Learn from the Past
Mortgage backed securities (MBS) lost 10 basis points (BPS) from last Friday’s close which caused back-end pricing to move sideways from the prior week. The market saw its lowest rates on Monday and its highest rates on Tuesday.
The bond market focused on the Federal Reserve as they hoped to learn more about the timing of their taper for MBS and Treasury purchases as well as any potential rate hike. But really, the Fed gave very little (if any) guidance that the markets could trust. While the lack of direction from the Fed was good for mortgage rates, the combination of rising oil prices and strong domestic economic data (Durable Goods and GDP) were negative for mortgage rates.
The Talking Fed
While there was a mixed bag from the FOMC, it was actually fairly balanced and gave some dovish and hawkish commentary.
Here are the key highlights:
– They left their key inflation rate unchanged.
– Unlike the last meeting, this was a unanimous vote.
On the balance sheet (taper):
– Reinvesting to continue “for the time being” but the normalization plan (taper) will begin “relatively soon.” The bond market interprets that to mean an announcement in September and the beginning of the taper in December.
– Tweaked their language from their last statement to show that inflation is no longer “somewhat below” their target rate as they also dropped “recently” when describing headline and core inflation dropping. This is telling the markets that the Fed has shifted from pushing the “transitory” theme when in addressing inflation running below 2% and that it will remain below 2% for longer, but still sees inflation hitting 2%.
– Risks to economic outlook appear roughly balanced.
– Labor Market strengthened and activity rose moderately. Job gains have been “solid.”
– Household spending and fixed investment have continued to expand.
Durable Goods: The headline reading which contains the very volatile transportation and defense sectors jumped 6.5% vs. estimates of 3.00%. This was a big beat considering that the prior month (May) was revised upward significantly from -1.1% to -0.1%. Ex Transportation, Durable Goods missed with a 0.2% gain vs estimates of 0.4%. However, the main culprit was a large upward revision to May from 0.1% to 0.6%.
Gross Domestic Product: We got our first glimpse at the 2nd quarter GDP (it will be revised several times). The market was expecting a strong growth rate of 2.6% and that is exactly what we got. But the final revision to the 1st quarter dropped from 1.4% to 1.2%. Some bright spots include Consumer Spending growing at a very strong 2.8% rate and Business Investment up 5.2%. But inflation was very low with Core PCE dropping to 0.9%.
What’s on the Agenda for this Week?
Look for a real “yawner” today but this week is very pivotal with key readings on inflation, jobs, manufacturing and more. It will take a “perfect storm” for MBS to rally past the 103.00 level this week. It will take PCE YOY below 1.4%, Average Hourly Wages at 0.1% or below and ISM Services at 50.0 or below…not just one but ALL THREE need to happen for MBS to rally. That is VERY difficult to see happening given recent economic data.
The Three Things that have the largest ability to impact back-end pricing this week are: (1) Jobs, Jobs, Jobs, (2) Inflation and (3) ISM.
1) Jobs, Jobs, Jobs: The first Friday of each new month brings Big Jobs Friday. This includes the Headline Non-Farm Payroll number and the Unemployment Rate which get all the attention of the media. However, bond traders will be very keen on Average Hourly Wages which are expected to rise a respectable 0.3%. The higher that number is, the worse it is for mortgage rates.
(2) Inflation: Is there any? Is our current/historical methodology even capable of capturing an accurate snapshot of true inflation? The Fed uses Personal Consumption Expenditures (PCE) as their primary gauge of inflation and that will be released on Tuesday. But it has been trending below 1.5% on a YOY basis due to oil prices and lower utility costs. (Yellen and crew have cited mobile phone bill wars as an example of a large portion of consumer costs moving lower due to competition.) The closer this number gets to 2.0%, the worse it is for rates. The closer this number gets to 1.0%, the better it is for rates.
(3) ISM: There will be both Manufacturing (1/3 of our economy) and Non-Manufacturing/Services (2/3 of our economy) this week. With our recent 2nd quarter GDP at a very strong 2.6%, the U.S. economy has actually been trending along a nice growth path, particularly given our recent very strong trend of manufacturing data. Any reading above 50.0 signifies good growth and expansion (more hiring, capital investment, orders, etc.). The ISM Manufacturing is projected to be a very strong 56.7 and the ISM Services sector is expected to be in the 56.9 range. These numbers would have to drop to 50.0 or below for MBS to improve this week. The closer these numbers get to 60.0, the worse it is for mortgage rates.
The Talking Fed
07/31 – Vice Chair Stanley Fischer
08/02 – Cleveland Pres Loretta Mester and S.F. Pres John Williams
There is plenty for the markets to worry about. We have a situation where healthcare went nowhere and there is a justifiable concern that tax reform, budget and debt ceiling bills will not get anywhere. Across the pond, there is North Korea and Iran firing test missiles and China telling the U.S. to back off. We also have sanction news regarding Russia and now Venezuela.
The stock market (DJIA +60.81) has set yet another new record.
As expected, today was a real “yawner” ahead of tomorrow’s very important PCE (inflation) report. Today’s economic data did show some good growth but not by enough of a margin to impact pricing.
Housing: June Pending Home Sales improved by 1.5% over May and May was revised upward slightly. This was despite a huge 7.2% decrease in available inventory compared to a year ago.
Manufacturing: The July Chicago PMI report came in at a very robust 58.9. Any reading above 50.0 is expansionary and any reading above 55.0 is really strong. In June, this reading was 65.7 which is one of the highest readings on record.
The Dallas Fed Manufacturing Survey showed that the district is doing well with the Production Index moving from 12.3 in June to 22.3 in July.
On Deck for Tomorrow: Personal Income and Spending, PCE, ISM Manufacturing, Construction Spending and Total Vehicle Sales.
The Talking Fed
Vice Chair Stanley Fischer said, “Uncertainty about the outlook for government policy in healthcare, regulation, taxes, and trade can cause firms to delay projects until the policy environment clarifies.”