Weekly Preview; last Friday’s stronger than expected employment report sent interest rates screaming higher with MBS prices down as much as 200 bps at one point in the day. It isn’t news that interest rates were heading higher, most investors have been bailing out of fixed income investments since early May. We have consistently noted that all of our data was pointing to increasing rates. What we are surprised about though, is the magnitude of the increases; we thought the run up would find some temporary support at 2.60% for the 10 yr note, Friday the 10 climbed at one point to 2.75%. Mortgage rates are closing in on 5.0%. This week Treasury will auction $66B of notes and bonds, recent auctions have not been met with strong demand; if this week’s auctions don’t show and increase in demand interest rates will suffer more price declines and rate increase. Expect continued high levels of volatility and use any rallies to get deals locked.

The massive increases in interest rates last Friday on the better employment report may have been too much in too soon a time frame. The markets were thinly managed last Friday as many took the day off leading to increased panic selling. The bond and mortgage markets, already quite bearish, pushed those still hanging on to sell, sending rates to levels not expected this soon in the continual increases in rates. The 10 yr hit 2.73% Friday, up 22 bps in yield and 30 yr mortgage rates up 18 bps in rate to close in on 5.0%. Non-farm jobs were up 195K about 30K more than expected and April and May were revised higher adding an additional 70K jobs than originally reported.

At 9:00 this morning some improvement frm the route on Friday; the 10 yr yield at 2.69% down 4 bps; 30 yr mortgage prices +32 bps from Friday’s 151 bp decline. US stock indexes better, pointing to a strong opening at 9:30. Europe’s stock markets all better this morning.

Economic data this week is rather sparse. Today at 3:00 May consumer credit is about it for the day. This week Treasury will auction a total of $66B of notes and bonds; the last couple of months the demand at the auctions has not been as strong as the average of the last 12 months, will demand increase now that rates have risen? On Wednesday the minutes from the 6/19/FOMC minutes will be released; it was that meeting and Bernanke’s press conference after the meeting that sent interest rates higher when Mr. Bernanke said the Fed was ready to begin tapering its monthly buying of treasuries and mortgage-backed securities. The minutes will be released at 2:00 Wednesday then Bernanke is scheduled to speak at 4:00 pm, he will likely attempt to calm markets after the recent climb in rates that has completely surprised the Fed, especially Bernanke. How will he frame it? Oh, I really didn’t mean what I said a couple of weeks ago? Not likely, and unlikely he has the power to turn the rate markets around.

At 9:30 the DJIA opened +71, NASDAQ +15, S&P +8; 10 yr note 2.68% -5 bps and MBS prices for 30 yr conventionals +47 bps.

We expect the bond and mortgage markets will improve this week, but we do not believe that the bearish trend will end. Interest rates are going to continue to increase over time as long as the US economy expands and stock prices increase. That said, at present levels there is value in the fixed income world, at least to certain investors. The price declines last Friday were unreasonable but the action clearly demonstrates how bearish the underlying sentiment is currently. Use any improvements to get deals done now. To change the technical outlook for markets the 10 yr note rate must decline to under 2.50% (2.68% now). Q2 earnings’ season is about to get underway; talk around is questioning whether earnings in the quarter will match the strong earnings in Q1. As long as equity markets continue to increase the outlook for interest rates will remain bearish. How Bernanke frames his speech on Wednesday will have an impact on near term direction for the bond and mortgage markets.

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- Michael Corboy