We appear to be at a crossroads with rates.  This Friday we have the all important “Employment Report” for December and a strong employment situation report would essentially confirm a month’s worth of weakness in the bond market, thus putting a firm layer of resistance under the mortgage rate market, making mortgage rates under 5.00% a thing of the past.   Basically, here’s an evaluation of the percentage chances on events in the rates market. Note: these are forecasts for Q1 2010. Not beyond.

Here is the outlook:

1. HOLD STEADY OR MOVE HIGHER: Rates could fall briefly only to rebound back to current levels or even higher. Either way, mortgage rates would bounce around a new, higher costing range. This would occur because economic perceptions for many are optimistic. This is a favorite for early 2010. After several months of choppy growth, the market is beginning to believe “the worst really has been avoided”. If economic activity continues to show signs of improvement (even if its scattered), the bond market will take the “better than expected” side of the trade and mortgage rates would creep into the 5′s and maybe even test the 5.50 level (at best). This is if the OPTIMISTIC perception grabs hold of headlines. This category also includes an outlook with no brief recovery. 55% chance in short run and 75% overall for Q1 2010
2. CORRECTION BACK INTO RECENT RANGE: Rates could move back into the range we enjoyed from August to December, and stay there (4.50 and 5.00 at best). If this occurs, it will likely be a function of continued economic uncertainties. In the short term, a few more negative New Home Sales like reports would help rates fall at least towards six month averages. After that, in order for the recent rates range to be revisited for an extended period, we would expect to see mixed economic messages via volatility in monthly economic reports. Very similar to what we’ve experienced over the past five months. The Fed also plays a huge role in this theory. Their rhetoric must continue to fight off inflation hawks with strong dovish verbiage (dovish = low rates), or number #1 will be even more likely. Many feel the recent rates sell off was over dramatized by very light trading conditions which would support this scenario. 45% chance in short run and 25% overall in Q1 2010.
3. A DOUBLE DIP FLIGHT TO SAFETY. This is very unlikely early on in 2010, so don’t get your hopes up for an immediate rally in bonds that sets new all time lows. In 2010, it is possible that rates could completely recover all lost progress and move back towards record lows, but only if the economy takes a major turn for the worse. This is not something we expect to see early in 2010. This outlook is less likely to occur if the market is focused on short term growth spurts. Over the long haul, most economic activity is just now stabilizing, right above record low levels. <1% chance in short run. <1% chance in Q1 2010.

In the short run….for almost the entire month of December, the bond market  reflected the “worst is behind us” perception. Long term Treasury yields moved considerably higher in a very short time frame all while stocks  set new 2009 index highs (after the November Jobs report). This bias towards higher rates was however not confirmed by any strength in the market because price action was distorted by light (thin) trading conditions. Thus, the market did not provide a clear outlook for rates heading into 2010….it only provided hints.

That is why the short term (early 2010) chances of rates holding steady at recent highs (or rising) and rates returning to the 5-month range were so close. 55% chance of holding steady or moving higher. 45% chance of rates moving back into the 3.27-3.50 range that moderated directionality from August to December.

This is where the “we’re at a crossroads” theory comes in to play.

The question we were looking to address when the new year began was: WERE HIGHER RATES IN DECEMBER A FUNCTION OF SEASONAL INFLUENCES or DID THE ‘BIG PICTURE’ ECONOMIC PERCEPTION EVOLVE OPTIMISTICALLY?

We will get some serious feedback on that question throughout the course of this week. The “better than expected” perception will be put to test starting tomorrow morning when ADP Employment data is released at 830am. After that Fed FOMC minutes are released, ISM Non-Manufacturing is reported, Jobless Claims on Thursday….and then the biggee report for every month: NON-FARM PAYROLLS or the December Jobs Report!

Plain and Simple: There is a slightly better than average chance that in the short term rates hold near current levels or move higher. There is a slightly less than average chance that bond yields move down allowing mortgage rates to ease as well.  This week’s economic calendar will either confirm or reverse the recent bearish bias in the bond market.

As for later in the quarter…most will agree that rates will be moving higher but looking past Q1 2010…there are a TON of uncertainties out there that might make the case for higher rates VERY WRONG.  Many areas of the economy are still in some trouble and the US government has super-sized borrowing needs which might eventually crowd out private borrowing. The marketplace has proven itself more than happy to trade the PERCEPTION of economic stabilization. Any data trend that changes the perception that the economy is recovering might very well move rates much lower once again.  The consensus is that this is not at all a possibility for the first half of the year but as government support/stimulus recedes from the marketplace the economy must maintain it’s own footing to continue improving. If it falls down again, a double dip recession is possible in later 2010 early 2011 and rates could move lower again.  Let’s hope the economy continues on the mend as I’m sure you would all rather have more robust growth and higher demand for housing than, even at the expense of higher rates, than a double dip recession.  Let’s all root for more recovery!

Information taken from “Mortgage News Daily” www.mortgagenewsdaily.com