What happened last week?
Overview
Mortgage backed securities (MBS) lost 20 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher for the week, driven mostly by FOIL (The Federal Reserve and Oil) as WTI Oil jumped from Monday’s $44.74 to close on Friday at $48.57. The upward path in oil gives long bond traders concern over inflationary pressures. On the Fed side, we heard from several district presidents with a mixed message but the bond market put the most weight on Dudley and Williams which appeared to have more “hawkish” comments and clearly made an effort to let the markets know that September is still a “live” meeting for the Fed to consider a hike.
The Talking Fed
New York Federal Reserve President William Dudley is the third most important person in the FOMC (1 – Yellen, 2- Fischer). So, when he talks the markets listen. Last week during an interview he made it very clear that September is very much on the table. He said that the elections won’t weigh on the Fed and said that “the market is complacent about the need to gradually hike rates and the time for a rate hike is edging closer.” He also noted that the market’s reaction to “Brexit” was rather short lived.
Atlanta Federal Reserve President Dennis Lockhart also reminded the markets that rate hikes are possible and not to write off the Fed. He said, “I would not rule out September,” and “If the meeting were today I think the economic data would justify a serious discussion,” “It’s conceivable we could have two rate increases this year.”
Non-Voting member S.F. Fed President John Williams came out in support of raising rates. He said “In the context of a strong domestic economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later,” and “An earlier start to raising rates would allow a smoother, more gradual process of normalization.”
The minutes from the last FOMC meeting were released on Wednesday, you can read them here. Basically, the minutes showed that there was much more discussion and division over the timing of rates than the market expected, which certainly leaves the door still open for a rate hike in September and/or December. However, it’s clear that most of the long bond traders are still betting on the latter.
They cited concern over what would happen to the financial markets IF they raised rates (comment: I guess with that logic…they can NEVER raise rates).
But several FOMC members were worried over the impact of prolonged low interest rates and several wanted a rate hike in July but only one member voted for it. So, that means that a few of the Non-Voting members saw the need for a hike. But the markets focused in on the fact that unless Janet Yellen votes for a hike, it’s not happening.
What’s on the agenda for this week?
Overview
Monday is a vacuum for domestic and economic data. The Fed’s Fischer’s comments are negative for pricing but are offset by the drop in WTI Oil. Look for MBS to remain in the same narrow channel as Friday. For the week, WTI will have a larger impact on pricing as we don’t get any economic data with any gravitas until later in the week. Thursday and Friday will be driven by Jackson Hole with Friday’s comments by Yellen, the last piece that bond traders need to hedge for the September meeting. If she follows the same mantra as her number 2 (Fischer) and number 3 (Dudley), then MBS will sell off. If she walks it back from their comments, then MBS may pop back above the current channel.
Three Things
The three items that will influence bond pricing the most this week are (1) The Talking Fed, (2) Oil and (3) Domestic Flavor.
(1) The Talking Fed:
The annual Jackson Hole (WY) Economic Policy Symposium put on by the Federal Reserve Bank of Kansas City is the most important event of the week. There will be a bevy of Feds and economists speaking Thursday and Friday, but specifically from Janet Yellen on Friday at 11:00am EST and that will get the most attention from traders.
Last week, the number 3 person in the Fed (NY President Dudley) was very “hawkish”. This week opens with the number 2 person in the Fed, Vice Chairman Stanley Fischer, who also was very “hawkish.” He said that the Fed is close to hitting its targets for full employment and 2% inflation. He gave a generally upbeat assessment of the economy’s current strength, saying the job market was close to full strength and still improving. He said, “The behavior of employment has been remarkably resilient,” adding that inflation outside of food and energy prices was “within hailing distance” of 2%, the Fed’s target rate.
(2) Texas Tea, Black Gold: WTI Oil shot up $4.00 last week on comments out of Saudi Arabia that they would support some level of production limits at the next OPEC meeting which caused downward pressure on MBS prices. But this week opens to a different bias on oil prices as China is exporting more refined products, U.S. rig counts are up for the 8th straight month and it looks like Iraq and Nigeria are dumping supply. As a result, WTI Oil prices are trending lower which is positive for MBS pricing.
(3) Domestic Flavor: Our economic data will be largely steam rolled by Fed comments but we still do have an important Durable Goods Orders report and a revised 2nd quarter GDP release. We round out our data with New Home Sales and Existing Home Sales.
Market Wrap-up
As expected, MBS were contained and have stayed within the same trading channel as Friday, as WTI Oil has dropped 3.03% and provided some upward momentum for pricing.
The Fed’s Fischer’s comments are negative for pricing but are offset by the drop in WTI Oil.
There were no economic releases or Treasury auctions today.