Learn from the Past
Mortgage backed securities (MBS) gained 20 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly lower from the prior week. The market saw its lowest rates on Friday and its highest rates on Monday.
It was a very volatile week with a swing of 55 basis points from best to worst pricing of the week. MBS improved (lower rates) in reaction to Fed Chair Janet Yellen’s testimony as well as very tame inflationary data and Retail Sales data. But MBS had a large reversal on Friday after testing a very important technical resistance level.
The Talking Fed
Yellen is Yelling: The Fed Chair gave her Semiannual Monetary Policy Report to Congress last week. Here are some of the key points of her testimony:
– Sees roughly balanced odds that economy will be stronger or somewhat stronger than we project
– Expects the job market to strengthen somewhat further and inflation rising to 2%
– Uncertain about pace of inflation
– Fed funds rate will not have to rise much further to get to a “neutral” rate
– Says that the balance sheet run off will begin this year
– The Fed does not need to use the reduction in the balance sheet as an “active tool”
Yellen also responded to several questions from the House and Senate committee members. Overall, she stuck to her script but did say that the Fed is not on a “preset” course (to raise rates), that the level of national debt is not sustainable, that she is opposed to a mathematical formula that dictates Fed policy, and that she would definitely stay on and serve her full term but refused to comment on her being Fed Chair after that point as she has not been ask to as of yet.
Fed Beige Book: Overall, it was a positive report but not by enough to change how the markets are pricing in risk of a rate hike this year which is currently below 50%. All 12 districts claimed economic expansion of varying degrees with 11 at “modest to moderate” and one at “slight.” Consumer Spending seemed on the rise and employers are able to add new hires without significant upward pressure on wages but it’s getting harder to add employees as there is a shortage of qualified workers for many of the advanced fields.
Retail Sales: The June data was weaker than the market expected. The headline reading came in at -0.2% vs estimates of +0.1%. However, that miss was more mathematical as May was revised upward from -0.3% to -0.1%. Without the upward revision (improvement), Retail Sales would have matched estimates. Still, it was weak as the low unemployment rate and high sentiment levels are not translating to more spending. Ex-Autos, Retail Sales were -0.2% vs estimates of +0.2% which is dismal.
Inflation? Not in this data set. The Headline YOY Consumer Price Index came in short of expectations with a 1.6% reading vs estimates of 1.7% and a large falloff from the 1.9% pace in May. The Core CPI YOY reading matched estimates and May’s pace with a steady 1.7% reading. Drops in airfares, fuel prices and apparel led the decline. We did see inflation/price increases in medical and rents.
What’s on the Agenda for this Week?
We have entered the “black out” period, so there will not be any talking feds this week. This week’s domestic economic calendar doesn’t have a single economic release that has the gravitas to move the needle on MBS pricing. Thursday is very key as the market will react quickly to any “taper” talk out of the European Central Bank. Experts expect MBS to move sideways (+19 to -12) until Thursday. If the ECB does taper, then MBS could move back below that 100 day moving average.
The three areas that have the greatest ability to impact pricing this week are: (1) Central Bank Palooza, (2) Geo-Political and (3) Across the Pond.
(1) Central Bank Palooza: While we await our own Fed next week, there are two important Central Bank meetings this week. Both on Thursday. The Bank of Japan will hit first in the early morning; important to watch but the markets are not anticipating anything new from them. The biggest event of the week is the European Central Bank policy statement that same morning. This one has some wiggle room. President Mario Draghi made some comments two weeks ago about being close to a point to start to pull back on their bond purchases. This actually started two straight weeks of long bond selloffs (higher rates). The market will react swiftly to any “hawkish” commentary or policy change from the ECB.
(2) Geo-Political: The second round of Brexit talks starting this week will dominate the markets internationally. Domestically, healthcare and tax reform will get the most attention. Looks like for now healthcare is stuck but it also looks like momentum and effort is shifting to getting tax reform moving forward. Reduced taxes will be a major economic stimulus.
(3) Across the Pond: There will be some very big releases from the top 5 economies: China – Retail Sales and GDP; Germany – PPI; Eurozone – CPI; Great Britain – CPI and PPI; Japan – Imports/Exports.
As expected, it was a nice and boring opening to the week. It most likely will remain boring until Thursday. There were no major economic releases and the trading channel is very well defined. At +10, BPS were right where they were expected to be today. WTI Oil dropped 52 cents which was beneficial to MBS. China’s economic data was strong but did not impact pricing.
Manufacturing: The July Empire (NY) Manufacturing Survey hit 9.8 vs estimates of 15.0. But this really has not seen a lot of lower readings until recently. Certainly not a bellwether for the rest of the U.S., and as such it gets little attention from bond traders.
On Deck for Tomorrow: Import and Export Prices, NAHB Housing Market Index and Treasury TICs.
Across the Pond
China (number 2 economy): Across the board they had much stronger economic data this morning with Retail Sales at 11.0% vs estimates of 10.6% and GDP at 6.9% vs estimates of 6.8%.
Eurozone: CPI Core YOY was a little higher than expected – 1.2% vs estimates of 1.1%, and Headline was at 1.3%. These weren’t high enough levels to show inflationary pressure.