What happened last week?
Mortgage backed securities (MBS) lost 14 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly lower for the week. While the net change for the holiday-shortened week is fairly narrow, there was actually some volatility as MBS sold off by a massive -73 basis points from the intra-day high on Wednesday and the intra-day low on Friday.
There was a real “whipsaw” during the week as MBS rallied on weaker than expected ISM data, but then sold off dramatically as the 10 year German bond made it back into positive territory. That swing in the bond was due to the ECB’s Mario Dragahi’s press conference where he did not extend their bond buying program. We also had a big dose of Fed talk with the release of their Beige Book and very hawkish comments by Rosengren.
ISM Non-Manufacturing (Services): This accounts for about 80% of our economic activity. The ISM Manufacturing report was weaker than expected and came in below the important 50.0 level but bonds largely held off any reaction as it’s just too small a piece of the pie (about 20%). But last week, the larger piece of the pie was much weaker than expected (51.4 vs estimates of 55.7). This still showed an monthly expansion but it was a big miss and has caused MBS to rally to start the week.
The Talking Fed
The Beige Book, which is compiled specifically to be used in the next FOMC Meeting, was released. You can read the official statement here.
Basically, there was nothing that would cause bond traders to reconsider their bias of no rate hikes until December.
• US economic growth was “modest” as inflation stays ‘slight’
• Contacts in several districts expect modest price gains
• Most Fed districts reported ‘modest’ or ‘moderate’ growth pace
• Kansas City, New York reported no change in economic activity
• Philadelphia, Richmond noted pace of economic activity slowed
• Labor market conditions still tight in most districts
• Moderate upward wage pressures increased further
• Election damping real-estate outlook in several districts
• Consumer spending little changed in most Fed districts
• Credit demand appeared to expand at moderate pace
• Demand for energy-related products, services weakened
Separately, Boston Fed President Eric Rosengren (voting member) added his name to the long list of voting members expressing a very “hawkish” tone. He said, “If we want to ensure that we remain at full employment, gradual tightening is likely to be appropriate,” and “A reasonable case can be made for continuing to pursue a gradual normalization of monetary policy,”
The German 10Y bond has had a negative yield (i.e., investors were PAYING Germany to lend them money) since June and finally popped back above zero on Friday (due to the European Central Bank’s inaction) at their Thursday meeting. This directly caused MBS to sell off which caused the highest rates of the week.
What’s on the agenda for this week?
This is a very pivotal week. The keys will be German 10Y yield bond and Retail Sales. It will take a reversal back into negative territory in the German 10Y bond for any real improvement in pricing. Just like last week, the risk vs reward model simply doesn’t justify any risk this week.
The three items that can have the greatest influence on pricing this week are: (1) German 10Y yields, (2) The Talking Fed and (3) Domestic Flavor.
(1) German 10Y Bond: Their yield has been negative since June and at one point it was down to 0.20%! But that streak ended on Friday when it closed back above 0.00%. Was it a fluke or is the German 10Y going to continue to claw its way back up? If it does, it is bad news for MBS pricing.
(2) The Talking Fed: They enter their “Black Out” period tomorrow as they are not allowed to give public commentary a week before their FOMC meeting. But there are a few today and the markets are looking for one final signal ahead of next week’s meeting.
- Atlanta Fed President Dennis Lockhart (NON-voting member) was the first to speak today. He certainly made the case for at least considering a rate hike when he said, “If 1.6 percent inflation and 4.9 percent unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower bond still appropriate?” He also said, “I think circumstances call for a lively discussion next week.”
- Minneapolis Fed President Neel Kaskari, also a NON-voting member and Fed Governor.
- Lael Brainard is the most important of the day. As a VOTING member, her comments carry much more weight than the other two. But also, she has been incredibly steadfast in her “dovishness,” so if she moves towards more “hawkish” comments, it could move pricing.
(3) Domestic Flavor: Thursday’s Retail Sales (ex-Autos) will be the most important economic release of the week. But we also have some important inflationary data with PPI and CPI. CPI is expected to remain above 2.00% while PPI is expected to remain below 1.0% (YOY).
Treasury Auctions this Week:
09/12 – 3 year note
09/13 – 10 year note
09/14 – 30 year bond