Tuesday, August 11, 2009

The trading day got off to a mortgage market friendly start when the Labor Department announced that productivity rose at its fastest pace in six years during the second-quarter.

Productivity, a measure of how much an employee produces for each hour worked, rose 6.8% during the previous three-months, much stronger-than expected and well ahead of the 0.3% gain during the first three-months of the year. The surge in worker productivity drove unit labor costs, a gauge of inflation and profit pressures closely watched by the Fed, 5.8% lower to its lowest level since the second-quarter of 2000. Solid gains in productivity with wage pressures solidly in check will keep a lid on overall inflation - and that is certainly a condition that tends to be supportive of steady to perhaps fractionally lower mortgage interest rates.

Unfortunately for those looking for a strong rally in the mortgage market today-- the economic news is only one-part of a three-part story.

The initial improvement in mortgage interest rates spawned by friendly news from the labor sector is being curbed by lingering concerns over the reception Uncle Sam's record setting three-part $75 billion auction will receive this week. The Treasury Department will kick things off with a $37 billion auction of three-year notes this afternoon. This offering is the biggest for this particular security ever. The yield on this security has climbed notably higher since the last auction in July - which should serve to increase the general attractiveness of this offering to domestic and foreign investors alike. If so, this event will likely produce little visible effect on the current level of mortgage interest rates. A poorly bid auction today will ramp up investor anxiety regarding the outcome of tomorrow's $23 billion 10-year note offering and Thursday's $15 billion 30-year bond sale. As you well know, nervous mortgage investors tend to push mortgage rates higher - not lower. I'll post the results of today's 3-year note auction as soon as possible following the conclusion of bidding at 1:00 p.m. ET.

Last but not lest -- the members of the Federal Open Market Committee have gathered in Washington for a regularly scheduled two-day meeting. There is a lot of chatter in the marketplace about the likely outcome of policymakers' deliberations. Central bankers are broadly expected to leave their benchmark short-term interest rate (fed funds) at 0.0% to 0.25% -- the range that it has been in for months. In their post-meeting statement the Fed will likely give a nod to signs the recession is beginning to wane -- but Mr. Bernanke and his fellow committee members will likely unanimously warn that the recovery will probably be painfully slow. All of those assumptions are already priced into the mortgage market.

The pivot point of tomorrow's post-meeting statement from the Fed as far as mortgage investors are concerned is what, if anything, policymakers have to say about their plans to unwind their unprecedented intervention in the financial markets. If as expected, the Fed indicates they will not extend their direct purchases of Treasury obligations and mortgage-backed securities beyond the planned expiration at the end of September - the approaching retreat of a "big-checkbook" buyer from the credit markets may cause mortgage investors to shove rates fractionally higher. The Fed's post-meeting statement is expected to be released tomorrow afternoon at 2:15 p.m. ET.