As noted here, we have talked about volatility that would dominate markets the next couple of weeks. today a good example; yesterday MBSs prices fell 33 bps on the day, this morning the 30 yr 3.5 FNMA coupon at 8:30 +73 bps. All about data points and markets were surprised (again) when at 8:30 the final read for Q1 GDP reflected the economy was not nearly as strong in Q1 as was widely believed. The overwhelming expectation was Q1 would be +2.4% unchanged from the preliminary report last month; as reported the economy grew at just 1.8%. The reaction sent 10 yr note yield down to 2.52% from 2.60% yesterday, and spiked MBSs prices higher.

The weaker growth in Q1 has turned speculation that the Fed would begin tapering in Sept into turmoil. As we noted, it is all data dependent on how and when the Fed would begin to end its market support; Bernanke made that plain when the surprised the markets with his comments that he was ready to begin the end of Fed market support. That part of his remarks was swept under the rug by markets that focused only on his remarks that the Fed would rapidly wind down its support and be completely out by mid-2014. The softer than expected Q1 growth will change some of those outlooks that have driven interest rates higher recently. Most of what we had been hearing from analysts and economists were forecasting a slowdown in Q2 that ends Friday, and that corporate earnings would be down from Q1. If those forecasts hold the take away has to be that the Fed isn’t likely to taper as soon as what had been expected until this morning. It is still a bearish bond and mortgage market however the selling binge will likely lessen somewhat.

The weakness in Q1 was due to less consumer spending that accounts for about 70% of GDP growth. Household purchases were revised to a 2.6% advance compared with the 3.4% gain estimated last month. Households cut back on travel, legal services and personal care expenditures and also curbed spending on health care as the two percentage-point increase in the payroll tax caused incomes to drop by the most in more than four years. Disposable income adjusted for inflation fell at an 8.6% annualized rate, the biggest drop since the third quarter of 2008. The immediate reaction from the bullish camp was that the second half of the years would see consumer spending increase---hope is what markets are living on these days.

Mortgage applications decreased 3.0% from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending June 21, 2013, the lowest level since November 2011. The Refinance Index decreased 5.0% from the previous week to the lowest level since November 2011.  The seasonally adjusted Purchase Index increased 2.0% from one week earlier, and was 16% higher than the same week one year ago. The refinance share of mortgage activity decreased to 67% of total applications, the lowest level since July 2011, from 69% the previous week. The adjustable-rate mortgage (ARM) share of activity increased to 7% of total applications. The government share of purchase applications dropped to 28%, the lowest level in the history of this series. The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,500 or less) increased to 4.46%, the highest rate since August 2011,  from 4.17%, with points decreasing to 0.35 from  0.41 (including the origination fee) for 80% loans. The average contract interest rate for 30-year fixed-rate mortgages with jumbo loan balances (greater than $417,500) increased to 4.52%, the highest rate since March 2012,   from 4.23%, with points decreasing to 0.28 from 0.34 (including the origination fee) for 80% loans.  The average contract interest rate for 30-year fixed-rate mortgages backed by the FHA increased to 4.20%, the highest rate since August 2011, from 3.85%, with points increasing to 0.40 from 0.22 (including the origination fee) for 80% loans.  The average contract interest rate for 15-year fixed-rate mortgages increased to 3.55%, the highest rate since November 2011, from 3.30%, with points increasing to 0.43 from 0.39 (including the origination fee) for 80% loans. The average contract interest rate for 5/1 ARMs increased to 3.06%, the highest rate since October 2011, from 2.81%, with points increasing to 0.39 from 0.35 (including the origination fee) for 80% loans.

At 9:30 the DJIA opened +89, NASDAQ +28, S&P +9; 10 yr note at 2.52% -8 bps and 30 yr MBSs price +82 bps.

At 1:00 this afternoon Treasury auction $35B of 5 yr notes; yesterday’s 2 yr auction was not well bid.

In Europe the stock markets rallied that added to it when Q1 US GDP hit on relaxed concerns of an early exit by the Fed. A German consumer confidence gauge for July rose to 6.8 from 6.5 in June, Nuremberg-based research company GfK AG said today. That would be the highest since September 2007. Analysts had expected a reading of 6.5. The German 10 yr bond yield fell seven basis points to 1.74% from 1.85 two days ago. Euro-area bonds rose, led by those of peripheral nations including Italy and Spain as European Central Bank President Mario Draghi said monetary policy will stay accommodating, boosting the appeal of fixed-income assets.

Today’s fall in US interest rates is a welcome move; that said the technicals remain bearish. The 10 yr and MBSs could rally a lot more and still not change the bearish outlook. The 10 yr would have to fall to under 2.35% the 3.5 July FNMA coupon price would have to exceed 102.50---presently 100.64. Today’s weak Q1 GDP report is adding support to the bond and mortgage markets that maybe the Fed will not be moving as quickly as had been thought to unwind its easing. That said, although Q1 was softer, it is to an extent history. The future remains unsure however recent Q2 data has been strong; yesterday May durables were better than expected so too May consumer confidence index and May new home sales. Us this and any rallies to button up deals; interest rates are not likely to fall much from current levels. 

- Michael Corboy