What happened last week?
Mortgage backed securities (MBS) lost just 1 basis point (BPS) from last Friday’s close which caused fixed mortgage rates to move sideways lower for the week. While the net change for the week is very narrow, there actually was some volatility as MBS had a -54 BPS swing from highs to lows for the week.
The biggest move of the week occurred on Tuesday and Wednesday. MBS sold off on Tuesday after a key Federal Reserve president announced that he was stepping down. But then MBS had a nice rebound on Wednesday and there was a strong technical bounce off of the 100 day moving average.
The Talking Fed (More Mixed Messages)
On the “hawkish” side was Atlanta Fed President Dennis Lockhart (non-voting member). He certainly made the case for at least considering a rate hike on Monday when he said, “If 1.6% inflation and 4.9% unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower retbound still appropriate?” He also said, “I think circumstances call for a lively discussion next week.”
One day later (Tuesday), he announced his resignation effective in February 2017. What is very interesting is that he is not currently a voting member but next year he would be. What does this mean? Is this a form of protest against a FOMC committee that refuses to raise rates when our economy is clearly no longer in crisis mode?
On the “dovish” side was Fed Governor Lael Brainard, who is a voting member. She said, “Today’s new normal counsels prudence in the removal of policy accommodation.” She also said that she wanted to see a stronger trend in U.S. consumer spending and evidence of rising inflation before the Fed raises rates, and that the United States still looked vulnerable to economic weakness abroad.
There is no way to put a positive spin on this as across the board, it was weaker than expected. The headline August reading dropped -0.3% vs estimates of only a -0.1%. When you strip out autos, it dropped -0.1% vs estimates of a gain of +0.2%.
The Producer Price Index for August month-over-month flat at 0.0% vs estimates of 0.1%. But the data point that gets all the attention is the PPI YOY (year-over-year) Core and it moved upward from 0.7% in July to 1.0% in August which was a little stronger than expected. The Consumer Price Index did show some upward pressure on prices. The most closely watched component is the YOY Core reading which moved up to 2.3% vs expectations of 2.2%. So this, along with Average Hourly Wages YOY at 2.4%, are the only two Indexes that show any type of inflation at levels above 2.0%.
What’s on the agenda for this week?
This week could change the path of MBS trades for the rest of the year. Look for MBS to trade sideways until Wednesday and then look out. There are three possible outcomes of the Fed activity and MBS. Two of those outcomes point to sideways or worse pricing. Only one will get better pricing. But it’s not only on our Fed, there is the European Central Bank and Bank of Japan as well. This could be a very volatile week and this is not the time to be complacent.
The three events that have the greatest potential to impact MBS trades are: (1) the FOMC, (2) the Bank of Japan, and (3) the European Central Bank (ECB) and Draghi.
Yes, all Three Things are basically a Central Bank Palooza as there are no domestic economic reports that can impact pricing this week.
(1) The FOMC (Federal Open Market Committee) will conclude two days of meetings on Wednesday. Here is the schedule:
2:00EST Policy Statement and Interest Rate Decision
2:00EST Economic Projections and Dot Plot Chart
2:30EST Live press conference with Fed Chair Janet Yellen
The market is basically pricing in zero chance of a rate hike, but the market could be wrong. Even if we do not get a rate hike, will the language turn more “hawkish” to prep everyone for a December rate hike? The “dot plot” chart with all members (voting and non-voting) best guestimates of future interest rate levels by month will also get a lot of attention. Of course Janet Yellen is the dog that wags the tail and her responses to live questions from financial reports can really move the markets.
(2) The Bank of Japan also have their Central Bank meeting along with the release of their economic projections and a live press conference by their chair on Wednesday. It is widely expected that they will cut their rate even more negative but the unknown is any other action that they may take.
(3) The ECB also have meeting on Wednesday but it’s a non-monetary policy meeting (meaning they won’t set an interest rate). But the key will be on Thursday when ECB President Mario Draghi speaks and will react to the Bank of Japan and our FOMC. Will their action (or inaction) cause the ECB to loosen up and extend their bond buying program?
While there are no major domestic economic releases this week, there is a lot of industry news that will give us a good read on the state of our housing market with the releases of: Home Builder Sentiment, New Housing Starts, Building Permits, Weekly Mortgage Applications and Existing Home Sales.
As expected, this was a very uneventful day as the long bond market is basically “on pause” until Wednesday. There were no major economic releases today.
Housing: The September NAHB House Market Index showed a big jump to a reading of 65 (anything above 50 is positive). This was much better than market expectations and an 11 month high. Good news for the New Housing segment but not a factor in bond prices.
On Deck for Tomorrow: FOMC meeting begins, New Housing Starts and Building Permits.
Across the Pond
China: Their housing news was also strong as their August Home Price Index shot up to 9.2% vs. July’s 7.9% reading.