What Happened Last Week?
Mortgage backed securities (MBS) lost 13 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move sideways from the prior week. But the devil is in the details as MBS attempted to rally and then sold off in dramatic fashion, falling 114 BPS from Wednesday’s highs to Thursday’s lows.
It was a very big week with a lot of economic data that hit. But the long bond market focused on two areas: Central Bank action and our Jobs report on Friday. MBS sold off in a major way in direct response to Central Bank action (described below) and then found a bottom and rebounded after our Jobs data on Friday.
The European Central Bank (ECB) was supposed to deliver with their monetary bazooka but instead used a pea-shooter. The ECB left their key interest unchanged at 0.5% but did lower their deposit rate down to -0.3% (which was widely expected; the market was hoping for a surprise of deeper cuts in the core rate).
During the following press conference, President Draghi announced that they would keep their 60 billion euro asset purchase program in place (not increasing the monthly purchase amount, nor changing the product mix)but would extend the program out to March 2017 or beyond.
This was very disappointing to bond traders that were told by the ECB that they would use their “bazooka”. As a result, MBS came under pressure as many traders were simply caught on the wrong side of the trade. We might have seen a rally if they moved their asset purchase program from 60 to 80 billion euros…but that didn’t happen.
Yellen is Yelling
She testified before the Joint Economic Committee in DC. The bond market focused more on her responses to the sea of inane questions more than her prepared remarks. Two quotes are worth mentioning: “To simply provide jobs for those who are newly entering the labor force probably requires under 100,000 jobs per month,” with anything above that helping “absorb” those who are unemployed, discouraged or had dropped out of the labor market. And Job creation has been averaging around 200,000 a month this year, a figure Yellen said was “quite a bit” above the number needed to continue absorbing slack in the labor market.
She also said the United States may be “close to the point at which we should be raising” This caused many to speculate that the Fed is getting ready to raise rates.
Jobs, Jobs, Jobs
The report was very strong, but does it actually solidify anything with the Fed? Non-Farm Payrolls got all the attention in the media with a stronger than expected reading of 211K (vs estimates of 190K to 200K) and perhaps more importantly, October and September were revised upward a combined 35K.
Average Hourly Earnings matched market expectations of 0.2% but more importantly, on a YOY basis pulled back from 2.5% down to 2.3%. And this has the most weight with the Fed and bond traders alike. It effectively stopped the two day sell off and caused MBS to move back towards positive territory as it leaves the door open for the Fed NOT to raise rates.
The Participation Rate ticked upward from 62.4% to 62.5%, so it increased for the second straight month albeit by a small amount. The Unemployment Rate remained at 5.0%, as expected.
The Unemployment Rate is really driven by the Participation Rate so it is good that it remained at 5.0%.
What’s on the Agenda for this Week?
MBS were in negative territory but meandered back into the black after a weaker than expected LMI report. For the week, the “Three Things” listed below could cause some significant volatility…particularly a possible government shutdown. It’s the last full week of data, auctions and speeches before next Wednesday’s Fed announcement and there is still plenty of action that could have an impact on their decision.
Three Things: The three biggest things to watch out for this week: (1) government shutdown? (2) Retail Sales, and (3) PPI.
Below are this week’s auctions. The 10 year and more importantly, the 30 year will need to be closely watched. However, in this stage of things, these auctions are reflective of trader sentiment that is already pervasive in the marketplace. If bond trader sentiment changes, then it will instantly show up in live MBS trades.
12/08 – 3 year note
12/10 – 10 year note
12/11 – 30 year bond
The Talking Fed
There will be a light schedule as we enter the “blackout” period for speeches this week prior to next week’s Fed meeting:
12/07 St. Louis Fed President James Bullard
Why is this political wrangling important? Because there are just a few items that can tip the scale for the Fed into not tightening. And one of them is a government shutdown and the stall that it could provide to the economy. Just like a parent that has to once again help out a spoiled twenty something, the Fed will have to once again enable the fractured political system. The two sides are hashing out policy riders covering Syrian refugees, environmental policy and oil exports, among other issues.
Producer Price Index
Retail Sales will get a lot of attention, particularly with the recent pull back in some of the consumer sentiment readings. But the market is still expecting a nice gain from 0.1% to 0.3%. Producer Price Index will be closely watched as the Fed is missing that inflationary piece that will seal the deal. The YOY core price is what counts…expected to be 0.8%. The closer that is to 2.0% the worse it is for MBS.
Overview: Initially MBS sold off out of the gate but then moved back into positive territory after the LMI report was much weaker than expected. Then MBS made another move higher after the usually “hawkish” Bullard raised some concerns about a consensus at the Fed.
St. Louis Fed President James Bullard said that inaccurate Fed forecasts of growth, employment and inflation have pulled the central bank in conflicting directions and that policymakers have to continually shift their view of the proper rate path to adapt to the gap between their expectations and the outcome.
MBS traders looked at his comments this way: IF the Fed is really considering raising rates, THEN that can only come from future forecasted growth and inflation (because inflation is well below 2% right now), So, is he calling into question their estimates that future growth will soon lead to inflation above 2% and call in to question a rate hike? Clearly, he is still very much in the rate hike camp but this underscores the very real debate raging behind closed doors.
Labor Market Conditions Index (LMI): Was much weaker than expected 0.5 vs estimates of 1.7, but the prior month was revised upward from 1.6 to 2.2. The Fed’s research department created the labor market conditions index (LMCI) based on 19 labor market indicators.
Consumer Credit: Was also weaker than expected (16.0B vs estimates of 20.0B). When you strip out all the noise in Student Loans and Auto Loans, the closely watched Revolving Credit only increased $0.2 billion but it did mark the 8th straight gain.
On Deck for Tomorrow: Small Business Optimism, JOLTS and a 3 year Treasury note auction.