Dustin McAlister

Bad is bad but not worse.

As you are probably well aware by now -- employers slashed payrolls by a smaller-than-expected 539,000 workers in April. That was the smallest number of jobs lost on a national basis since October -- and was well below economists' estimates for an April headline nonfarm payroll job loss figure of 600,000+. April is the first month that job losses have not exceeded at least 600,000 since December of '08.

It is worth noting that private payrolls fell by 611,000 last month -- but that loss was offset by government hiring of 72,000 workers for the 2010 census. That particular detail, together with the fact that the national jobless rate rose to 8.9% from the March level of 8.5%, sharply muted the initial shock among mortgage investors caused by the "surprisingly improved" headline nonfarm payroll number.

As I write, it appears the "Maalox Moment" created by this morning's employment numbers has passed and calmer, cooler heads are buying mortgage-backed securities - most likely motivated by the idea that it will still be many months before meaningful improvements in the nation's labor sector will develop. These more experienced investors are also keenly aware the Fed still has more than $750 billion in their back pocket, earmarked for nothing other than to support steady to perhaps fractionally lower mortgage interest rates. It makes no sense to expect mortgage interest rates to move dramatically higher until the Fed has burned through at least another $200 billion of their big mortgage market friendly "war chest."

Looking ahead to next week the economic calendar will include Wednesday's April Retail Sales numbers together with the inflation story contained in Thursday's Producer Price index and Friday's Consumer Price Index. All three measures are expected to show minuscule gains. If so, look for these reports to draw nothing more than a disinterested shoulder shrug from mortgage investors.

Mortgage investors will no doubt approach the next two days as carefully as a naked cowboy facing the challenge of climbing over a barbed wire fence. There is nothing like a major Treasury auction, the release of a much anticipated government mandated bank stress test, and an upcoming major macro-economic report to make mortgage investors antsy.

Uncle Sam is in the credit markets once again this morning looking to borrow $14 billion in the form of 30-year bonds. This will be the last leg of the Treasury Department's three-part quarterly refunding. A number of analysts are concerned that the current yield of 4.17% is not high enough to attract significant buying interest from auction participants. If these concerns are proven to be well founded -- the bid price for this offering will fall - pushing the yield on the 30-year bond higher. That's a scenario that will almost certainly result in higher mortgage interest rates. In my judgment, while the yield on the 30-year bond may indeed be pushed higher -- as investors chose to remain guarded in front of this afternoon's release of the government's bank stress test results and tomorrow's big April nonfarm payroll data - the 30-year bond yield won't climb by much and the overall impact on the current level of mortgage interest rates related to these events will be minimal.

The results of the government's "stress test" for 19 of the top banks in the country will officially be made public at 5:00 p.m. ET today. Treasury Secretary Geithner has reassured investors that none of the 19 banks under examination are at risk of insolvency. Some banks in the group may need injections of additional capital to meet the new government standards. Should the total amount of capital required to bring these banks "up-to-snuff" fall below $300 billion - most analysts believe investors will breathe a big sigh of relief -- and the rally in the stock markets will continue unabated. I'm not so sure - but should this scenario "pan-out" like most predict it will - this event will tend to put some modest additional upward pressure on mortgage interest rates.

The unexpected drop in the number of people filing first-time claims for unemployment benefits during the past week was a bit unsettling for mortgage investors. The Labor Department reported weekly jobless claims for the period ended May 2^nd fell by 34,000 - equaling a mark last experienced in January. The four-week moving average of jobless claims, a better gauge of underlying labor trends because it irons out week-to-week volatility, fell for the fourth week in a row. The survey period for this week's jobless claims data falls outside of the survey period for tomorrow's much more important April nonfarm payroll report. Nonetheless, a number of mortgage investors are marking their headline forecast for nonfarm payrolls down to a loss of 600,000 to 590,000 jobs from their earlier estimates for April job losses of 620,000 or more. Only a handful of analysts have elected to mark down their expectations for a national jobless rate of 8.9% to be reported tomorrow.

Mortgage investors will no doubt approach the next two days as carefully as a naked cowboy facing the challenge of climbing over a barbed wire fence. There is nothing like a major Treasury auction, the release of a much anticipated government mandated bank stress test, and an upcoming major macro-economic report to make mortgage investors antsy.

Uncle Sam is in the credit markets once again this morning looking to borrow $14 billion in the form of 30-year bonds. This will be the last leg of the Treasury Department's three-part quarterly refunding. A number of analysts are concerned that the current yield of 4.17% is not high enough to attract significant buying interest from auction participants. If these concerns are proven to be well founded -- the bid price for this offering will fall - pushing the yield on the 30-year bond higher. That's a scenario that will almost certainly result in higher mortgage interest rates. In my judgment, while the yield on the 30-year bond may indeed be pushed higher -- as investors chose to remain guarded in front of this afternoon's release of the government's bank stress test results and tomorrow's big April nonfarm payroll data - the 30-year bond yield won't climb by much and the overall impact on the current level of mortgage interest rates related to these events will be minimal.

The results of the government's "stress test" for 19 of the top banks in the country will officially be made public at 5:00 p.m. ET today. Treasury Secretary Geithner has reassured investors that none of the 19 banks under examination are at risk of insolvency. Some banks in the group may need injections of additional capital to meet the new government standards. Should the total amount of capital required to bring these banks "up-to-snuff" fall below $300 billion - most analysts believe investors will breathe a big sigh of relief -- and the rally in the stock markets will continue unabated. I'm not so sure - but should this scenario "pan-out" like most predict it will - this event will tend to put some modest additional upward pressure on mortgage interest rates.

The unexpected drop in the number of people filing first-time claims for unemployment benefits during the past week was a bit unsettling for mortgage investors. The Labor Department reported weekly jobless claims for the period ended May 2^nd fell by 34,000 - equaling a mark last experienced in January. The four-week moving average of jobless claims, a better gauge of underlying labor trends because it irons out week-to-week volatility, fell for the fourth week in a row. The survey period for this week's jobless claims data falls outside of the survey period for tomorrow's much more important April nonfarm payroll report. Nonetheless, a number of mortgage investors are marking their headline forecast for nonfarm payrolls down to a loss of 600,000 to 590,000 jobs from their earlier estimates for April job losses of 620,000 or more. Only a handful of analysts have elected to mark down their expectations for a national jobless rate of 8.9% to be reported tomorrow.

Uncle Sam is splashing around in the credit market this morning looking to borrow $22 billion in the form of 10-year notes. He'll wrap-up things up at 1:00 p.m. ET.

As expected, yesterday's three-year note auction went off without a hitch and generated solid investor demand. Keep you fingers crossed that today's outsized 10-year note auction goes as well. The Treasury's 10-year notes are currently carrying a yield better than 3.0% -- which should make them enticing to domestic and foreign investors alike. A well bid 10-year note auction will tend to support steady to perhaps fractionally lower interest rates while weak auction results will likely put some upward pressure on mortgage rates. In my judgment, today's 10-year note offering will likely produce unremarkable bid results. If so, this event will exert little, if any meaningful influence on the direction of mortgage interest rates today.

There was nothing in the way of important economic news from the government on today's calendar - so the private ADP payroll survey and the Challenger, Gray and Christmas survey of layoff announcements garnered a little more attention from mortgage investors than normal. The ADP National Employment Report showed a 491,000 drop in private payrolls in March, a far less severe decline than the 650,000 job loss in the private sector most analysts had been expecting to see. The Challenger report showed planned job cuts totaled 132,590 in April, significantly less that the 150,411 March number. Both of these private reports are known to vary significantly from the labor sector numbers the government reports. Even so, the marked improvement in the private April data has some mortgage investors nervous that the nonfarm payroll report from the Labor Department on Friday may not be nearly as bleak as most analysts currently expect.

Most market participants, economists and analysts in general are expecting the government's April Nonfarm Payroll report will show the nation lost 620,000 jobs (from both the private and government sectors) last month - a condition that has caused the unemployment rate to surge to 8.9% from the March level of 8.4%. Actual numbers that closely approximate this consensus estimate are already priced into the mortgage market and will therefore create little if any impact on the current level of mortgage interest rates.

With respect to the mortgage market, the risk on Friday is that the headline payroll number posts a job loss of 600,000 or less and/or the national jobless rate post a reading of 8.7% or less. Actual numbers that fall meaningfully below current expectations will probably unsettle a rather large number of mortgage investors. As you well know, spooked investors tend to sell first -- and ask questions later. If this scenario were to develop, even aggressive buying by the Fed will not likely be enough to keep mortgage interest rates from moving uncomfortably higher from current levels. In my opinion while this outcome is possible - it is not very probable.

Economic activity will turn a positive corner later in the year as long as the financial sector continues to mend. The improvement will come even as unemployment remains high. This was part of the fairly positive assessment of economic conditions Fed Chairman Bernanke provided to the Joint Economic Committee of Congress earlier this morning. Bernanke said central bankers see reason to believe the housing market may be approaching the bottom of its three-year slide, driven in part by tentative signs of a rebound in consumer spending, the primary driving force behind economic growth. He went on to say that even after the recovery begins, "the rate of growth of real economic activity is likely to remain below its longer-run potential for a while." The story behind all this mumbo-jumbo from a mortgage market perspective is that improved economic activity levels tend to lead to an increased demand for capital from consumers and businesses -- which in-turn ultimately leads to higher interest rates. I realize there are those that argue higher mortgage interest rates are unlikely if for no other reason than the Fed has been an aggressive buyer all year.

Granted, at one time this year the Fed had roughly $1.25 trillion dollars in their back pocket to support steady to lower mortgage interest rates through the direct purchase of mortgage-backed securities. As of last Thursday, the Fed has spent a $404 billion of their available capital. The good news is that experts agree these purchases by the Fed have been instrumental in driving agency- eligible mortgage interest rates to historical lows. The bad news is that the Fed is running a "burn-rate" of roughly $100 billion per month in direct purchases of mortgage-backed securities. The "so what" factor here is definitely worth noting. Once the Fed passes the half-way point (roughly $612 billion in direct mortgage-backed securities purchases) their ability to hold mortgage interest rates near historical lows will begin to fade at an accelerating rate. The probability the Fed will choose to ramp up the amount of capital currently authorized is small. As we move into the second half of the year it is reasonable to expect conforming mortgage interest rates to begin a slow, but progressive march to 6.0% levels and above