What happened last week?
Mortgage backed securities (MBS) lost 88 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move higher from the prior week.
There is no question, last week was all about the Fed and the path of future rate hikes. While the bond market priced in a hike at last week’s meeting, the sell-off in bonds was not due to the rate hike. It was due to the expectations of future rate hikes as the Fed showed us a pace of at least three rate hikes in 2017 and 2018 when the market was expecting a slower pace of 2 hikes in 2017.
The Talking Fed
The FOMC took the following actions last week:
• Raised their Fed Fund Rate from 0.5% to 0.75% and raised their Discount rate to 1.25%.
• Increased their reverse repo rate from 0.25% to 0.50 which will have a larger impact on market participants than their Fed Fund rate increase.
You can read their official statement here.
You can read their economic projections here.
Their famous dot plot chart showed that based upon the median rate projected by the end of 2017, it would equate to 3 rate hikes next year. The bond market was assuming only 2, so this pressured MBS pricing and caused mortgage rates to rise.
Here are some key changes from their November statement:
• Fed says labor markets continued to strengthen, growth moderate
• Fed says job gains have been solid in recent months
• Fed says spending rising moderately, investment stayed soft
• Fed says inflation has increased since earlier this year
• Fed lifts rate paid on excess reserves to 0.75% vs 0.5%
• Fed raises discount rate to 1.25% from 1.0%
• Fed officials see three 2018 rate hikes
• Fed median estimate for longer-run funds rate 3% vs 2.9% in September
• FOMC instructs NY Fed to raise reverse repo rate to 0.5% vs 0.25%
In her live press conference, Janet Yellen did say that she would stay on for the remainder of her term and does not know if she will be reappointed in the future and if she would accept if that were the case. But it’s not a decision that she has to make right now.
What’s on the agenda for this week?
This is a holiday-shortened week with an early close to the bond market on Friday. Most traders will be gone after the barrage of economic data on Thursday morning though. So, really there will only be a couple of active trading sessions this week, and next week is a short week as well. While MBS moved into a new and lower trading channel last week, the good news is that they will likely tread water and have some temporary support until after traders return to the market in full force after the first of the year. It will take Janet Yellen “walking back” talk of three rate hikes in 2017 in her afternoon speech for MBS to convincingly break above the channel. If she “doubles down” on the path of rate hikes, then MBS will move towards the bottom of the channel. Regardless, MBS are expected to move in a relative sideways pattern for the week but the longer term bias continues to be locking.
The three things that have the greatest ability to impact pricing this week are: (1) Central Bank action, (2) Domestic Data and (3) Parking Lot.
(1) Central Bank Action: The week starts off with our own Janet Yellen speaking today. Will she walk back expectations of 3 rate hikes in 2017 or double down on it? On Tuesday will be the Bank of Japan’s interest rate decision and policy statement. Any action from the world’s number 3 economy could have an impact on pricing Tuesday.
(2) Domestic Data: There really isn’t any major data until Thursday and then there will be a glut of it. This includes our 3rd quarter GDP but this will be yet another revision and the third time we have seen this data. There will also be Durable Goods, Personal Income and Spending and PCE.
(3) Parking Lot: Just like every major road leading to a mall, it’s a parking lot out there. The stock market has been on a tear as of late, setting new highs and records. And many traders will be looking to book those profits by the end of the year to make their performance look better and increase their bonuses. As a result, it will at the least provide a nice temporary bottom for MBS and at the most, may even help pricing a tad as they “park” their funds.
There was a nice (and fleeting) spike in intra-day trading on Friday on the saber-rattling over China snatching our property (a naval drone). This situation is still ongoing and may provide some momentum. But it is a reminder that even though we are having a boring session, there is always the potential for volatility that is not scheduled or expected.
As expected, MBS have been trading near the top of the channel today and have even spent most of the afternoon above the channel (which was not expected). The reason for the upward momentum is the combination of “fear factor” buying due to the geopolitical events listed below and the market moving money into bonds on this short week. There were no economic events to impact pricing today.
The Talking Fed: Federal Reserve Chair Janet Yellen spoke at the University of Baltimore commencement ceremony, where she was due to receive an honorary degree. She addressed the graduating class and said that the U.S. has the strongest jobs market in nearly a decade thanks in part to accelerating wage growth and a low layoff rate. But she also mentioned challenges, including “slow economic growth” and “disappointing productivity.”
The Election: The markets are a little skittish on the “potential” for Electoral votes not being officially cast the way they are supposed to. The concern is that voting laws would not be followed and that it could drag the results of the election to the Supreme Court and cause uncertainty.
Germany: Another terrorist attack claimed nine lives and injured 50 others as a truck was driven into a crowd in Berlin at a busy Christmas marketplace.
Russia: Their Ambassador to Turkey was murdered in a terrorist attack.
China: Still has our naval drone and President-Elect Trump is telling them to keep their “stolen” drone, that we don’t need any favors from them. They replied that they resent the word “stolen.”
On Deck for Tomorrow: The Bank of Japan interest rate and policy statement and our GNMA monthly bond coupon rollover.