Is There Madness In The Mortgage Market?

Mortgage bonds have been rallying since Bhutto was killed yesterday, all due to uncertainty about who will take control of the nuclear power there.  As is typical with uncertainty, there is a "flight to quality" which means bonds, including mortgage backed securities, benefit even when the fundamentals are lacking.

Is it madness?  Not really, just temporary insanity.

Once the dust settles on the geopolitical issue and we return to fundamentals, bonds will find themselves without much to stand on.  The drastic swings in prices are fueled by low volume and that is rarely sustainable, especially without solid fundamentals.

So, mortgage rates will tick down temporarily, and the correction that has been foreseen will complete itself before the trend higher will resume (readers of my company blog, Florida Mortgage Daily, already knew this was coming).  So, enjoy the rally, but don't expect it to last.

Why not?  In one word, inflation.  CPI and PCE, as well as other economic reports, point to rising inflation and that spells trouble for bonds.  With the Fed still dumping money into the system through auctions and lowering rates, inflation is only going to get worse before it gets better.  That means that when fears subside and reality returns, bonds will not be feeling any love.