[jgillisp]

Last week the markets finally woke up to the reality that that what has been the driving force for the economy may now be ending. Credit has been historically cheap for the past two years allowing corporate borrowing, stock buybacks and M&A activity to exceed anyone's expectations at the beginning of the year. It is over! With the sub prime mortgage problems now infecting the broader mortgage market and no end of the housing slump in sight, credit spreads between treasuries and other debt widening rapidly, the stock market presently running out of gas; it all combines to lead to increasing expectations that the economy will not do as well as the Fed has been thinking (as well as most private analysts).



Last week the S&P 500 index decline was the worst week in five years. Although the preliminary Q2 GDP exceeded expectations; the worry now is that with corporate borrowing costs increasing, the housing market not anywhere near a bottom, and likely going to get worse, energy prices headed higher, consumers tapped out and beginning to default on home equity loans, and a whole lot more to come in the sub prime mortgage foreclosures, the economy is headed for a major slowing. Add in home values in 20 U.S. metropolitan areas fell by the most in at least six years, making it harder for homeowners to borrow against their equity to fund purchases----consumers drive the economy and account for 66% of GDP.



The US bond market has been fueled by safe haven buying as the stock market declines and credit problems increase. Driving rates lower last week in the Treasury market didn't feed much into the current mortgage market pricing as mortgages are not considered as safe today as in the past. By the end of last week trading in the Fed funds futures market had priced a 100% chance that the Fed would lower rates by the end of the year; two weeks ago the betting was for just a 40% chance. But don't make a lot out of it at this point; trading in that market is a day to day thing and we don't make a lot out of it other than it does support the present price increases in treasuries.



Still no great number of bears out there for the stock market; most are still waving the red bull flag. Wall Street doesn't make money in bear markets so it takes a lot for the Street to admit a bear market may be on the horizon; most analysts are continuing to forecast better stock prices ahead, but it is getting harder for them to justify it given all that is building against a bullish outlook.

Today, and through the week; the bond market will take its lead from how the equity market performs. The stock market is technically oversold and may see some support as a result, but the smart money is looking to get out as the pundits try to hold it together with bullish talk. Mortgage prices will find some support as treasuries gain, however it is safe haven moves and mortgage prices will lag the treasury market on rallies but will fall as fast as treasury prices on any selling. The bellwether 10 yr note will continue to find resistance at 4.75% as long as the equity market holds; once 4.75% is taken pout the next target is 4.60% where more serious resistance can be expected.