Tuesday, October 5, 2010

Look for the mortgage market to trade in a very tight range today as mortgage investors continue to speculate on the size of the Federal Reserve's quantitative easing 2.0 program. Some analyst have estimated the Fed will buy at least another $1 trillion of Treasury debt obligations while others have predicted the Fed will buy $80 to $100 billion between Open Market Committee meetings until the economy generates enough sustained growth momentum to justify ending the program. The Fed is broadly expected to launch this second round of quantitative easing as early as the next meeting of the Federal Open Market Committee, scheduled for November 2nd and 3rd.



Quantitative easing is a process wherein the Fed prints dollars and uses the cash to directly purchase Treasury debt obligations in the open market - with the expressed intention of rekindling economic activity to the level that inflation pressures grow and the threat of a downward recessionary spiral dissipates. Keep-in-mind should the Fed be successful in this endeavor -- the longer-term upward pressure on note rates will be far more significant that any support this strategy may give to the short-term prospects for steady to fractionally lower mortgage interest rates. Be at least a bit skeptical of some who claim the coming round of "quantitative easing" from the Fed will virtually guarantee a 3.5% or lower target for 30-year conforming fixed rate mortgages.



The dynamics of the next effort by the Fed to simulate economic growth will be largely determined by Friday morning's September nonfarm payroll report. If last month's data shows the economy lost more jobs than it created -especially if the private sector component of the report shows renewed weakness -- the actual dollar size of the Fed's direct government debt purchase program will likely increase dramatically. In the off-chance the September nonfarm payroll data shows positive job growth - particularly in the private sector - the Fed will likely choose to take a more cautious approach toward injecting more stimulus into the economy.



The credit markets have already rallied quite a bit as investors have been buying up all manner of government debt obligations in anticipation the Fed will soon resume large-scale purchases of these assets. A stronger-than-expected employment report on Friday will take a considerable amount of the wind-out-of-the-sales out of investors' current front-running strategy. If so, look for a mad rush to the market exists to develop as investors scale back their estimate of the Fed's forward looking buying interest - a condition almost sure to put upward pressure on Treasury yields and mortgage interest rates alike.



The Institute of Supply Management reported earlier this morning that its measure of activity in the service sector of the economy, a sector which accounts for two-thirds or more of all economic activity, accelerated last month more rapidly than most economists had expected. The ISM said its services index rose to a reading of 53.2 in September from 51.5 in August. The report's employment component rose to 50.2 last month after having dipped to 48.2 in August.



New orders also showed a solid improvement rising to 54.9 from 52.4. This survey covers industries that range from utilities and retailing to health care, housing, finance and transportation. Today's results suggest that after a brief hiccup in late summer, the handoff from manufacturing to service sector led growth is slowly taking place. The current pace of growth is probably not fast enough to dissuade the Fed from giving the "green-light" to another round of economic stimulus.