UMBS starting the day in the red.  Down 11 bps on the 6.0.  5.5 is down 17.

The S&P 500 traded just a few points away from its all-time peak on Thursday, extending its 2023 advance to nearly 25%. The Nasdaq 100 has already posted its best year since 1999 on expectations the Federal Reserve will cut interest rates aggressively in 2024.

Treasuries extended Thursday’s losses, with the 10-year yield rising three basis points but still more than 100 basis points below its mid-October high.  Yesterday’s $40bn 7yr treasury offering was awarded a yield of 3.85%, the lowest since June.   However, the auction disappointed expectations since investors were less willing to buy longer-duration paper into the year end.

The bond market will close early Today and remain closed Monday in honor of New Years. Jobs will come front and center the first week of the year with U.S. Job openings, initial jobless claims, ADP, and the unemployment report all squeezed into a shortened first week. Many remain hopeful that cuts may come as early as March, but some Fed officials have hinted that it could be May before we see a cut. The Fed implemented 11 rate hikes in the latest monetary policy cycle starting in March of 2022.

From Brent Nyitray

IMO the most dangerous words in financial markets are “this time is different” and we probably have a recession this year. The fact that 40% (!) of borrowers skipped their student loan payment is an ominous sign. Spending has been artificially inflated by fiscal stimulus and rent / debt holidays that are ending.

The inflation dragon has probably been slayed, although it might stick around at a point above the Fed’s target rate for a while as housing shortages keep shelter prices high. Global demand is falling (China is hitting the wall) which will keep energy and good prices low.

The market sees about 150 basis points in rate cuts next year, which is probably aggressive unless we hit a recession. The Fed is nominally non-political, but Powell got his marching orders from Biden a couple of weeks ago to stop tightening. I suspect the Fed will prefer to err on the side of being too loose in the 2024 election year.

As the Fed moves from tightening to easing, we should see a decline in bond market volatility, which will work to push MBS spreads lower.

2023 may be a year that we won’t soon forget, but the past two weeks have been quite the opposite. Today’s holiday-shortened trading session did nothing to change the narrative.  Yields were modestly higher overnight, giving chase to a slightly bigger sell-off in Europe.  Domestic traders pushed back toward unchanged levels by mid day but sellers resurfaced at the 1pm CME close. Trading levels remained easily within the exceptionally flat range seen since Dec 14th. We continue to focus on next week’s economic data and Fed Minutes as the first major sources of potential volatility in 3 weeks.

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