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January 26, 2011

MBS prices are down -17/32 (FNMA 30-yr 4.0 at 98.19), below 9:45 et pricing of -10/32. Unfavorable repricing took place. Investor concerns about inflation following the release of the Fed statement (see below) pushed MBS markets to the lowest levels of the session. December New Home Sales rose 17% from November to an annual rate of 329K units, above the consensus forecast of 300K. Demand was stronger than average for the 5-yr Treasury auction. The bid-to-cover was 2.97, and foreign buyers purchased 45% of the total. The Dow was up 10 points, crossing above the 12,000 level for the first time since June 2008. Tomorrow, Durable Orders, Jobless Claims, and Pending Home Sales will be released. The results from the 7-yr Treasury auction will come out at 1:00 et.

Overall, there were few changes in the Fed statement. The Fed repeated its intention to purchase the full $600 billion in Treasuries under the quantitative easing program. Investors focused the most attention on one portion of the statement concerning the debate between different measures of inflation levels. Core inflation excludes food and energy, and economists are divided about which measure is a better indicator of inflationary trends. In recent months, commodity prices have increased significantly, driving up overall inflation levels. The Fed statement suggested that core inflation is still trending lower, however, and Fed officials are believed to place more weight on core inflation. Concerned that overall inflation levels may rise further without triggering Fed action, investors sold MBS and longer-term bonds after the statement was released.

Tomorrow, we will be switching the current coupon from the 30-yr 4.0% to the 30-yr 4.5% to better reflect current market conditions.

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