Fed meets today

Tuesday, September 18, 2007

ECONOMIC DATA / NEWS

The drop in oil prices last month brought PPI down by 1.4%, but the increase this month will probably bring it back up by a similar amount.  The more important core number rose just .2%, which met average expectations.  Consumer prices are considered the most relevant measure of inflation, but as long as producer prices stay low, there is a better chance that consumer prices will be low.  The CPI comes out tomorrow morning.  It does give the Fed one more factor to consider at their meeting today, and the low inflation measure allows them flexibility to consider a more aggressive rate cut of .50%.

That Fed rate decision will be announced at 2:00 PM ET.  Our forecast has been for a .50% cut to 4.75%, which would match the amount of their cut in the discount rate.  There is very little doubt that they will cut the rate.  The pace at which they will cut it has really been the only thing truly up for debate.  Their statement will also be listened to carefully, especially depending on how much they cut by this time.  There has been talk that the Fed may cut by 1.0% or more over the next six months to a year.  We’ll most likely be sending out some sort of update after the announcement, and it will be covered in more detail in tomorrow’s report.

Another issue that has moved toward center stage is foreign investment in U.S. securities.  Net foreign investments for July were just $19.2 billion, compared to $97.3 billion in the previous month.  Many European nations are struggling because they are too heavily invested in U.S. mortgage-backed securities, which have been going bad lately.  That has been a big cause of the scaled back foreign money.  If rates are lowered, then that will cut the difference between U.S. and other countries’ investment returns.  Foreign investors will start looking to those other countries that are going to provide a better return, even with the increased risk.  This could be a deterrent to cutting rates too far, but the prospect of a recession has to be at the front of most of the Fed members’ minds.

Oil prices hit a new high over $81 per barrel this morning, and that could also be fuel for the inflation controversy fire.  If adjusted for inflation, prices are still below prices from the early 80’s, which would have been close to $100 per barrel in today’s dollars.  Plus, if anything, higher oil prices could be another step toward the economy being pushed into a recession.  The Fed seems to have more reason to cut rates, than they have leeway to hold steady.

TECHNICAL ANALYSIS

The FNMA 30-year 6.0% is down 9bp at 100.25, but that just reverses the gains from yesterday.  Traders don’t want to be over-committed to any position until they find out what the Fed is doing.  We still have good support from the 200-day moving average at 100.12.  It is unlikely that prices would fall by more than 13bp regardless of what the Fed does, but if momentum was strong enough, it is not impossible.  As for a rally, there would be nothing stopping it for a good 75bp.

Treasuries have given up a little ground as well.  The 10-year yield is barely under 4.50%, which has held as a resistance for the last four days.  But unlike MBS prices, the 10-year yield is caught in a narrow range between 4.45% and 4.50%.  One of these levels should be broken once the Fed statement is released.

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