Market Update June 21, 2007

Current Price of FNMA 6.0% Bond: $98.59, Unchanged

With the extremely high level of volatility we've seen lately, it sure is clear how important it is to stay dialed in to what the market is doing and why. In just the past 24 hours, we have seen the Bond shift from positive momentum to negative momentum rather quickly. In fact, just this morning we have seen prices move from up 6bp on the day, to down 12bp, back higher to be unchanged on the day in just one trading hour - now that's volatility!

So as we ride through the volatility, it's important to understand all the factors causing the change - and with a light news week continuing, technicals continue to play a huge role. In yesterday's update we discussed the Falling Resistance Line, and how the overall trend for Bond pricing remains lower. Seeing Bond prices fall back after approaching resistance yesterday was not a good technical sign, and could lead to a continued move lower.

Here's another very interesting factor playing into the current weakness of Bonds - Corporate Bond Issues. What the heck does a company selling their own Corporate Bonds have to do with Mortgage Bonds? Here's the story. Companies will from time to time issue debt against their company, as a way to raise capital without giving away stock ownership. But as they prepare to do so, they see that if rates are continuing to move higher, the price they will get for their Corporate Bonds will be lower. So just before they issue their Corporate Bonds, they "hedge" against upward swings in interest rates by shorting other Bonds, like Treasuries. This protects the companies from a sudden move higher in rates, as if rates were to move higher, the companies would likely have to pay more interest on their new corporate issues to meet current market conditions...but at the same time make money on the selling of the Treasuries - thereby "hedging" their actions.

This shorting or selling of Treasury Bonds temporarily drives prices lower in the entire Bond market - including Mortgage Bonds. But when the Corporate Bonds are actually priced and issued, this "hedge" trading is reversed, with the Treasuries being bought back, providing a subsequent boost to the Bond market in the other direction. These hedging activities can create abrupt volatility in the Bond market and this was likely a contributor to the volatility both yesterday and so far today.

For now, the Bond looks poised to move lower and test a floor of support at the $98.28 level, about 30bp lower than present levels. With no high-impact reports due until next week and the technicals turning negative, a bias towards Locking appears prudent at this time.