Learn from the Past
Mortgage backed securities (MBS) gained 38 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move lower from the prior week. The market saw its lowest rates on Thursday and its highest rates on Wednesday.
After two weeks of no gains, mortgage backed securities finally saw a small improvement over the holiday-shortened week. The most significant domestic events were Wednesday’s Beige Book and Friday’s Jobs report. MBS enjoyed their best levels of the week (lowest rate) on Friday as the bond market pushed back on expectations that the Fed would raise rates two more times this year.
Jobs, Jobs, Jobs: Big Jobs Friday!
Here is the Tale of the Tape:
-May Non Farm Payrolls (NFP) 138K vs estimates of 185K (this will be revised 2 more times).
-April NFP revised from 211K down to 174K.
-March NFP revised from 79K to 50K.
-Average Hourly Wages matched market expectations for a MOM gain of +0.2%.
-Average Hourly Wages YOY also matched expectations with a 2.5% rate.
-Average Weekly Hours remained at 34.4.
-The Unemployment Rate fell to a 15 year low of 4.3% which was lower than expectations of 4.4%.
-The Participation Rate is still awful and fell down to 62.7% from 62.9% the prior month.
There are certainly pluses and minuses in this round of jobs data. It is certainly weaker than expectations but that could also mean that expectations were wrong. Regardless, the number of jobs added is lower than recent trends. But there are more jobs being added. The debate among long bond traders is if the macro economy is at a level where there is reduced supply of qualified workers or a reduced level of demand from employers? Part of that answer can be found in the previously released JOLTS report which has over 5M unfilled jobs. That means the jobs are there and there can be more job growth but the labor force is not there. That question has been answered. But that brings up a bigger question – since that is the case, then why aren’t we seeing a more accelerated pace of wage pressure? And there is not an answer for that one yet.
The Unemployment Rate is at a 15 year low and part of the reason for that is that more people are working each and every month and the total work force is always increasing. But the main reason that the Unemployment Rate fell to such a low level is simple math. It’s that the Participation Rate fell. That means more people responded to the survey that they do not have a job….but they are also not looking for work.
The Fed’s Beige Book was released on Wednesday. You can read the transcript here.
Here are some key highlights:
– As usual, all districts expressed “moderate” to “modest” growth (there is no rule as to which phrase to use apparently).
– Inflation is interesting as we are seeing large increases in lumber, steel and other commodities that are pushing up input costs for manufacturers. But they are seeing falling prices in apparel, groceries and autos.
– Labor market conditions continue to tighten. There are still only modest signs of wage growth but employers are already offering larger benefit packages. However, there is frustration among employers in being able to fill even the lowest end jobs. The following example came from the S.F. District: “Leisure and hospitality contacts said they have not been able to fill many entry-level and seasonal positions due to a lower number and inferior quality of applicants compared with past years… Attracting qualified applicants for low-skilled manufacturing jobs is difficult, and many newly hired workers prove to be unreliable… Several contacts observed that applicants for some low-skilled positions did not meet the minimum job requirements or were unable to pass pre-employment screenings such as drug tests.
– But are wage increases coming soon? It would appear so which these quotes: “Competition for low-skilled workers is strong and is driving up starting wages…. one firm increased driver pay by 3 cents per mile, equating to a 7.5% wage increase.” Also: “A manufacturing firm that was expanding raised wages for unskilled workers 10% and noted a significant improvement in retention and the quality of applicants.”
That will continue this week as well; as such we will continue to enjoy very elevated pricing levels for MBS that otherwise would not exist. Thursday is very key with the combination of the ECB, Great Britain and the Comey testimony. Either event could have a major impact on pricing and all three happen on Thursday.
What’s on the agenda for this week?
We have yearly highs in both the stock markets and bond markets at the same time. IF the market was based upon economic fundamentals then those would be inverse. But they are not, because the market is suspending economic and inflationary fundamentals and has been for the past three weeks.
The three areas that have the greatest ability to impact MBS pricing this week are: (1) Central Bank Palooza, (2) Fear Factor and (3) Domestic Flavor.
(1) Central Bank Palooza: The two biggest central banks that drive global bond prices are our own Fed and the European Central Bank (China a close third). The ECB will have its policy statement and rate decision Thursday morning followed by a live press conference with their President Mario Draghi. They have already begun purchasing bonds at a slower pace than they did last year and the market will be keen to learn about any adjustments to that pace as well as their outlook (good economic numbers out of the Eurozone lately) and inflation expectations.
(2) Fear Factor: Geopolitical concerns (fear) have kept MBS trading at abnormal and elevated levels for the past month and that is likely to continue as the market is concerned over two major elections (Great Britain and Germany) as well as developments in Qatar and here at home in the U.S. as well. Thursday’s testimony by former FBI chief James Comey could have a big impact in pricing.
(3) Domestic Flavor: Once again taking a back seat but still important is our domestic economic data. This morning’s ISM Services (56.9 vs estimates of 57.0) is very strong and shows that more than 2/3 of our economy is doing very well. But for the rest of the week, we have very limited releases that only have low to mid-level gravitas.
There was strong ISM data and some good manufacturing data overseas but also a healthy dose of fear which squeezed MBS in a very narrow range today.
Productivity: Non-Farm Productivity was flat and matched market expectations of 0.0%. Unit Labor Costs rose 2.2%. However, this data is for the 1st quarter and is already a quarter too old to be relevant.
ISM Non-Manufacturing: The Services sector represents more than 2/3 of our economic engine and it grew at a monthly pace of 56.9 which basically matched market expectations of 57.0. Anything above 50.0 is expansionary and anything above 55.0 is red hot.
Factory Orders: The April reading matched market expectations of -0.2% but March was revised upward from 0.2% to 1.0% which is a large revision upward.
On Deck for Tomorrow: JOLTS