Morning Report - Dissecting the Bernank

Vital Statistics:

	Last	Change	Percent
S&P Futures	1590.7	6.8	0.43%
Eurostoxx Index	2595.4	9.0	0.35%
Oil (WTI)	95.37	0.2	0.24%
LIBOR	0.273	0.000	0.07%
US Dollar Index (DXY)	82.08	0.168	0.21%
10 Year Govt Bond Yield	2.39%	-0.03%
Current Coupon Ginnie Mae TBA	102.3	-0.7
Current Coupon Fannie Mae TBA	101.8	0.3
RPX Composite Real Estate Index	204.8	0.3
BankRate 30 Year Fixed Rate Mortgage	4.24

Markets are higher this morning after yesterday's bloodbath. There is no economic data this morning. Bonds and MBS are up small.

Mortgage rates are up 30 basis points this week so far. We should be best-exing into 4% coupons soon if not already. Will the higher rates crush the purchase market? Well, the National Association of Realtors reported May Existing home sales rose 4.2% to a seasonally-adjusted 5.18% annual rate. The median home price rocketed 15.4% year-over-year. Days on market fell to 41 days from 46 days in April. During the month of May, the 10 year went from 1.67% to 2.13% and the 30 year mortgage went from 3.43% to 4.10%. So, at least on the purchase front, so far, so good. 

The sell-off in bonds has been dramatic. Is it overdone? IMO, not really. Two things in Bernake's press conference jumped out at me. First, was that the Fed expects the labor market to improve slowly and for inflation to remain moderated. And if the economy acts as expected, they will start tapering QE by the end of the year and fully exit by mid 2014. In other words, the default path is to exit QE, and it will take exceptionally weak economic news to change that. I think going into the FOMC meeting, the market was discounting the possibility that the default path was to continue QE and it would take strong economic data to change that. That possibility has now been taken off the table.

Second, when asked about his concern over the recent increase in interest rates, Bernake said that their economic forecasts were done in the past few days, so they take into account the recent spike in rates. He went on to characterize the increase in rates as "increasing for the right reasons" - i.e. economic strength and the markets getting ahead of the Fed. 

The next question is "how high can rates go?" Well, if you look at historical numbers, a lot higher. Below is a chart of the 10 year yield less the Fed Funds Target Rate since we went to ZIRP. The yield curve had been a lot steeper in the past few years. 

Finally, I recently did an interview on Capital Markets Today, where I talked about the Fed, shadow inventory, mortgage rates, and the real estate market. It is a deeper dive into what the Fed had to say (it was done right after the FOMC release). Check it out.