Learn from the Past
Overview
Mortgage backed securities (MBS) lost 57 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move higher from the prior week. The market saw the lowest rates of the week on Monday and the highest rates of the week on Thursday.
A very interesting and very telling week for MBS trends. Everything about last week should have caused MBS to at least move slightly higher (meaning lower rates). Retail Sales were dismal, Consumer Sentiment dropped, a missile was shot over Japan, a London terror attack, and the Atlanta Fed lowered its GDP forecasts.
Analysis
So, why didn’t MBS rally (or at least move a little higher for lower rates)? This is where it gets interesting as long bond traders have two things weighing on their desire to add to their positions. First are lower taxes. Yes, Tax Reform has shot way up in probability over the past couple of sessions with Paul Ryan’s press conference earlier in the week as well as Treasury Secretary Mnuchin’s comments and then followed up with a dinner between President Trump and two Democratic leaders making it appear that there could be some actual bi-partisan work in D.C. Lower corporate taxes and/or lower personal taxes would cause our economy to grow at a pace that would be too hot for long bond holders that profit from slow growth and inflation rates, so any increase in probability of tax reform actually getting done this year will cause long bond traders to lose interest in holding MBS.
Next is effectively a “white paper” by the Bank of Canada (BofC) (which unexpectedly hiked their interest rates this month). This paper and accompanying comments by Senior Deputy Governor Carolyn A. Wilkins, who said that Canada was open to changes in the BofC mandate, has bond traders concerned that there could be a MAJOR shift in global central bank policy in 2018.
Keep in mind that Fischer, the number 2 person in our Fed, will be gone in October, and Yellen is very much in doubt to be renominated in 2018. Even if she did stay, there would be at least 4 Fed Governors that would be appointed by President Trump and a rotation in of 4 district Presidents that are generally more conservative than the current rotation of district voters.
Enter the BofC where Wilkins says it is appropriate for the BofC to reconsider its mandate and lower the target inflation target (for example from 2.0% to 1.5%) or even remove the inflation target altogether. This has reminded bond traders that even the N.Y. Fed President (number 3 at our Fed) hinted last month that the Federal Reserve could adjust its own inflation target.
Last week, the Bank of England (BofE) left their interest rates and asset purchase program unchanged but BofE Governor Carney made comments that put the market on notice that the BofE may be raising rates soon.
This is all digesting in the long bond traders’ tummies as everyone is awaiting this Wednesday’s FOMC meeting where the market expects that rates and interest rate policy and forward guidance will be unchanged but we will learn about the great “wind-down” as they reduce their monthly MBS purchases. As one of the largest volume purchasers of all Agency MBS, they will consistently lower their purchases each month…which means consistently more supply available each month and with even a smidge less artificial demand for MBS, it has many bond traders worried.
This is certainly not a “sky is falling” scenario, it simply explains that the sentiment of bond traders (not stock traders) is one of caution, making it very difficult to justify bidding up prices.
What’s on the agenda for this week?
Overview
MBS are effectively stuck in a very well defined channel that is supported by the 50 day moving average and capped by the 25 day moving average. There is no new fear in the marketplace today which means that that there is no reason for MBS to improve. After Wednesday’s Fed statement, MBS will do one of two things. IF the Fed completely goes against any and all commentary by all the governors and district presidents over the past month and does NOT make any type of announcement on their balance sheet (MBS purchases), THEN MBS will rally towards that 25 day moving average and may make it to our 10 day. But that is an extremely “dovish” position. IF they raise rates, THEN MBS will sell off. IF they don’t raise rates but do finally give a start date on their “taper,” then MBS will move towards the bottom of the channel. IF they announce a start date and it is in 2018, then MBS will rally.
Three Things
The Three Things that have the greatest ability to impact backend pricing this week are: (1) The Talking Fed, (2) Geo-Political and (3) Across the Pond.
(1) The Talking Fed: The Federal Open Market Committee (FOMC) will start their policy meeting on Tuesday and conclude on Wednesday with their 2:00 pm EDT release of their interest rate decision and policy statement. The bond market currently has almost no chance of a rate hike at this meeting but has recently moved up their probability from 30% to 51% for a potential rate hike in December.
The bond market will be paying very close attention to any new hints or even actual policy on their massive balance sheet that has been used to keep a tight lid on interest rates by gobbling up Treasuries and MBS at a pace that a true open market could never support. Even the most “dovish” Feds have expressed the need to address the issue. They have outlined a plan in the past where they still buy Treasuries and MBS but at a slower pace while allowing maturing notes and bonds to roll off the balance sheet instead of reinvesting the principal in new purchases. We even have seen timelines from them. But will this meeting be the meeting that they start it or give us an official start date? That is the major focus for bond traders this week. There will be a live press conference with Fed Chair Janet Yellen at 2:30 pm EDT to explain their new policy.
Talking Feds this Week
09/19 – Start of FOMC Meeting
09/20 – Interest Rate Decision and Policy Statement, live press conference with Janet Yellen
09/22 – John Williams, Esther George and Robert Kaplan speak. There will also be the Atlanta Fed Business Inflation expectations.
(2) Geo-Political: The focus this week will be on the United Nation’s meeting in New York. President Trump will speak at the event. The U.N. voted last week to increase sanctions against North Korea which has not, as of yet, had the desired effect as N.K. fired another missile over Japan last week. The bond market will also react to any significant movement in policy over Tax Reform.
(3) Across the Pond: The Bank of Japan will be in the spotlight on Thursday when their Central Bank will issue their interest rate and policy statement. The market is not expecting a change but will focus on forward guidance.
Location, Location, Location
There is a lot of housing industry news this week. None of it will impact pricing but it will give a good understanding of the industry.
09/18 – Home Builders Sentiment Index
09/19 – New Home Starts and New Building Permits
09/20 – Existing Home Sales
09/21 – FHFA Home Price Index
Market Wrap-up
Overview
There were no major economic releases today. The odds of a December (not September) rate hike have moved up in trading today from around 50% on Friday to just over 60% today which kept the overhead pressure on all long bonds today.
Domestic Flavor
The NAHB Home Builders’ Sentiment Index for September came in at 64 vs estimates of 67, August was at 67. Any reading above 50.0 is good and any reading above 60 is great, but this report does not impact pricing.
On Deck for Tomorrow: New Housing Starts and Building Permits, Import and Export Prices and the start of the FOMC Meeting.
Across the Pond
Eurozone: CPI rose by 1.5% on a YOY basis which matched market expectations.
Brexit: BofE Governor Mark Carney said, “On balance, the de-integration effects of Brexit can be expected to…be inflationary.” This is more “hawkish” commentary from him.