What Happened Last Week?
Mortgage backed securities (MBS) lost just 2 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move sideways from the prior week. With a net change of only +4 BPS for the month of October, mortgage rates have moved sideways all month long.
This was a very light week for economic data and there weren’t any major Treasury auctions to contend with.
There was a lot of housing data and overall, it showed plenty of strength in the housing sector. The Home Builder’s Index jumped to a level not seen in 10 years. Meanwhile, New Housing Starts were stronger than expected and Building Permits for Single Family Residential prosperities were flat. But Existing Home Sales (the biggest chunk off all home sales) jumped up from 5.30M in August to 5.55M in September which was a nice pick up and would have increased more if it weren’t for very tight inventory constraints.
All the focus of the long bond market was on central bank action and there were two major events last week, the European Bank (ECB) meeting and the People’s Bank of China’s (PBOC) rate cut.
The European Central Bank rate left their key interest rate unchanged at 0.5% but more importantly, during the live press conference, President Mario Draghi downplayed the risk with China but acknowledged for the first time that the ECB has officially discussed the potential of lowering its discount rate (which is different from its interest rate). He also said that the current asset purchase program (QE) will continue on schedule and in the same amount as planned and will run through 2016. But he made it very clear that it could very well go beyond 2016 and that they had the “flexibility” to add to the current program at any time but would wait until their December meeting to review more current economic data. The markets are viewing this as telegraphing that further QE is on its way and was largely expected, and therefore did not have a major impact on rates in the U.S.
The Peoples Bank of China surprised the markets by taking action. MBS sold off initially by as much as -35BPS but recovered most of that sell off. This move, while simulative in nature, calls into question China’s recently released GDP of 6.9% (which most traders didn’t buy anyway). This is now the sixth time that China has made some form of rate cuts since November.
– Cut their one year lending rate by 0.25
– Cut their 1 year deposit rate by 0.25
– Removed their deposit rate ceiling for banks
– Cut their reserve ratio by 0.50
What’s on the Agenda for this Week?
MBS pricing will be stuck in the exact same range as last week until the Fed meeting but Thursday’s GDP report will probably have much more of an impact on pricing. The closer it is to 2%, the worse it will be for pricing. But the closer it is to 1.5%, the better it will be for pricing. So, barring a surprise rate hike from the Fed or a GDP close to 1.0%., MBS will be trapped in the same relative range.
This is a HUGE week for economic releases with juggernauts like 3rd quarter GDP and Durable Goods. But the focus will be squarely on our Federal Reserve which will announce its policy statement and interest rate decision on Wednesday.
The Talking Fed: Unlike the last Fed meeting in September, there will be no live press conference and their economic projections will not be updated/released. Most of the “Talking Fed” since the last meeting have made it fairly clear that it is difficult to see global and domestic economic conditions changing by enough in just one short month to cause the Fed to reverse course from their last meeting and start raising interest rates.
Manufacturing will take center stage with Durable Goods Orders, Richmond Fed Manufacturing and the bell-weather Chicago PMI.
The state of the consumer will also be key this week with Consumer Confidence, Consumer Sentiment, Personal Income and Personal Spending. There will also be an important PCE report.
Treasury auctions this week:
10/27 2 year note
10/28 5 year note
10/29 7 year note
Overview: MBS are trapped in the same trading channel that has lasted three weeks until the Fed meeting on Wednesday. And most likely that wont break us out either. Today was a very quiet and boring trading session for long bonds. As you can see by the line chart, MBS have done nothing all day.
There was only one low-level report today, New Home Sales, which fell to an annual rate of 468,000 in September which is 81,000 below the consensus estimates of 549K and the lowest rate since November last year. Making matters worse is a steep 33,000 downward revision to August. Some of the reason for the decrease is the fact that builders have been building higher price homes that could be outside the already steep and steady increase in median sales prices. Regardless, this is too small a piece of the pie to impact pricing in a meaningful way.
Debt Ceiling: There are 2, 5 and 7 year note auctions this week….or are there? The Treasury is using emergency cash management procedures right now to make it appear that we are below our debt limit and without major “smoke and mirrors” will not be able to issue more debt unless the ceiling is raised. The New York Times is reporting that Congressional leaders and the Obama administration are close to a crucial budget deal that would modestly increase domestic spending over the next two years and raise the federal borrowing limit. While congressional aides cautioned that the deal was far from certain, and the Treasury Department declined to comment, officials briefed on the negotiations said the emerging accord would call for cuts in spending on Medicare and Social Security disability benefits.
On deck for tomorrow: Durable Goods, Case-Shiller, Consumer Confidence and the Richmond Fed Manufacturing Index.