Weekly Market Update

Thanks largely to the likelihood of passing a tax deal, interest rates have been climbing at a rapid pace and analysts have brought worries about rising future inflation back into the economic discussion. It may at first seem like just another swing-- from concerns about possible deflation to anxieties about rising inflation, and back again but this time the worries may have some staying power.



The two central issues here are extensions of tax benefits: first to the unemployed, second to higher-income taxpayers. What is remarkable about these two central issues is that, taken together, they amplify a few worrisome possibilities for the economy's future. Specifically extending unemployment benefits expands the economy's growth- a good thing but probably an inflationary thing. Further, foregoing receipt of higher taxes from wealthier citizens most likely means that we will have to auction even more Treasury securities which is also potentially inflationary.



Now, a strengthening economy, both of these measures should help the economy grow (in the short term, at the least). This nearly always translates into higher inflation and in anticipation of that our interest rates will start to climb as indeed they already have. Further, the likelihood of even more massive auctions of Treasury securities increases the near certainty that interest rates will rise (as demand for Treasury securities fails to fully cover the number of securities being auctioned; its a supply-and-demand equation).



The credit markets don't wait until after something has happened; they react in advance of whatever their investors believe will happen. Investors have begun to worry about inflation already and they anticipate that the seeds of higher interest rates are being sown. Thus Treasury security interest rates are already on the rise and may continue to rise for as long as the tax deal is in place or until something else captures the attention of traders, investors and economists.



It is difficult to predict what, if anything, will grab the markets attention so it seems relatively likely that the rising interest rate trend will be with us for quite some time. However, the bond guru Bill Gross of PIMCO Securities placed a $5.5 million bet on municipal bonds a few days ago. He apparently feels bond prices have fallen quite far and are likely to recover. (Bond yields decline as bond prices rise.)



The take away here is that while rates are clearly on the rise and could continue to rise, the economy is still reacting to external forces to government programs and legislation and not to forces inherent to the current economy itself.



KEY INDICATORS [12/14/10]



Gold $1401.60/ounce [down]

Crude Oil (Brent) $91.55/brl [up]

U.S. Dollar to&

Euro .7577 [up]

Japanese Yen 83.37 [up]

6-mo Treasury Bill Yield 0.18%

10-yr Treasury Note Yield 3.38%

[6-month up 1 bp, 10-yr up 30 bps]

11^th Dist Cost of Funds 1.654%[-]

30-yr Fixed-rate Mortgage 4.95%

15-yr Fixed-rate Mortgage 4.33%

1-yr ARM 3.82%

[HSH averages rates: 30-yr up 9 bps;15-yr up 7 bps; 1-yr ARM up 9 bps]



Mortgage Bankers Association Mortgage Applications Index

week ending 12/3

Overall

Down 0.9%; down 16.5% from the week prior

Purchase Money Loans

Up 1.8%; up 1.1% from the week prior

Refinancing Loans

Down 1.4%; down 21.6% from the week prior



Jobless Claims 12/4

421,000 prior week 436,000 (rev) total insured 4.086 million, down 191,000



Producer Price Index (PPI) Nov

Up 0.8% month-to-month with food/energy prices removed, up 0.3% (1.2% annualized)



Retail Sales Nov

Up 0.8% month-to-month without auto sales, up 1.2%