What happened last week?
Mortgage backed securities (MBS) lost 113 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move higher for the week and brought mortgage rates to levels not seen since July of 2015.
MBS sold off (higher rates) due to two primary factors: (1) future expectations of growth and (2) increased odds of a rate hike in December.
Future Expectations of Growth
Long bonds are very sensitive to economic growth and inflation. They have done very well in our recent low-growth and low-inflation environment. So, that is why during recessions or low growth, you see lower mortgage rates. But that is no longer the expected growth path moving forward by long bond traders. They see a potential Reagan type growth period spurred by lower personal and corporate tax rates, stimulative policies, and less regulation. While the impact of President-Elect Trump’s policies is purely speculative at this point, it is clear that bond traders have been selling off. So there can be no confusion as to where long bond traders see the economy going in the future.
The Talking Fed
We heard from several Federal Reserve members and when you take their commentary all together, the bond market has shifted its bets that a rate hike is on tap for December. But even more importantly, due to the higher growth bias by traders, they now are beginning to price in rate hike expectations in the first quarter of 2017 as well.
Fed Chair Janet Yellen testified before the Joint Economic Committee in Congress. She didn’t really make any type of effort to go against the market’s assumption of a December rate hike but she also didn’t fully commit to one neither.
In her statement she said, “Were the FOMC to delay increases in the federal funds rate for too long, it could end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of the Committee’s longer-run policy goals” on inflation and jobs. Yellen added, “Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and ultimately undermine financial stability.”
She also signaled that rate increases would be gradual: “The risk of falling behind the curve in the near future appears limited, and gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance over the next few years.” MBS lost 31 BPS from Wednesday’s close which caused fixed mortgage rates to move higher for the session.
What’s on the agenda for this week?
Have we found a new and temporary bottom? Last week, MBS behaved like they did by staying above the support until Friday and then broke through it. The lesson to learn is that if MBS make any type of run, the next batch of MBS being held by long bond traders will be dumped. This is still only the beginning of the Great Unwinding. The trend is very clear: floating is very dangerous and not advised.
The Three items have the greatest potential to impact pricing this week are: (1) The Great Unwinding, (2) Domestic Data and (3) The Talking Fed.
(1) The Great Unwinding: MBS holders want out. The only major entity that is willing to hold on to MBS longer term is the Fed. The remaining field is looking for their best timing and then will unload. This was demonstrated on Friday as MBS sold off in the absence of any market-moving news. It was solely due to more supply being liquidated. The pace and timing of other holders selling their positions will have a large impact on pricing.
(2) Domestic Data: There will be a lot of housing data this week which will give us a good read on the health of the housing market. These include Existing Home Sales, Mortgage Applications, New Home Sales and FHFA Home Price Index. But it will be Durable Goods that will have the most impact on pricing. This has been fairly volatile as of late with large swings in the reading.
(3) The Talking Fed: We get to look “behind the scenes” of the last FOMC Meeting with the release of their Minutes on Wednesday. Also, the lone “talking fed” this week, Vice Chair Stanley Fischer, said this morning, “Certain fiscal policies, particularly those that increase productivity, can increase the potential of the economy and help confront some of our longer-term economic challenges,” and “Some combination of improved public infrastructure, better education, more encouragement for private investment, and more effective regulation all likely have a role to play in promoting faster growth of productivity and living standards.”
Treasury Auctions This Week
11/21 2 year note
11/22 5 year note
11/23 7 year note
Texas Tea, Black Gold
On the Radar is next week’s OPEC meeting. WTI Oil is up on speculation that some sort of freeze will be announced. There will be some volatility as these rumors and announcements ebb and flow.
Wednesday is a full session on paper but traders will be closing up after the 2:00 Eastern release of the FOMC Minutes. The bond market is CLOSED on Thursday but will reopen on Friday only to CLOSE early at 2:00 Eastern on Friday. Bottom line is that there will be a skeleton crew of traders beginning Wednesday afternoon and some thinner volumes, which can always skew the appearance of large movements up or down.
While MBS are in positive territory, floating was not a good choice as each time the benchmark MBS attempted to make any type of gains, it sold off. For example, at 8:50 EST, MBS were up 36BPS from open and then sold off -21BPS from that level; at 12:30EST, MBS were up +31BPS from the open but then sold off -25BPS from that level. Then at 2:30EST, MBS were up +25BPS and then sold off -18BPS from that level. Why? Well, MBS are going to be sold any time there is any real movement upward as the “Great Unwinding” has just begun and there is a lot of MBS that holders want gone off of their books.
Chicago Fed: The Chicago Fed National Activity Index rose from -0.23 in September up to -0.8 in October.
Treasury Auctions: We kicked off three days of shorter term debt auctions with the 2 year fixed rated Treasury note. $26B went off at a high yield of 1.085%. That is the highest rate on a 2-year term since 2008. Last month, it was only 0.855%. But demand was actually strong with a bid-to-cover ratio of 2.73, which was the best since May.
On Deck for Tomorrow: Existing Home Sales, Richmond Fed Index, and 5-year note auction.
Across the Pond
ECB: President Mario Draghi addressed the EU Parliament and said that the ECB is “committed to accommodative policy” but that financial stability risks are “for the time being, contained”. This may mean no new rounds of stimulus.