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Market Update

Posted by Kevin Connolly on March 20, 2014 at 1:35 AM

Is the market just a deer in the headlights? We have a new Fed Chair, tapering continues without hesitation, the Fed has moved to a qualitative (subjective) approach from a purely quantitative approach, there are huge weather disruptions, emerging markets are struggling, mortgage applications are at a 5yr low, inflation is uncomfortably low and all the while the market ceases to move. Today the 10yr stands at 2.68. Three weeks ago it closed at 2.68 and five weeks ago it close at 2.71. Normally this would be a traders market, lots of uncertainty about the future, plenty of volatility and a very actively traded market. Today the market is thinly traded, liquidity is quite low and dollar prices are pretty constant.

What’s causing this sudden calm? Is it weather or Janet Yellen or inconclusive data, perhaps a calm before the next storm or perhaps the storm was already felt in 2013 instead? In actuality, all play a role to some degree, but for now I pay my compliments to the Fed. To move to a qualitative approach while simultaneously removing a massive amount of stimulus and keeping volatility near zero was genius in its simplicity. The risks all still exist and we should all be aware of those risk. And so we have to ask ourselves after this important and successful first move by the Fed, is the Fed asking the right questions? Are they a step ahead or behind the risks at hand and do they have the tools at their disposal to address and combat the underlying issues?

One of the bigger risks I see is what becomes of the Mortgage-Backed Securities market once the Fed stops gobbling up all of the production every day. Are there enough buyers to support that market and to keep dollar prices from falling? Thankfully the Fed is aware and addressing that risk. One of NAF’s trading partners was invited to meet with the Fed yesterday. Three traders and fourteen people from the Fed. While I don’t want to draw any conclusions from the meeting, I would say it’s a good sign that number one, there were fourteen of them, and number two, they asked all the right questions. Decisions often come from politicians and it’s hard to predict what those decisions will be, but it is always important to be asking the right questions. The Fed appears to gathering all of the information it needs to make the right decision.

There has been a lot of talk about weather and its impact on the economy. Almost every poor economic data point has been blamed upon weather; so much so that many have started to question how much has weather really played a factor. It’s one of those excuses that could blind the market of the potential reality that it’s more about the economy than the weather. Janet Yellen addressed the weather yesterday in the most effective manner by being honest in saying that it’s likely the weather but at the same time it can be very difficult to determine how much is weather related versus a weak economic outlook. Way to acknowledge both sides. She also said that there would have to be a significant change in their assessment of the economy to slow the pace of tapering asset purchases.

So where do we go from here? In my humble opinion, I think the market is at greater risk of rates rising than failing further. Rates have come down 35bps since the end of 2013 and the Fed has basically told the market they are not going to flinch first. Ms. Yellen all but said the data will have to be very weak. Slightly weak data will be pushed aside, blamed by weather, ignored to some degree and they will continue to taper. Where is their flinching point? How bad is bad? If the data is somewhat positive, watch out as the market is expecting weather impacted moderately weak data. If it is weak, get ready for arguments over the ten levels of weakness. What are the varying degrees of weakness and how weak is too weak?

Jobs and the unemployment rate come out next week. The way things have gone recently, unless the number is a huge surprise, it might not have the impact it typically does on the market.

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