Learn from the Past
Mortgage backed securities (MBS) lost 20 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher from the prior week. The market saw its lowest rates on Tuesday and its highest rates on Friday.
It was a very light week of economic data with only one major economic release (ISM Services). The bond market was dominated by geo-political news and events.
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.
All eyes were on Former FBI Directory James Comey’s testimony. The bond market was waiting to see if there was anything like a “smoking gun” or other testimony that would cause traders to view the risks of further escalation on the legal front. While there was plenty of drama during the testimony, there simply was nothing that would cause traders to be more concerned which is why MBS retreated from their highs (less risk).
Across the Pond
Great Britain: Theresa May won (sort of). It was a political gamble that backfired on her. The end result is that she narrowly won but her party lost its majority. So, in order to remain the Prime Minister, her party must partner up with other parties to have the block of votes to keep her in power and to move any legislation through, and she will have to make many compromises that she wouldn’t have needed otherwise. This has market participants speculating that Brexit negotiations will be more difficult (which start in 10 days).
European Central Bank (ECB): Left both rates unchanged (interest rate 0.00% and savings rate -0.40%). The markets focused on a slight but important change in forward guidance as the ECB policy statement said, “The Governing Council expects the key ECB interest rates to remain at their present or lower levels for an extended period of time, and well past the horizon of the net asset purchases,” which is a more “hawkish” tone than their prior policy statement by removing the term “or lower.”
What’s on the agenda for this week?
MBS are expected to end the week at a slightly lower level than Monday’s open. It depends on Wednesday: if the Fed does not hike rates, or they hike rates and change their dot plot chart from showing a consensus of one more rate hike this year to none as well has very dovish commentary from Janet Yellen. Expectations are that there will be a hike, and the dot plot chart will still show the majority of FOMC members seeing one more hike this year. While all of that will cause MBS to be under pressure…there is still great support in the form of geo-political fear which will mitigate the downside.
The three things that have the greatest ability to impact pricing this week are: (1) Central Bank Palooza, (2) Geo Political and (3) Domestic Flavor.
(1) Central Bank Palooza: Obviously all eyes will be on our Federal Reserve but there will also be Central Bank rate decisions and policy announcements from the Bank of England (5th largest economy) and Bank of Japan (3rd largest economy).
Our Federal Open Market Committee (FOMC) will begin meeting on Tuesday and will conclude Wednesday at 2:00EDT. The following is the schedule:
2:00 EDT: Release of their Interest Rate Decision and Policy Statement
2:00 EDT: Release of their Economic Projections and Dot Plot Chart
2:30 EDT: Fed President Janet Yellen live press conference
While most bond traders publicly say that they expect a 25 BPS rate hike at this meeting, it doesn’t seem to be fully priced in. That is mostly due to the fact that long bond traders have significantly walked back their expectations for a third hike this year. Their forward guidance (dot plot chart) and Yellen’s live comments will have more of an impact on MBS pricing than a rate increase will by itself.
(2) Geo-Political: There is still a lot of uncertainty in Great Britain as their new government attempts to gain some sort of majority and direction. Qatar and the Saudis appear deadlocked into more conflict, and at home we have more Senate testimony (Attorney General Sessions to testify) and the state of Maryland has filed a lawsuit against Trump.
(3) Domestic Flavor: This is a huuuugge week for economic data with the focus on inflationary data (PPI and CPI) and Retail Sales.
Treasury Auctions this Week
06/12 10 year note
06/13 30 year bond
As expected, MBS have traded right in the range that we identified in the MCU (see below). Net of the rollover effect, MBS have been bouncing in a very narrow range. A strong 10-year note auction was unable to impact MBS as we await the first dose of inflationary data tomorrow.
Treasury: The 10-year Treasury note auction was held today at 1:00EDT and the results were very strong. $20B went off at a high yield of 2.195% which is the lowest rate this year. Demand was also strong with a bid-to-cover ratio of 2.54 which is the highest level since March.
Treasury Budget: Our Deficit kept on growing in May, as the monthly budget came in at -$88.4B which was very close to estimates of -$87.0B. Outlays (spending) jumped +19% while tax receipts only increased by 7%. Hmm.
Treasury Secretary Steven Mnuchin spoke before a House committee this afternoon regarding the administration’s economic projections and proposed policies.
On Deck for Tomorrow:
– FOMC meetings begin
– Attorney General Jeff Sessions will testify
– PPI and the 30-year Treasury bond auction