all the other controversy and problems surrounding future economic growth, the Fed has quickly swept the issue of inflation under the rug.

August’s Chicago PMI was almost identical to July’s reading, coming in at 53.8.  Of the three major regional manufacturing reports, Chicago’s has been the most accurate in predicting the national average provided by the ISM.  Since 50.0 is the boarder between expansion and contraction, you can see that manufacturing is still sluggish.

TECHNICAL ANALYSIS

Investors clearly didn’t like what they heard from Bernanke and the economic data releases, but after further assessment, the money is coming back to mortgage-backed securities.  Prices on the FNMA 30-year 6.0% had been down as much as 18bp, but they are now only losing 6bp from yesterday.  They have also jumped 12bp since 10:00 AM ET, which is getting close to a level that would prompt lender re-prices for the better.  The 10-day moving average seems to be propping up prices for now, but it is a weak support level at best.  The 200-day moving average is going to remain a tough resistance, at least until the Fed cuts the overnight lending rate.

The 10-year Treasury yield is a little worse off than MBS at the moment.  The yield shot to 4.55% rather quickly, and it continues to hang around this level.  We are still cruising along down the center of the downward trend channel, and it is providing additional strong resistance at 4.60%.

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