I suggest starting the day by floating; we normally do that. It is a bear market now however so we will not press it and move to lock mode on any weakness. If you float today keep close for our alerts. Unless mortgage markets gain a little traction through the rest of the day we will lock over the weekend.Look for interest rates to remain stable today.

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As we expected, the 10 yr and mortgages opened slightly better this morning with the benchmark 10 yr testing its technical support yesterday and holding it at the 3.50% area. No change in the bearish path however, just a bounce in what we believe will be a range for the note and mortgages of about 25 basis points (3.50%/3.25% on the 10) and 5.00% to 5.25% for 30 yr mtgs. At 9:00 this morning the 10 yr note traded +8/32 at 3.44% -2 BP; mtgs +5/32 (.15 bp). The DJIA futures traded -58 on some weaker than expected earnings reports. At 9:30 the DJIA opened -95; 10 yr +12/32 3.42% -4 BP, mtg prices +5/32.

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Prior to the equity market open at 9:30; Sept industrial production was expected to +0.2%, it jumped 0.7% and August production increased from 0.8% to +1.2%. Manufacturing output rose 0.9%, lower than +1.2% in August. Sept capacity utilization, also better than expected, 70.5% against estimates of 69.6%; August capacity use was revised slightly better to 69.9% frm 69.6% originally reported. Manufacturing use increased to 67.5% frm 66.8% in August. The reaction to the better data pushed mortgages backed to unchanged and the 10 yr note from +8/32 to unchanged.

At 9:55 the U. of Michigan consumer sentiment index, expected at 74.0 frm 73.5 at the end of Sept, was lower at 69.4. The 12 month outlook question on the survey fell to 79 frm 88.0 at the end of Sept; consumer expectations at 67.6 frm 73.5 at the end of Sept. The survey is subject to wide variations at times, but does take some wind from the sales and reminds consumers are still not in the game of recovery being so heavily bet in the equity markets. No real positive reaction to the report in the bond and mortgage markets but the DJIA fell 10 points on the report.

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The stock market is opening lower this morning on reports from BofA and GE; BofA took another $1B loss for the quarter, the second this year. Loan defaults drove the losses. GE made a profit by cost cutting but its revenues fell short of expectations.

Treasury reported August net foreign purchases of US debt. A total of $32.9B in August; $21.3B by private foreign investors, $11.6B by foreign “official” institutions (central banks) and $4.3B by US residents. No need to look any farther as to who is supporting US deficits.

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Being Friday trade will likely have a narrow range through the remainder of the day. The wider outlook is bearish for the bond and mortgage markets; the shorter view however is a little better after the 10 yr note managed to  hold its first key support at 3.50% yesterday. Still looking for a trading range on the note and mortgages of about 25 basis points; 3.25% to 3.50% on the 10 yr and 5.00% to 5.25% for mortgage rates. So far this morning mortgage markets are somewhat soft.

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Floating is going against the grain these days with the rate markets bearish. However, we always look for that opportunity to catch a bounce. If you are able to keep tuned to our rate alerts we suggest floating to start, but if you are unable to keep close we suggest locking through the day. We will not float overnight unless mortgage prices improve enough to reduce overnight risk (+.25 bp frm initial pricing levels)

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More selling in the interest rate markets this morning. Prior to 8:30 data the 10 yr note was off 5/32 and mortgages were unchanged, the DJIA futures trade had the index -25 after closing slightly above 10K yesterday At 8:30 weekly jobless claims were down 10K to 514K; continuing claims also declined to 5.992 mil from 6.067 mil last week. Sept CPI was fractionally higher than forecasts; +0.2% for both the overall and the core (ex food and energy components). Finally at 8:30, the NY Empire State manufacturing index jumped to 34.57, the estimate was a decline to 17.5 frm 18.88 in Sept, new orders component jumped to 30.82 frm 18.82 (above zero is expansion). All three reports added more negative response in the bond and mortgage markets.

On the weekly claims; continuing claims are declining but may be due to those unemployed running out of unemployment benefits. 514K new filings however isn’t a reason to cheer too much, workers continue to lose jobs at a lesser rate but jobs are still eroding. On the CPI, inflation based on the Sept report suggest a slight increase on the core, but so far we consider it an anomaly, traders however are on edge with the inflationary outlook with interest rates at the current low levels. Don’t have much to comment about on the NY Empire State index jumping like it did, rather surprising given the index was expected to decline, it didn’t go unnoticed by traders.

At 10:00 the Philly Fed business index was expected at 12.5 frm 14.1 in Sept, as reported the overall index fell to 11.5; new orders at 6.2 frm 3.3, prices pd at 21.3 frm 14.9 and employment at -6.8 frm -14.3. Overall the report is slightly better but not nearly as robust as the earlier NY Empire State data at 8:30. No initial reaction to the report in either stocks or bonds.

The bellwether 10 yr is approaching where we expect to hold at 3.50%. Looking for a new range between 3.25% and 3.50%. The 10 yr and mortgages are however technically bearish and it is not advisable to make decisions that the 3.50% will hold until it actually is tested. Both mortgages and long term treasuries are trading below their 20 and 40 day moving averages and have broken various chart support levels after interest rates declined to unsustainable levels based on the increasing view the economy is recovering.

PIMCO is betting on deflation based on the view that the economic recovery will be slow and lethargic. PIMCO reduced its holdings of mortgages in favor of long term treasuries a month ago on the bet deflation and not inflation will keep interest rates low. The increase in treasuries was minor however, from 44% to 48% of the total $185.7B Total Bond Fund. Traders concerned about inflation, Bill Gross at PIMCO concerned that deflation is the coming issue. A lot of uncertainty about the outlook in 2010 will keep volatility high with overall interest rates at these historic low levels.

The FOMC minutes yesterday noted some of the members want to consider having the Fed buy mortgage MBSs after the $1.25 commitment runs out at the end of Q1 2010. If the Fed does signal it will continue to buy MBSs it will keep mortgage rates from increasing as much as they would otherwise. Mortgage rates however will track the 10 yr note direction; if interest rates increase so too will mortgage rates but with less of an increase if the Fed is in the game.

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I have started the day by floating.  Mortgage rates are bumping against their best since last Spring; both the mortgage driver 10 yr note and mortgages themselves are overbought in the near term; susceptible to selling. The longer outlook remains constructive, the short view slightly bearish. Note; we are changing the time we post for mortgage prices frm 10:00 to 9:30, lenders are pricing earlier these days.

The bond and mortgage markets opened a little soft in early trade this morning; the 10 yr at 8:00 -4/32, mtgs -2/32, the DJIA futures index +70. At 8:30; mtgs -1/32, 10 yr -4/32 and DJIA +65. At 9:00; mtgs -1/32, 10 yr -4/32 and DJIA +61. At 9:30 the DJIA opened +73, 10 yr note -3/32 and mortgage prices at 9:30 -2/32.

No economic data to think about today; rate markets will focus on this afternoon’s (1:00) $39B 3 yr note auction starting three days of Treasury borrowing. The equity markets had a strong day yesterday with the DJIA +112 and S&P +15, starting stronger again today.

Yesterday we reported that Obama is considering another stimulus plan to try and lower the unemployment rate. This morning we hear Obama is considering extending the first time homebuyers’ tax credit and increasing spending in the transportation sector. Won’t be labeled as another stimulus plan of which only 40% of the $787B has been used; taxpayers and consequently the Congress are not in the mood for more government spending that has gotten completely out of hand. So the slight of hand is tax cuts and increased spending; in any other language but government it is more stimulus with only the name changed to protect the guilty.  Administration officials have told allies in Congress that a broader transportation bill, and extensions of a homebuyer tax credit and unemployment benefits are all on the table.

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A few days ago, at the end of Sept the government fiscal year ended for 2009. Next we will get the 2009 fiscal deficit, the CBO is saying $1.6T with 2010 deficit at $1.4T. It wasn’t more than three years ago the deficit was just $300+B. Much of the exploded deficit was used to save the financial system; it had to be done but probably not to the massive extent the panic required. Congress led by the likes of Barney Frank have little desire to cut any spending programs, actually increasing them where it isn’t necessary other than to be re-elected. Yesterday Frank said he wants to use $2B of TARP loans that have been re-paid for more spending. The price America will pay in the future for the spending now will be high interest rates, likely approaching 8.0% for mortgages by 2011. Don’t worry, be happy; let the next Congress gag on it—-how Congress and administrations think.

Hardly a week goes by without talk of the demise of the dollar as the world’s reserve currency. Today reports of Mid-East oil producers looking to other currencies as payments for oil exports. Oil has always been settled in US dollars. The exploding deficits, the conviction the US does not have the stomach to cut spending, the Fed keeping interest rates low, and foreign investors drowning in dollars are issues that will not easily be ignored much longer. For now however, it is mostly chatter but the rumors are increasing. Every rumor so far has been vehemently denied from the sources.

Australia raised its interest rates by 25 basis points this morning; suggesting their economy is rebounding faster than the US. IN fact most of the world is coming out of their recessions more rapidly than what we are doing here.

The rest of the day will center on this afternoon’s $39B 3 yr note auction and the equity markets that have no intention of rolling over.

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Continue to float but stay tuned for rate alerts. Rate markets are overbought and unless the stock market really implodes today there is no more to the rally with Treasury auctions looming next week and near term technical overbought oscillators drawing attention.

Prior to the 8:30 employment report for Sept the 10 yr and mortgages traded +4/32 after the huge rate decline yesterday once the 10 yr broke its resistance at 3.28%. The DJIA at 8:15 was off 30 points. At 8:30 Sept non-farm jobs were reported down 263K against market estimates of -180K to -200K, the unemployment rate at 9.8% was in line and +0.1% frm August. Average hourly earnings in Sept were up just 0.1%, also seen as a negative to the economic optimism. August non-farm jobs were revised a little better, from -216K to -201K. The knee jerk reaction sent the 10 yr to +16/32 at 3.11% and mortgage prices +9/32, but by 8:50 the 10 yr backed down to +10/32 and mortgages +4/32.

The DJIA futures at 9:00 -124, 10 yr +14/32 at 3.13% -5 BP and mortgage prices +6/32 frm yesterday’s close. At 9:30 the DJIA opened -70, 10 yr +10/32 at 3.14% -4 BP, mortgage prices at 9:30 +7/32. (see below for 10:10 levels)

The reversal in the equity markets is finally taking hold after a month of waiting; even the most bullish investors are now having to face the reality that the equity markets may have over-shot. That said, listening to various guests on CNBC after the employment report suggests the bulls are not going to give up easily. Lot of chatter coming from the NYSE floor that traders are excited about the turn lower in the stock market, as have noted previously traders say they want a decline in the stock market so they can buy at lower levels. As far as we are concerned, talk is a very cheap commodity; we do not take those thoughts seriously. Changes in sentiment can occur rapidly based on unfolding data. At the end of the day, the basic question in the markets now is whether or not we will have a double dip recession? The bond market is leaning that way while the equity markets are tilted toward no double dip; will likely to increase market volatility over the next few weeks.

At the low yield this morning the 10 yr this week was down 21 basis points and mortgage rates down 16 basis points. A lot of day ahead, short term technicals are now reading overbought after the rally yesterday and the action so far this morning.

Bernanke yesterday said the expansion may not be strong enough to “substantially” bring down unemployment, indicating the central bank will be slow to drain the trillions of dollars it’s pumped into the economy. With the Fed expected to not initiate any tightening moves for most of 2010 and inflation off the radar at the moment, the fixed income markets are benefiting in a major short covering move after the strong resistance at the 3.25% yield level fell yesterday (10 yr treasury) triggering huge stop loss selling. Carrying on with the rally so far this morning on the weaker than expected employment data at 8:30; mortgages are riding the wave so far this morning.

Additional bad news for the economic outlook this morning from the Labor Dept; its preliminary estimate for the annual benchmark revisions to payrolls that will be issued in February. They showed the economy may have lost an additional 824,000 jobs in the 12 months ended March 2009. The data currently show a 4.8 million drop in employment during that time.

At 10:00 August factory orders concluded the data this week; expected to be +0.5%, orders were down 0.8%; August durable goods orders revised to -2.6% frm -2.4%.

next week Treasury will auction a total of $71B in 3s, 10s and 30s on Tuesday, Wednesday and Thursday ($39B of 3 yr notes, $20B of 10 yr notes and $12B of 30 yr bonds); Monday Treasury will also auction $7B of 10 yr inflation-indexed notes. Demand for US debt has been very strong from foreign and domestic investors in the past three months. This time the auctions will face the lowest yields in six months if rates hold current levels.

By 10:00 the rally early ended; the 10 yr unchanged mortgages unchanged. Not likely to see much movement through the rest of the day. The stock market is slowing finding a little traction from the worst levels at 9:00 this morning.

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