What Happened Last Week?
Mortgage backed securities (MBS) lost -8 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to rise to their highest levels of 2015 (so far).
It was a very “choppy” week with a huge swing of 104 BPS from the intra-day high to the intra-day low for the week, but when the smoke cleared, MBS were slightly less at the end of the week than at the beginning of the week.
So far for the month of June, MBS have sold off -169 BPS, which have caused mortgage rates to increase from May’s levels significantly.
Many long-bond traders feel that last week’s positive economic data and inflationary readings have given the Federal Reserve the ammunition it needs to begin raising rates. The only question in their mind is if the Fed will raise rates in June or September.
Across the board, every economic report last week was positive. Both Wholesale Inventories and Business Inventories were double the market forecasts. Retail Sales were better than expectations and showed a very nice month-over-month gain and Consumer Sentiment shot up from 90.7 to 94.6 and handily beat market expectations.
But the “data dependent” Fed is watching two things very closely: Jobs and Inflation. On the Jobs front, the JOLTS report showed a big improvement from 4.994M to 5.376M jobs ready to hire qualified personnel and the Labor Market Conditions Index rose from -1.9 in April to +1.3 in May. Both reports basically mirrored the very strong Non-Farm Payroll data we got a week ago.
On the Inflation front, things have finally turned around as oil prices have moved well off their bottoms. PPI moved from -0.4% in April all the way up to +0.5% in May. And Import Prices also moved from negative to positive:-0.3% in April to +1.3% in May.
There were two very strong Treasury auctions with outstanding demand (as reflected in the bid-to-cover ratios) for out 10 year note and 30 year bonds. However, we had to pay a much higher interest rate for each auction compared to a month ago….so we had to effectively “buy” the demand and it is reflective of the larger trend towards gradually higher rates.
What’s on the Agenda for This Week?
Today is all about Greece as their Prime Minister is about to hold an “emergency” meeting with his cabinet. This deterioration in expectations by bond traders for a new bailout is providing fantastic support for MBS right now but at this point it is not enough of a stimulant to drive pricing above the current channel…so some small gains are expected today from Friday’s close but not a trend reversal. IF it appears that the Greek cabinet is going to cave in and accept the IMF/ECB/Troika’s demands then MBS will sell off. Wednesday’s Fed meeting is key. IF they raise rates, then MBS will drop like a rock (higher rates). IF they don’t raise rates but in Yellen’s press conference it appears that she is trying to prepare the markets for a rate hike in September, then we will see some moderate pressure on pricing. IF Yellen and crew make it clear to the markets that there is no chance for a tightening until 2016, then MBS will rally.
This week is about two things – The Fed and Greece – as this week’s domestic economic data will be overshadowed by those two items.
Fed: The Federal Open Market Committee (FOMC) begins meeting on Tuesday and finishes up Wednesday. They will release their policy statement and interest rate decision at 2EST along with their updated forecasts. But there will also be a live press conference with Fed Chair Janet Yellen afterwards. We have often seen MBS react one way to their policy statement and then completely reverse course after Janet Yellen answers live questions from reporters. The “data dependent” Fed certainly has the reduction in labor slack that they have been looking for and while inflation is not at their 2% level yet….it is on its way and the Fed has been very clear that they do not need to wait for inflation to hit 2%…they just need to have projections of it in the near term. Currently, about 85% of long bond traders expect a rate hike by September with about 25% of those expecting one by this Wednesday. So, a rate tightening by the Fed this week is NOT currently priced in the market. Most traders are expecting the FOMC to lay the ground work out in this meeting for a tightening in September.
Greece: Another “deadline” will likely come and go this Thursday when the finance ministers from the EU all meet. Talks have once again collapsed between Greece and the Troika. Any positive movement in talks (of which there has been none in the last week) will hurt pricing, and any continued stalemate will provide support (i.e., a “bottom”) for pricing.
There will be a good dose of new housing data with the Home Builder’s Index and Housing Stars/Building Permits but these reports generally do not impact pricing too much.
On the Manufacturing front, there will be several reports that should give a good gauge on our economy with the release of the Empire Manufacturing Index, Philly Fed, Industrial Production and Capacity Utilization.
There are no major Treasury auctions this week but there will be a GNMA bond roll over.