DUE FOR A SHAVE? Mortgage Bonds were on a tear all week, so what happened on Friday that took the whiskers right off and gave Mortgage Bonds a clean shave? Although Mortgage Interest Rates had improved gradually during the week, they worsened by about .125% on Friday alone, so let’s lean in and take a closer look. Much of the Mortgage Bond price run-up early in the week was in response to the belief that foreign bank buying of Bonds would be ongoing. Logically, more buyers would mean a stronger market continuing for Bonds. Around mid-day on Friday, news circulated that Euro-bank officials had implied that their upcoming meeting would involve a discussion of European interest rate cuts. After digesting these rumors, Traders knew this could mean that the “Sugar Daddies” in the foreign markets might be less inclined to purchase US Bonds to protect their cu rrency against the US Dollar. Simple rumors, but panic ensued, and the shaving began with a frenzy late on Friday. Once the selling began, the Bears who had been sitting on the sidelines licking their paws jumped into the selling action, as well as those Traders who dislike holding weekend positions. Additionally, Bonds had already been trading at very lofty levels not seen since last September, so technical Traders seeing the failure to break key resistance levels added their blade to the selling action as well. After a nice week of stair-stepping higher, Friday’s aftershave was a harsh slap in the face for Bonds as they lost a whopping 63 basis points. Now that stings.

Turning the other cheek, Stocks continue to be resilient. The S&P 500 Index has strung together nine consecutive weeks of gains…a streak like this has not been seen since 1989. But the other indices closed slightly lower for the week to break their recent string of weekly advances. An interesting note - the Japanese have a "Record Session Highs" theory. After experiencing anywhere from 7 to 10 record session highs, they say “LOOK OUT BELOW” as it means the market is ripe for a reversal lower. With stocks closing flat to slightly lower last week, are equities finally getting a bit tired as we approach the end of fourth quarter earnings season? A correction in the stock market, should it occur after this earnings season winds down, could help mortgage bond prices, which would result in a relatively stable Mortgage Interest Rate environment.

HAVE YOU STARTED TO RECEIVE MAIL BOLDLY STAMPED “IMPORTANT TAX INFORMATION ENCLOSED”? AH YES, TAX PREPARATION TIME IS UPON US. BUT MAJOR REFORM IN THE TAX CODE COULD RESULT IN SOME SHAVING OF YOUR TAX BILL FOR THIS YEAR, IF YOU KNOW WHAT TO WATCH FOR. DON’T MISS THIS WEEKS MORTGAGE MARKET VIEW, WHICH HIGHLIGHTS THE KEY CHANGES AND HOW THEY CAN SAVE YOU MONEY!

After Friday’s news and technical issues combined to “lay the smack down” on Mortgage Bonds, what action can be expected this week? Most importantly, The Fed (the Federal Open Market Committee or FOMC) begins a two-day meeting on Wednesday. The most significant aspect of the meeting will not be the direction of policy interest rates but rather the wording of the policy statement. The Fed statement that “policy accommodation can be maintained for a considerable period” is expected to be presented once more, as the Fed will again make clear that interest rate changes are on hold for at least another quarter. The Fed will need to balance the recent flurry of strong economic data against the absence of new job creations. It will be interesting to see the careful construction of their statement, in their efforts not to “spook” the markets.

The chart below shows Friday’s large loss in Mortgage Bonds, which resulted in shaving off all the gains made during the week. If good economic news is delivered next week with the Fed Meeting and several other high impact economic reports, Mortgage Bonds may likely head right down to the 200-day Moving Average shown below, which would result in Mortgage Interest Rates heading very slightly higher in the week ahead.

A tax loophole is something that benefits the other guy. If it benefits you, it is tax reform. - Russell B. Long

Once again – tax preparation time has arrived. Although the deadline is not until April 15th, tax reform enacted in 2003 might have you actually excited to get that return completed early this year and reap the benefits. Here’s a highlight of the changes that will probably mean some extra spending money this time around.

New lower income tax rates. Here’s the skinny on what the tax rates were scheduled to be, and what they now really are:

• The 27% rate originally planned for 2003 is now 25%
• The 30% rate is now 28%
• The 35% rate is now 33%
• The 38.6% rate is now 35%

What does this mean to you? Because the tax change was enacted mid-way through 2003, tax withholding was calculated at the higher levels for the first half of the year. This means excess money was probably withheld, and will increase your refund or decrease your tax bill.

The standard deduction has increased, for those who do not itemize. If you can itemize and save money, by all means – do it. If you claim the standard deduction, good news! New higher standard deductions await the EZ filer.

• Married filing jointly - $9500
• Head of household - $7000
• Single or married filing separate - $4750

Much of the “Marriage Penalty” has been eliminated. The brackets for “married filing jointly” have been expanded, and combining this with the new higher standard deductions and lower tax rates across the board translates into very meaningful savings for married couples.

Kid stuff: The child tax credit jumps to $1000, up from only $600 in the previous year. This credit wasn’t scheduled to reach this level until the year 2010! Families who qualified for this credit may have received $400 of it in the form of a rebate check sent out during late summer and fall. Not enough to send them to college, but certainly more than just play money. Speaking of college expenses – two pieces of very good news. Qualified education expenses can be deducted up to $3000 for tax year 2003, heading up to $4000 for 2004. Also – student loan interest deductions become more meaningful, as the deduction can now be claimed with no time limitations, and the income limitations have been expanded so that more people can take advantage of the deduction. Because income limitations do apply, be sure to check this out with a qualified tax consultant. Last but not least, a break in the “kiddie tax” me ans earnings on investments made in your children’s names will suffer less from the Tax Man as well.

Investing for your future becomes even more attractive, as you can now contribute up to $12,000 to your 401K, up $1000 from last year, and due to increase to $13,000 for 2004. IRA contributions are now allowed up to $3000, and although the deductibility depends on your income and the availability of an employer-sponsored plan – those levels have increased as well. Over age 50? Great news! Your levels of contribution are even more expanded, as you can invest an extra $2000 to your 401K and an additional $500 to your IRA.

A last couple of goodies for upper bracket tax payers: The Alternative Minimum Tax (AMT) exemption has increased by nearly 20%, allowing many more tax payers to escape the extra hit. And if you have been longing for that new expensive car or boat – the luxury tax has been eliminated completely.

Taxes are never fun to pay - but the reform this year is significant, benefits everyone, and puts some real dollars in your pocket. As always, it’s a good idea to consult your tax advisor on a regular basis, or for more specific details on the above tips.

What’s in store this week? Tuesday’s Consumer Confidence Report is always of interest, but Traders will be likely thinking ahead about what The Fed (the Federal Open Market Committee or FOMC) may or may not do when they begins a two-day meeting on Wednesday. Several other hot reports are due out in the latter half of the week, including Home Sales, Initial Jobless Claims, and the Chicago Purchasing Managers Index. With all this upcoming action in mind, mortgage bond Traders will not likely make large moves ahead of the news beginning on Wednesday.

Remember, as a general rule, weaker than expected economic data would indicate the economy is not improving as quickly as expected, and could cause mortgage rates to improve. Positive data would indicate a strengthening economic climate, and could cause mortgage rates to gradually climb higher.

For the week of January 26 – January 30, 2004