What happened last week?
Mortgage backed securities (MBS) gained 23 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to improve slightly from the prior week.
Even though MBS “popped” by +60 basis points on Friday, they still only closed up 23 BP for the week because MBS were under steady pressure for the entire week until Friday.
MBS closed at their highest levels (which equals lowest rates) since February 2, 2015. However, they have traded in this range several times over the past two months.
Brexit
It was a very close vote and in the end the “leave” votes prevailed totaling 17,410,742 or 51.9% of the total votes.
Prime Minister David Cameron announced his resignation but will stay put for the next 3 months or so.
Great Britain is still officially part of the EU. This was a populist referendum and not a policy vote. It is expected that the next Prime Minister and Parliament will at some time in the near term invoke “Article 50” which is the exit clause in their membership with the EU. At that point then Great Britain will have 2 years to gradually ease out of the EU and negotiate new trade agreements with each individual country.
Primarily, voters were most concerned about the UK’s sovereignty and were frustrated with being forced to follow rulings imposed upon them by unelected officials that were operating the EU as a socialist operation and dictating immigration (refugee) laws among other liberal policies that were clearly not the desire of the conservative British nation.
The voters did not fall for and even disliked the “doom and gloom” projections from President Obama, and the heads of the IMF, ECB, BofE as well as just about every major financial institution in London.
We certainly don’t know the timing of their actual exit from the EU but the ripple effects are definitely on the radar of bond traders.
Scotland overwhelmingly voted to stay in the EU. There is already talk of another referendum vote to separate from Great Britain so that they can remain in the EU. This won’t be a major market event though. It was a big concern the last time that they had a referendum vote but that was because the market was concerned about the impact on Great Britain’s economy and that certainly isn’t an issue now.
The Federal Reserve: Just about every “Talking Fed” had come out saying that our own economic conditions were supportive of a rate hike or two this year but held off at the last meeting citing concern over a possible Brexit vote. Does this now mean that there will be no rate hikes this year? Does there need to be a rate cut? This is a big issue and won’t be known for some time. Clearly our economy has been, is and will be operating at a level that does not warrant “emergency low rates” which is what we have right now. Our economy can certainly support (and even needs) a rate hike in order to progress but we might not see one until December if at all.
The Fate of the EU: Does this spell the end of the EU? Maybe…it certainly spells the end of the EU in its current state. Every single member nation has an opposition party that has wanted to exit the Eurozone but has not had the traction to do it. Bond traders are concerned that now those opposition efforts will increase. Since the UK was not part of the currency it’s not as large a factor but if other member nations that are a part of the currency (Germany, Spain, Italy (etc.) leave then it’s game over for the EU.
Domestic Flavor
Durable Goods: There have been some wild swings in this data set and the May data was no exception coming in at -2.2% vs market expectations of -0.5%. When you strip out the volatile transportation sector it fell 0.3% vs market expectations of a flat reading. The culprit? Much has to do with capital goods but this data set simply isn’t jiving with the strong ISM and labor, production, etc., data readings that we have been seeing. Either this report is wrong or all the others are too early to tell.
Consumer Sentiment: The revised June reading (from 94.0 down to 93.5) is actually pretty strong. The current conditions index increased to 110.8 which is a positive for future spending. Of course, sentiment may change after the Brexit. It will be interesting to see how Americans perceive that event as a headwind if anything at all.
Existing Home Sales: The May reading increased by 1.8% for 5.53M units, which was basically in line with forecasts calling for 5.54M units. The median price moved up to $239,700 which is a 4.7% increase from May last year. Inventory levels were only at 4.7 months.
The Talking Fed
Fed Chair Janet Yellen testified before the Senate Banking Committee and the House Financial Services Committee. Overall, she seemed to have softened up a little bit more from her last press conference. There was nothing really new or shocking in her responses that would change any bond trader’s mind on the timing and trajectory of future rate hikes. She was asked in several different ways about the impact of a “Brexit” and she responded, “If it does so, it could have consequences in turn for the U.S. economic outlook that would be a factor in deciding on the appropriate path of policy.”
What’s on the agenda for this week?
Three Things
The top three events that long bond traders will be focusing on this week are:
(1) Brexit fallout: The financial markets (currencies, bonds and stocks) will be in a state of “flux” for the near term with tremendous volatility. But that is not so much to do with figuring out the future economic growth of Great Britain. Instead it’s due to very real fear of what the fate is of the EU. We now have reports of the following nations that want to have a referendum vote: France, Holland, Italy, Austria, Finland, Hungary, Portugal and Slovakia.
(2) Yellen is Yelling: Perfect timing as she will be speaking on a panel alongside the Bank of England Governor and the ECB President on Wednesday.
(3) Manufacturing Data: This is back loaded towards the end of the week. Domestically, there are Chicago PMI and our ISM Manufacturing data. But there are also the Japanese Nikkei Manufacturing PMI and the Chinese Manufacturing and Non-Manufacturing (services PMI).
Market Wrap-up
Overview
MBS had another positive day as every market out there is in “risk off mode.” It’s only the second trading session since the Brexit results and there will be a lot more volatile trading sessions to go before this levels out. Good pricing today.
Domestic Flavor
International Trade In Goods showed a widening goods gap (which is already reflected in a more well known Trade Deficit report). While exports dropped, Imports “popped” which could signal strong consumer consumption.
On Deck for Tomorrow: The 3rd release of the 1st quarter GDP, Case Shiller Home Price Index, Consumer Confidence and Richmond Fed Manufacturing.
Across the Pond – Brexit
Current Prime Minister David Cameron gave a fantastic speech before parliament this morning. We continue to see several headline stories that are getting plenty of attention but are diversionary at best. These include:
– Putin is happy about the Brexit.
– The voters for the “leave” did not know what they are doing and a request has been made (and denied) that they take another vote. But watch this…it could gain traction.
– Britain will not do anything until a new PM and cabinet are in place.
– Scotland officially said that it plans to hold its own vote as they want to stay in the EU.
– European Parliament President Martin Schulz said that Great Britain should formally request (Article 50) a separation at Tuesday’s EU Summit (which they won’t) but he also said, “The British have violated the rules. It is not the EU philosophy that the crowd can decide fate.”