What Happened Last Week?
Mortgage backed securities (MBS) lost 44 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move higher. There were the lowest rates on Tuesday and the highest rates on Friday.
The dominant story for long bonds (and therefore mortgage rates) was clearly the concern over a potential currency war with China. Tuesday, The People’s Bank of China (PBOC) devalued their currency (yuan) by the most on record. The PBOC was trying to jump start their economy by making their exports more attractive to foreign buyers because of the lower currency (you can buy more for less). This caused widespread disruption across all markets. However, long bonds settled down and started to give up their low yields as China spent the next three trading sessions supporting their currency and making several moves to keep their currency from devaluing.
Domestically, we got some news on the big three areas of our economy: Jobs, Inflation, and Sales.
On the Jobs front, the four week moving average for the Weekly Jobless Claims data fell to its lowest level in 42 years, which continues to show decent improvement in the labor market.
Retail Sales is where it all starts…and then trickles down to manufacturing, hiring, etc. July’s reading was “nice” but not a blockbuster. The headline reading beat expectations by a tick (+0.6% vs estimates of 0.5%). When you strip out the big ticket Autos, Retail Sales rose 0.4% vs estimates of +0.5%. The real story is the fact that June was revised upward significantly. Headline June sales was revised from -0.3% to 0.0% and ex Autos from -0.1% all the way up to +0.4%. That is a huge swing. And it is yet another report that the 2nd quarter is much stronger than originally thought.
One of many measures of inflation, Producer Price Index (PPI), was released. The headline reading for July showed a month-over-month increase of 0.2% which was 100% higher than market expectations. The Core PPI was 0.3% which was three times higher than market expectations. Guest room rental jumped 9.9%. This did provide some slight pressure on pricing but the market knows that there is not any real threat of inflation in the short term. This report really has no impact on the timing of the Fed Rate hike as they have made it clear that they expect inflation to remain low for a very long time and they are focusing on labor slack instead.
What’s on the Agenda for this Week?
We opened up on Japan’s GDP drop and our own Empire Manufacturing tanking, but have pulled back from the early highs. Last week MBS sold off from the 100 day and found support at the 25 day. Now for the week the maximum upside is back at the 100 day which is +35BPS from current levels. The maximum downside is at the 50 day moving average which is about -35BPS from the current position. It will take Greece making their ECB payment and maybe even getting their bailout as well as FOMC minutes that look weighted towards a September rate hike to get there.
This is a much lighter week for domestic economic data than last week.
The biggest release of the week will be Wednesday’s minutes from the last FOMC meeting as we try to get a better understanding of their discussions during the last policy meeting to see if there is any wiggle room on their first rate hike.
There will be a good dose of housing data with the Home Builders Sentiment Index, New Housing Starts, Building Permits and Existing Home Sales which will get the bulk of the attention but none is likely to move pricing materially.
There are no major Treasury auctions and only one Fed speaker (John Williams) scheduled this week. So, since this is a light week, we will once again get the most momentum from overseas events:
Japan: 2nd quarter GDP hit -1.6%. If they get a negative reading for the 3rd quarter, then that would make the fifth recession in six years!
China: European stocks have bounced back as investors are taking some reassurance as China has fixed its yuan exchange rate slightly higher for the second straight session. If this continues on this path, then long bonds may shed some of their fear factor premium.
Greece: Germany is hesitant to get on board unless the IMF will participate. However, the IMF has resisted so far as Greece is still behind a payment with them (we are not supposed to call that a default) and the IMF has crunched the numbers and said that the math doesn’t add up unless there is a haircut on Greece’s debt, and Germany is not willing to go along with a haircut. So it seems that this will be very interesting as Greece has a large ECB payment to make this week that may have to come from a bridge loan instead of getting their bailout package through.
As of 3:00 pm EDT, the stock market (DJIA +57.83) was up with 60 minutes left to trade.
MBS have been trapped in a very narrow channel capped by the 10 day moving average and supported by the 25 day moving average.
Domestically, there were two very low-level economic reports. The Empire MFG Index was dismal and the NAHB Home Builder Sentiment was hot.
Empire State Manufacturing Survey: Out of the blue, the Empire State index has plunged deeply into negative column this month, to -14.92 in August vs +3.86 in July. This is by far the weakest reading of the recovery, since April 2009. New orders, which had already been weak in this report, fell from July’s -3.50 to -15.70 for the weakest reading since November 2010. Backlog orders, which had also been weak, came in at -4.55 from -7.45. Shipments, in the weakest reading since March 2009, fell to -13.79 from +7.99. This week’s Philly Fed report will carry much more weight than this as this reading simply does not jive with recent national reports like Industrial Production and ISM Manufacturing which show a completely different picture than this small regional report.
Home Builders Sentiment: Home Builders are feeling good as the August reading hit its highest level since 2005 with a reading of 61. While this reading matched market expectations, any reading above 50 is positive and a reading above 60 is downright strong. The strength of the labor market is often the primary force in heightened Builder Sentiment.
Tomorrow will be Housing Starts and Building Permits but it will be news out of China and Greece that will drive pricing.