Market Review
August 2008

After a short climb in the latter part of July, rates are once again moving lower, albeit in a volatile fashion. With the Fed message mixed once again (both a deterioration in economic growth and a pick-up in inflation are of concern) bonds are left watching fear in the stock markets and profound weakness in the job market. The Fed expects (hopes for?) a moderation in inflation pressures going forward, which would give them more wiggle room on overnight rates. But, notwithstanding a somewhat more dovish Fed statement on the whole at the latest meeting, the hawks are certainly circling.

After climbing above 4.25% in June and peaking back above 4.10% recently, the 10-yr treasury yield has dipped back below 4.00%. An early release on the July employment figures on August 1st, showing further job losses and another increase in the unemployment rate, was followed the next week by another spike higher in initial unemployment claims. The Conference Board’s consumer confidence index actually showed a slight rebound in July, but this more likely is attributed to a decline in gasoline prices than a general impression of economic improvement. Most manufacturing and economic growth indices continue to hover near their break-even points and core inflation readings remain relatively tame.

On top of a confusing economic picture for bonds is a somewhat clearer picture for the GSEs: namely, that their losses are mounting. Freddie Mac recently released results of a brutal quarter and equity prices for both Fannie and Freddie continue to fall. In some cases, loans closed in early 2007 are beginning to show poorer results than ones closed in 2006, meaning underwriting standards were still quite loose at that point and that housing market likely still has a ways to go before bottoming out. In another effort to re-price the risk of current originations, Fannie Mae announced an additional .25% “adverse market” price hit to all loan purchases and, presumably, Freddie will soon follow suit.

And so it goes: every two steps forward is followed by at least one step back. Just think, we’ll soon be able to add the November elections to the list of tough-to-define issues facing bond and mortgage markets. – Lindsay Hill