Ben Bernanke has ended his Q&A session with members of the Congressional Joint Economic Committee. Here are my observations:

POSITIVE CONTRIBUTIONS TO THE ECONOMIC OUTLOOK

1. Business Inventories can only contract for so long before expanding. In Q4 2009, less inventory reduction played a pivotal role in GDP growth: "the boost from the slower drawdown in inventories accounted for the majority of the sharp rise in real gross domestic product (GDP) in the fourth quarter of last year". READ THE FULL STORY
2. "Capital spending on equipment and software appears to have increased at a solid pace again in the first quarter".
3. "Consumer spending should be aided by a gradual pickup in jobs and earnings, the recovery in household wealth from recent lows, and some improvement in credit availability."
4. "U.S. manufacturing output, which is benefiting from stronger export demand as well as the inventory adjustment I noted earlier, rose at an annual rate of 8 percent during the eight months ending in February."

TWO KEY QUOTES:

• "Supported by stimulative monetary and fiscal policies and the concerted efforts of policymakers to stabilize the financial system, a recovery in economic activity appears to have begun in the second half of last year."
• "On balance, the incoming data suggest that growth in private final demand will be sufficient to promote a moderate economic recovery in coming quarters."

Plain and Simple:Thanks to the historic actions of the US government, the worst case scenario appears to have been avoided. Minus government spending, the economy should be (thats how I read "suggest") able to support a slow recovery.  The use of the word "appears" and "should be" does not instill a great deal of confidence in this outlook, but it's a step in the right direction.

NEGATIVE CONTRIBUTIONS TO THE ECONOMIC OUTLOOK

1. "Sales of new and existing homes dropped back in January and February, and the pace of new single-family housing starts has changed little since the middle of last year."
2. "Outlays for nonresidential construction continue to contract amid rising vacancy rates, falling property prices, and difficulties in obtaining financing."
3. The flip side to Business Inventories: FIRMS WILL ONLY GROW INVENTORIES IF CONSUMER DEMAND IS STABLE!  "With inventories now much better aligned with final sales, however, and with the support from fiscal policy set to diminish in the coming year, further economic expansion will depend on continued growth in private final demand."
4. "Pressures on state and local budgets, though tempered by ongoing federal support, have led to continuing declines in employment and construction spending by state and local governments."
5. THIS IS A BIG ONE: "I am particularly concerned about the fact that, in March, 44 percent of the unemployed had been without a job for six months or more. Long periods without work erode individuals' skills and hurt future employment prospects." I have been discussing this issue in detail over the past 8 months. Unless this group of unemployed Americans can reeducate themselves and retool their specific abilities...there will be a lot more homeless people on the streets. Either that or the government increases social spending . Blah. Neither are good options.

ONE KEY QUOTE:

"To be sure, significant restraints on the pace of the recovery remain"

Plain and Simple: The road ahead is very uncertain. Restraints will not be easily overcome. While the worst case scenario was likely avoided...We Are Far From Being Out of the Woods

Bernanke didn't address the FOMC's "extended period" guidance in his prepared text, but it was the first question he was asked in the Q&A session that followed. In very good form, Ben replied with a "middle of the road", the Committee will continue to evaluate type answer.

Overall I really didn't take anything new from today's hearing. My dovish stance was reconfirmed.There are still significant restraints on the economy, inflation is controlled, we don't need to raise interest rates.We should be expecting the Federal Reserve to keep short-term borrowing costs extremely accommodative until phrases like "should happens" evolve into "will happens" and terms like "appear" are removed from monetary policy rhetoric.

Yesterday I explained why Federal Reserve policy communications were so important to mortgage rates (at the moment). To be as economical as possible: if 2yr note rates decline, it makes it easier for "rate sheet influential" 10yr yields to move lower. HERE IS AN EXPLANATION

Well. Regardless of Ben's gentle tone and tactful use of words...2yr note yields just can't seem to break below 1.00%. We did see yields improve in the short end of the curve. The 2yr note is still basically unchanged on the day though...

The 10 year note is waiting for more guidance...specifically for 2s to break 1.00%. Until then it looks like 10s are just passing time in a range. The yield curve did flatten considerably yesterday and it did so in strong enough volume to say the recent rates rally has some conviction behind it. 

The 3.625% coupon bearing 10 year note is -0-05 at 98-08 yielding 3.838%. A breakdown of 3.85% support would be bad for mortgage rates. We want 10s to test 3.78%...then our eyes are on the 3.71% prize.

Nothing fun to report in the agency MBS market today.  Yesterday provided the once or twice a week fireworks I expect to see in the weeks/months ahead. Yield spreads did loosen up late yesterday afternoon as originators hedged their pipelines. Today relative valuations are a touch of those wides...but nothing momentous or noteworthy. Tradeweb says MBS trading volume is running near average levels. Originator pipelines need time to rebuild after the $2 to 2.5bn in loan supply that hit screens yesterday afternoon. Once they do...we should see mortgage valuations get a bit more volatile. For now we are playing follow the leader with benchmark guidance givers (10s and 10yr IRS)

In terms of price, the rally we enjoyed on Monday is still intact. The range is consolidating and energy is being stored to be put to work at a later time. Usually that technical pattern does not turn out well as it implies prices will move lower. However because our directional guidance giver (UST10YR) is range trading..it doesn't tell us all that much.

The FN 4.5 is -0-03 at 100-06 yielding 4.484%. The secondary market current coupon is 4.478%. The current coupon yield is 64 basis points over the 10yr TSY note yield and 68.4 basis points above the 10yr interest rate swap.

Implied volatility is very low. The bond market is numb again. I do not like this feeling. While we see good reason to believe 10s are about to make a break lower...this is one of those situations where energy is being stored up for a big move. We are either about to test 3.71% or 3.92%.

 If 10s do rally on, mortgage rates will lag. This doesn't provide much hope for significant improvements to rebate. Considering rate sheets have recovered from the worst levels of 2010 all the way back to the best levels of 2010...now looks to be a great time to lock up a portion of your 30 day pipeline profits.