Low Inflation and Strong Auctions
While mortgage rates climbed in December, they have decreased during the first two weeks of January. A combination of factors was favorable for mortgage markets this week. Low inflation, weaker than expected economic growth data, and strong demand for the Treasury auctions all helped mortgage rates move a little lower. One primary long-term concern for mortgage investors is that the enormous level of stimulus intended to boost the economy will lead to higher inflation. Inflation erodes the value of fixed income investments, so future inflation expectations are a major determinant of bond values, including mortgage-backed securities (MBS). Inflation has not been a factor in the short-term, however, as virtually all of the data in recent months has shown it to be low. This week, the Consumer Price Index (CPI), the most widely watched inflation indicator, showed that core inflation rose only 1.8% from one year ago. The Fed's comfort zone is for core inflation to rise at a 1.0% to 2.0% annual rate, and Fed forecasts are for low core inflation this year. Mortgage investors will be watching these levels closely, and any surprises down the road could push mortgage rates higher. A second major long-term issue for mortgage investors is that the vast increase in the supply of government debt will exceed the demand. So far, both foreign and domestic demand has remained strong. This week's Treasury auctions saw very solid demand, particularly for the longer-term 10-yr and 30-yr securities, which are the most comparable to MBS. The cause for concern is that some important buyers, including China, have been hinting that they will reduce their Treasury purchases if the US doesn't display more fiscal discipline. If demand were to fall, then yields would need to rise to attract investors, which would not be good for mortgage rates.

Also Notable

• The Fed's Beige Book reported "broader" improvement in economic activity
• The European Central Bank (ECB) made no change in rates
• The Dow stock index reached a 15-month high during the week
• The Fed purchased $14 billion in agency MBS during the week ending 1/13

Average 30 yr fixed rate:
Last week: -0.02%
This week: -0.10%
Stocks (weekly):
Dow: 10,600 +25
NASDAQ: 2,300 +10 

Week Ahead

Next week, the Producer Price Index (PPI) will be released on Wednesday. PPI focuses on the increase in prices of "intermediate" goods used by companies to produce finished products. Housing Starts is also scheduled for Wednesday. Leading Indicators and the Philly Fed index will come out on Thursday. The Treasury will announce the size of upcoming auctions on Thursday as well. Mortgage markets will be closed on Monday for MLK Day.

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