Yesterday's Consumer Price Index showed a year-over-over increase of 3.5 percent in the Cost of Living.  Markets, however, are rejoicing over the "core" inflation rate of 2.2 percent, saying it's tolerable.

So what is "core CPI", you want to know. 

Well, core CPI is just like "regular" CPI except that it specifically excludes the prices of energy and food products because their respective prices can change so rapidly.

Volatilility distorts trends and charts, so when looking at CPI, economists tend to focus on more stable costs in life such as medical care, education, and apparel -- the "core" of living, so to speak.  Overall CPI makes for lots of zig-zags like in the chart at right.

The downside of only watching core CPI is that it's a fair system for looking at long-term trends, but in real life, the long-term is just a series of short-term stacked back-to-back.  Overall CPI does a much better job of reporting the true cost of living on a day-to-day basis.

And, as October's CPI report showed, the cost of living was higher last month in relative terms than it had been in the past year.  And this comes at a time when the U.S. economy could really use a boost.

With more dollars spent on essential items each month, Americans have fewer dollars available for savings and/or discretionary spending. 

If the pressures continues, we could see the beginnings of stagflation -- when everyday costs rapidly move higher while the economy rapidly slows down.  This would weaken the dollar, of course, and be terrible for mortgage rates.

After the Phillies dropped the first two at home, I should have known that this would happen, too.

Not only did September's job data exceed expectations, but August's net loss of 4,000 jobs was revised higher to a net gain of 89,000.  That's a bigger swing than Montpelier.

Mortgage rates are getting bludgeoned this morning as traders:

1. Shift their expectations for the Fed's next meeting
2. Question whether the Fed acted to quickly to lower the FFR last month

Me, I am more surprised that the Non-Farm Payrolls report has this much sway.  Statistically, it's somewhat insignificant.

Both the European Central Bank and the Bank of England left their respective interest rates on hold, relieving some of the pressure on the U.S. dollar.

Had rates increased, it would have increased the relative return of investing in euro- or pound-denominated instruments versus investing in dollar-denominated instruments.  This would have drawn dollars from mortgage bonds and have pushed rates higher. 

But, it didn't.

Instead, mortgage bonds are flat right now as traders prepare for tomorrow's jobs report.  Whispers on the street are calling for an in-line figure -- somewhere near 100,000 jobs.

There are a lot of scenarios that could benefit mortgage rates shoppers, but I am not optimistic that we'll see them.  It's a gut feel based on stories I am reading and business leaders to whom I am talking.  I've been wrong before, though.

In a worst-case event for mortgage bonds, The Doomsday Scenario looks like this:

• August's net loss of 4,000 jobs is revised lower
• September's report exceeds the 100,000 new jobs created expectation

The combination of the above data points would suggest that the credit crunch forced a huge blow-out within Corporate America, but that the pain was ephemeral.  Such a large swing in "new jobs" would suggest that those same businesses that cried poor in August are now pressing forward with internal growth plans as if nothing ever happened.

It would suggest that businesses looked at the credit markets as just a speedbump instead of a roadblock.

This could really complicate things for the Fed come October 30-31.

Down in August, up in September means that the Fed may have jumped the gun by lowering the Fed Funds Rate by 50 basis points at its last meeting and that will spark serious discussion about the role of the Fed in the economy.

And not in a good way; in a way that will create fear and uncertainty.  Incidentally, those are the two worst caretakers for mortgage rates that I can think of.

The last Fed meeting just finished up, but markets are already looking ahead to the next one, a two-day affair October 30-31.

If you'll remember, in the immediate aftermath of the Fed's announcement to lower the Fed Funds Rate by 0.500%, mortgage bonds were the hit of the party and everybody wanted to dance.  Rates on mortgages plunged immediately, despite the corresponding decline in the dollar pushing the value of the underlying bonds lower. 

It didn't really make sense at the time but, then again, markets don't always make sense or behave rationally.

The following morning, the markets woke up with a hangover. 

Immediately (if not sooner), traders undid everything from the day before.  Mortgage bonds gave up their gains and then some, starting a trend that moved mortgage rates to their highest levels in a month. 

Crash test dummies don't get whipsawed this hard.

True to form, the markets are ignoring last week's housing data because it's largely irrelevant and the players are instead focusing on jobs data.  This week, there are three jobs-related data points against which mortgage rates may move.

1. Wednesday's ADP Employment Report: Payroll company ADP releases its companion to the Bureau of Labor Statistics' monthly jobs report.  The ADP survey is rarely even close to the jobs report figures but still manages to spook investors.  "What if this time they get it?"  It's kind of like my Phillies -- once every 100 years, they're going to win the World Series.  Could this be the year?  ADP generates a lot of "whisper numbers" about what Friday's payroll data will look like.
2. Thursday's Initial Jobless Claims: A measure of how many Americans are filing for unemployment for the first time.  The lower the number (presumably), the higher the amount of jobs created.  Jobless claims have been trending lower over the past month.
3. Friday's Non-Farm Payrolls Report: Bureau of Labor Statistics releases the most important jobs data of the month, a survey showing the number of new jobs created in the month of September.  More employed Americans translates into more spending, stronger economic growth and potential inflation.  That is why strength in jobs tends to push mortgage rates higher -- inflation is the enemy of mortgage bonds.

Mortgage rates should idle today and tomorrow and then will react strongly to the ADP report.  If ADP shows strength versus the 100,000 jobs expected in Friday's report, mortgage rates should increase.

This morning, the Non-Farm Payrolls report showed a net loss of 4,000 jobs in the month of August, its first net decline since 2003.

Markets expected some weakness in the report, but not this kind of weakness.  Already, mortgage markets are up 31 basis points today. 

That's a swift, powerful reaction, especially considering that the unemployment rate remained unchanged at 4.6% and is viewed as "strong".

Today, mortgage rates are moving because the investors think the Fed now has an economic reason to lower the Fed Funds Rate later this month. 

But is the economics even there?  If we look deeper at the numbers, we can answer the question(s): What is the true significance of this morning's Non-Farm Payrolls report?  Is the mortgage market's reaction justified? 

Consider the following (subject to revision in October and November):

• 4,000 jobs were lost in August versus expectations of 110,000
• 24,000 fewer jobs were created in July than previously measured
• 57,000 fewer jobs were created in June than previously measured

Adding it up, today's actual news was that the number of working Americans was off by a measure of 195,000 against the total number of employed people of 146,000,000.  In percentage terms, the "surprise" represents 0.134% of the overall workforce.

Now, let's put that 0.134% adjustment in mathematical perspective:

• 0.134 percent is one foot in the height of the Golden Gate Bridge
• 0.134 percent is one person living in Foxfield, Colorado
• 0.134 percent is one double in the storied career of Charlie Hustle

Statistically, 0.134 percent is insignificant. 

And yet, mortgage rates are plowing lower today while economists chirp about dramatic economic weakness tied to the credit markets.  If I hear one more person say that Fed has to lower the Fed Funds Rate because of today's payroll report, I'll barf.

So, just like the last time I did a study like this, the market is reacting strongly to data because of its psychological implications, not because of a fundamental analysis.

This morning, three economic data points are pointing to stability in the economy.  However, while the data doesn't disprove an inflationary market, it's not showing enough of a slowdown to calm fears of it.

It's kind of like my backyard. 

I can't see the weeds, but I know that they're there.  I turn my back for just one weekend and -- thwapp! -- there they are.

The Producer Price Index registered a 0.3% increase, beating the expectations of a 0.2% rise.  Couple this with Industrial Production and Capacity Utilization effectively meeting estimates and you have a flat-to-higher inflationary reading on business.

In English, the data shows that businesses are producing more goods, under more strain, and with higher expenses.  But barely.  This worries mortgage markets because eventually businesses make a very important decision:

1. Should we absorb the higher costs and take them as a loss?
2. Should we pass on the higher costs to consumers?

Tomorrow, we may find out which path businesses are taking.

At 8:30 A.M. ET, the June Consumer Price Index will be released and that will help us understand if the higher costs are being passed on to consumers.  CPI is expected to increase 0.1%.

If CPI comes in higher than expected, it will be viewed as inflationary and inflation is the enemy of mortgage bonds.  Higher inflation means that mortgage rates will head higher, too.

As Retail Sales plunged 0.9% -- the steepest mark in two years -- and Consumer Sentiment surged by 8.3%, we have to (once again) question if the University of Michigan Consumer Sentiment survey is of any use at all.

Assuming that there is a lag between a consumer's "improving feelings about the economy" and the time they spend their dollars, we would expect that the improvement since February would translate into Retail Sales improvements, too.

It didn't, and it hasn't (in this very small sample set).

Here are the questions of the University of Michigan Consumer Sentiment survey, courtesy of the Federal Reserve Bank of Philadelphia:

1. We are interested in how people are getting along financially these days. Would you say that you (and your family living there) are better off or worse off financially than you were a year ago?
2. Now looking ahead--do you think that a year from now you (and your family living there) will be better off financially or worse off, or just about the same as now?
3. Now turning to business conditions in the country as a whole--do you think that during the next 12 months we'll have good times financially, or bad times, or what?
4. Looking ahead, which would you say is more likely--that in the country as a whole we'll have continuous good times during the next five years or so, or that we will have periods of widespread unemployment ordepression, or what?
5. About the big things people buy for their homes--such as furniture, a refrigerator, stove, television, and things like that. Generally speaking, do you think now is a good or bad time for people to buy major household items?

500 people are polled and the answers to these five questions are used to predict the future of consumer spending. 

However, how people say they'll act and what how they actually act are two very different things.  As the chart above illustrates.

Sources
Reuters: Customer Zone - Reuters/University of Michigan Surveys http://customers.reuters.com/community/university/default.aspx

Advance Monthly Sales for Retail and Food Services
U.S. Census Bureau

After ADP had traders questioning the 120,000 non-farm payrolls estimate yesterday, the Bureau of Labor and Statistics reported this morning that 132,000 jobs were created in June.

Like in every month, though, the bigger NFP story is what revisions were made to months prior. 

• May revised 33,000 jobs higher to 190,000 (21.02% revision)
• April revised 42,000 jobs higher to 122,000 (52.50% revision)

Through six months this year, new jobs are being created at the clip of 145,000 new jobs monthly.

Mortgage rates are higher this morning on the in-line data coupled with upward revisions.  With the holiday week contributing to low volume, pricing is slightly volatile, too.

All day, mortgage rates were feeling pressure to move higher and then in the last two hours, the heat intensified.  Many mortgage lenders are re-issuing rate sheets this afternoon to reflect the change in market dynamic.

Rates are pressured partly because of the ADP jobs report released earlier today.  The report predicts that tomorrow's 120,000 estimated jobs created in June is way below the actual number.

Job creation --> Spending --> Economic Growth --> Inflation

The safe play right now is to lock your mortgage rate in ahead of tomorrow's 8:30 A.M. ET release.  When you lock your rate, there is no losing scenario.

After a week in which the Fed expressed concern that "inflation may fail to moderate as expected" and the dollar did little to emerge from a long-running funk, this could be the week that the University of Michigan Consumer Sentiment Survey actually matters.

Stop me if you've read this one before: Consumer Spending makes up 70% of our economy.  When the cost of living increases for Americans, it has far-reaching implications that eventually trickle down to mortgage rates.

What people say and what they do are often two very different things but there eventually comes a tipping point where you have to pay attention.

This week may be that week.

First some background:  I don't drive a whole lot.  I live in Chicago and am walking distance to the El.  On weekends, I walk places unless I am headed to Dominick's, Costco or Trader Joe's.  For dinner or theater, we usually cab.  My car gets one new tank every 2-3 weeks, if that.

Now, check out the receipt at right.  This was my first $50 tank of the season.

My car is not large and neither is my tank, but I can't say the same thing for other Americans.  This is the Land of the SUV and we're all paying at the pump.  Surely other people are feeling the pain worse than me. 

And then you have the people that The New York Times calls Extreme Commuters.  They're getting punished, fer sure.

Back to my point.

The Consumer Sentiment survey is largely a waste, but when guys like me who rarely get behind a wheel notice that prices are moving higher, it helps to remind us that there are people that fill up their tanks 2-3 times per week.  That makes a major dent in a family budget.

Sooner or later -- if gas prices remain high -- there will be a breaking point for the consumer and that will spill over into other parts of the economy.  It's not a coincidence that credit card spending rose 209% in April.  Consumers may be using that last Visa and Mastercard lifeline as we speak.

Friday's survey is expected to show weakness, but if that weakness is over-the-top, there will be strong downward movement in mortgage rates as expectations for a slowdown pick up speed.   

So far today, a tepid response to the Non-Farm Payroll data. 

Against expectations of 100,000 jobs created in April, the Bureau of Labor Statistics reported a weak 88,000.  March's figures were revised downward by 1.6%, reflecting additional (albeit small) weakness.

The reaction today is different from months past.

Over the last 12-18 months, weak jobs numbers sparked rallies in mortgage bonds.  Today, by contrast, markets are taking the news in stride. 

This is because traders may no longer believe that the Fed has its finger on the Rate Hike Trigger.  The Fed's next step, traders believe, will be to ratchet the Fed Funds Rate lower. 

In other words, traders are leaning towards market softness in the months ahead.

So, with the Fed's scheduled meeting next week, and with traders gambling on weaker economic growth, there isn't much upside risk to floating a mortgage rate over the next few days.  The likelihood of mortgage rates increasing far outweighs the likelihood of them decreasing.

In its press release nextweek, if the Fed says it can continue to "be patient" while observing the economy, mortgage rates won't budge because that scenario is already priced in. 

But, if the Fed states that it may have to increase the FFR to cope with rising wage pressures and inflation, mortgage rates will jump.  Quickly.

Given the outlook for the next few days, it may make sense to lock your rate now.

According to the GDP data released this morning, economic growth is slowing.

Normally, slowing growth would be fantastic news for mortgage rate shoppers, because slowing growth tends to lead to lower mortgage rates.

Today, however, that's not the case because employment is strong, cost of living indicators are high, and the Fed is worried about inflation.  Inflation, you'll remember, is when the value of the dollar decreases and more dollars are needed to buy everyday items. 

A weaker dollar does more to raise mortgage rates for homeowners than an economic slowdown does to lower them.  It's not very common to see both conditions exist simultaneously.

As the inflation-and-growth controlling arm of the government, the Fed may now find itself in a bind with respect to setting the Fed Funds Rate going forward. 

See, the Fed can't raise the FFR to stave off inflation, nor can it lower the FFR to stoke growth.  Therefore, the Fed is somewhat resigned to sitting back and just waiting to see what comes down the river.

San Francisco Fed President Janet Yellen acknowledged this dilemma yesterday, stating that the Fed is most likely to enter a "watchful waiting" mode before deciding to raise or lower rates. 

This comment surprised markets which expected the Fed to begin cutting the FFR as soon as this summer.  Mortgage rates moved higher in response.

If you were floating your mortgage rate overnight, there is some bad news coming out of the trading pits.  Mortgage rates are getting killed this morning.

Low trading volume related to Good Friday generated extreme reactions to this morning's Non-Farm Payrolls.  When the jobs report showed 180,000 new jobs created -- a hot number by any standard -- the reaction was swift and decisive. 

Mortgage bonds are off 22 basis points and it's not even 10:00 A.M. on Wall Street.  The carnage won't be limited to just today, either. 

The stock market is closed today so when it re-opens Monday, capital will want to flow into stocks based on the perceived strength of the economy.  Some (most?) of those dollars will come from the bond market and that will place further downward pressure on bond prices.

When bond prices go down, their yields go up and yields = rates for those new to the game.  Markets close at 1:00 P.M. ET today so get your locks in quickly.

Update (10:07 A.M.): Mortgage bonds are now off 29 bps on the day.

Tomorrow is Good Friday and trading volume will be thin.  That means that mortgage rates will be extra jumpy in the face of the Non-Farm Payrolls report.

Right now, markets are expecting to see 120,000 new jobs created in March, but watching trading activity, many traders seem to be placing bets that the actual number will be lower than that.

This has created a bad situation for rate shoppers.

If the number comes in lower than 120,000, markets will not react much because that figure seems to be priced in to mortgage bonds already.  If the number comes in as expected (or higher), traders will have to quickly change their positions and that will cause mortgage rates to move higher.

In other words, there's very little upside and a ton of downside. 

The lack of liquidity because of the holiday will only add oomph to the rate swings we see in response to tomorrow's data.

If you're shopping, now would be a good time to lock -- if only for protection from tomorrow's data.

Thank heavens for a slow week on Wall Street because I have neglected you all these past few days.  Don't take it personally, of course.

Right now, it's all eyes on Friday and the non-farm payrolls report due at 7:30 A.M. CDT.  After Bernanke's hawkish remarks on inflation last week, traders are nervously waiting for the release to place their next major bet. 

Economists are predicting 120,000 new jobs created in March.

Until Friday (or Thursday afternoon), overseas tensions could spark rates in one direction or another.  If Iranian-British tensions spill over to the United States, for example, mortgage rates may fall on a flight-to-quality. 

Of course, mortgages may no longer be considered as "quality" as before so maybe there won't be as much foreign-nation buying to buoy down rates.

A little known fact about yesterday's CPI numbers: they weren't as inflationary as you would have otherwise thought.  It all comes down to decimals and rounding.

What The Headlines Reported

• CPI: 0.2% increase in January
• Core CPI: 0.3% increase in January

What The Actual Figures Were

• CPI: 0.174% increase in January
• Core CPI: 0.256% increase in January

Annual Impact of Decimal Rounding

• CPI: 0.312% increase to CPI
• Core CPI: 0.528% increase to Core CPI

Those annual figures are astounding (and extremely dangerous).

The rounding from three decimals places to one really warps the interpretation of the data.  After all, without three decimal reporting, Ty Cobb is a career .4 hitter and Ted Williams is no more special than Ginger Beaumont at .3.

Interpreting economic growth requires precision and the current rounding-in-reporting method is anything but. 

Today's Non-Farm Payrolls report damaged more than ADP's economic forecasting reputation -- it also damaged the market's hope that Fed will lower the Fed Funds Rate by May.

Prior to this morning's release, the Fed Fund Futures reflected a 53% chance that the FFR would drop from its current 5.250% level at or before the May FOMC meeting.  According to David Gaffen of the Wall Street Journal, the probability is now 34%. This expectation change will pressure mortgage rates higher. 

Why?  Because job creation is one signal of an expanding economy and this will force the FOMC to change course -- it had been planning for a gradual slowdown in 2007.

The Non-Farm Payrolls report offer key clues to the overall growth of the US economy and the logic works like this:

1. Growing companies hire new workers that were previously unemployed
2. New workers earn money that they didn't earn while unemployed
3. Money gets spent and put back into the economy
4. Companies continue to grow to meet the growing demands of consumers/workers

In addition, wages generally move higher in an expanding economy as companies try to keep their employees and we saw evidence of that in December as well; today's release showed a 0.5% increase in hourly earnings versus an expectation of 0.3%.

Once more, more money is earned and, therefore, more money is spent, propelling the economy forward.

Whereas last month markets were waiting for the other shoe to drop on the economy, they are now bullish on growth.  That does not bode well for people who have shopping for homes, or have not yet locked their mortgage rates in advance of a planned closing.

(Image source: ekkyp)

Well, now we know what ADP stands for.

This morning's Non-Farm Payrolls report (i.e. the number of new jobs created for industries other than farming) registered a 167,000 gain in November.  This is tremendously higher than economists had predicted.

Markets were caught leaning in the wrong direction after an ADP report said that 40,000 jobs were lost in November.

In a horrific (and immediate) whipsaw, mortgage rates have surged higher, reversing yesterday's gains.

In July, we talked about ADP's version of the Non-Farm Payrolls report and we had a good laugh about it.

Economists had predicted that 175,000 new jobs were created in June and ADP pre-empted the BLS release by estimating that 368,000 new jobs were created.

The actual figure when BLS released was 121,000.

ADP's prediction last July was so far out the ballpark, it was as if they got off at 35th St instead of Addison. 

That major swing-and-a-miss jolted the markets because it had suddenly wondered if ADP knew something "inside".  After all, ADP is one of the largest payroll processors in the world and certainly they would know if companies were adding jobs to the economy.

But, they didn't.

Naturally, it's big news that ADP is predicting that 40,000 jobs were lost in December 2006 versus economists' predictions of 115,000 jobs were created. 

Mortgage bonds have staged a small rally and mortgage rates are retreating as markets wonder once again -- what does ADP know? 

They won't have to wait long to find out because the government's job report is released at 8:30 EST Friday.  Then we'll know if ADP stands for "Another Dumb Prediction" or "Accurate Data Predictions".

With traders around the world on vacation (or otherwise taking it easy) this week, the impact of housing reports will be magnified because liquidity is missing from markets.

Since mid-Summer, the Fed has repeatedly told us that housing will lead to an economic slowdown.  As a result, markets have placed housing under a microscope and this week features two key housing releases -- New Home Sales and Existing Home Sales.

To understand why housing is an economic lynchpin, just think about the last time you bought a house.  What sort of purchases did you make that you wouldn't have made if you hadn't moved? 

Here's a small sample of what my family bought in the wake of our last move:

• Television(s)
• TiVO
• Stereo system
• Cabinets
• New doors for the patio
• Blinds/Shutters and window dressing
• Furniture
• DVD player

And, nevermind the 1,000 trips to Home Depot.  There is more that I could add to this list, of course, but it's a good sample.

If we hadn't moved, we would have never bought those items and our dollars would have "stayed out" of the economy.

Like most people, when we moved, we took residence in a larger home with more space, more rooms and more need for decorating.  All of that spending pumps money into the economy and keeps it growing.

So, each time that the Fed's members say that they expects housing to create an economic slowdown, what they are really saying is that because fewer people are buying homes, there will be less propulsion in the economic engine. 

Understandably, markets pay close attention to housing data because they now believe that housing will give clues about the economy's direction in 2007.

When housing news crosses the wires this week, there will be fewer buyers to match with sellers, resulting in price volatility.  As a result, mortgage rates may dance like Elaine with all sorts of herky-jerky movements.  That's the way it goes when the whole world goes on vacation -- the lack of liquidity leads to the absence of smooth pricing changes.

It could be a wild ride, but mortgage rates will remain in a tight range.

Sweet fancy Moses.