Morning Report - More bubblicious behavior in the bond market

Vital Statistics:

	Last	Change	Percent
S&P Futures	1997.2	19.7	1.01%
Eurostoxx Index	3069.9	2.6	0.09%
Oil (WTI)	57.95	0.1	0.24%
LIBOR	0.243	0.002	0.94%
US Dollar Index (DXY)	88.46	0.100	0.11%
10 Year Govt Bond Yield	2.11%	0.02%
Current Coupon Ginnie Mae TBA	104.9	-0.3
Current Coupon Fannie Mae TBA	104.3	-0.1
BankRate 30 Year Fixed Rate Mortgage	4.03

Markets are higher this morning after stocks got slammed in Asia last night. Bonds and MBS are down.

Wall Street is betting that inflation will remain dead for a long time. Treasury Strips are back (which basically slices and dices a long term Treasury into a bunch of zero coupon bullet bonds). This strategy has been a winner this year, rallying almost 50%. Foreign bond investors have had a great year with the the currency and bond markets posting big gains. The thing to remember is that US investors aren't the only ones who play the Treasury market - and foreign bond investors are often looking at their domestic bond markets and finding more value in the US. To put this in perspective - the US 10 year yields 2.12%. The German Bund (10 year) yields 64 basis points. The Japanese JGB (another 10 year) yields under 38 basis points. The Spanish 10 year yields 1.79%. There is a global relative value trade happening here.

Strategists have gotten the bond market wrong all year. This is a case where the textbook response - sell Treasuries as the economy improves - has been dead wrong, overwhelmed by events overseas. Keep this in mind when thinking about rates in the US - strong data might not be enough to push bonds lower and originators might be getting a gift here. It won't last, and the snap-back could be vicious. Second, anyone buying a 30 year zero at 43 which yields 2.86% should have their head examined. This is bubble behavior, and is the bond market equivalent of buying Cisco Systems at 70 (or 132x earnings) in 2000. Bonds will crack at some point, but keep in mind that bond market cycles are long.

Speaking of strong economic data, Industrial Production rose 1.3% in November and capacity utilization topped 80% for the first time since March of 2008. This production number was the highest since 2010. On the other side of the coin, the December Empire Manufacturing Index fell in December.

The FOMC meets this week, and the decision will be released Wednesday at 2:00 pm EST. This one should have a press conference, along with updated economic projections and a press conference. The focus is on the timing of rate hikes, and investors will key in on language regarding the labor market. 

In the budget deal last week, some regulations were relaxed for the big Wall Street banks, particularly the provision requiring derivatives to be housed in an entity without recourse to the parent FDIC - insured bank. This sparked a big rebellion on the left, but it ended up going nowhere. FDIC insured banks may now use credit default swaps as hedging instruments for their own books. To hear the left tell the story, this basically returns us back to the bad old days of 2005. To the industry, this is a common-sense relaxation of a rule that went too far in the first place. That said, banks were always allowed to use these products, but had to post more collateral than they wanted to. This is a knotty question, as many "hedges" are really speculative bets when you delve into the details. I suspect JP Morgan's 2012 London Whale trading loss was intended to act as a hedge in the first place.