Learn from the Past
Mortgage backed securities (MBS) lost 21 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher from the prior week. There was some “choppiness” on Wednesday. The markets saw their lowest rates on Monday and their highest rates on Thursday.
Last week was packed full of market moving news and most of it was positive for our economy which is always negative for longer term rates. There was also the grand unveiling of the Tax Reform and market sentiment moving away from expecting Janet Yellen to remain as the Fed Chair in 2018.
GDP: The final reading for the 2nd quarter GDP was revised upward to 3.1% vs estimates of 3.0%. Consumer Spending remained a very strong component at a 3.3% clip. This confirms that our economy had a good amount of momentum rolling into the 3rd quarter and that the 3rd quarter would likely be very strong except that the hurricanes will drag on the data.
Durable Goods: This data was much better than expected. The headline August reading came in at 1.7% vs estimates of only 0.7%. When the volatile transportation sector is stripped out, it increased by 0.2% which matched market expectations. The prior month (July) was revised upward from 0.5% to 0.8%. The Core Durable Goods Orders (non-defense and non-aircraft) came in three times higher than expectations (0.9% vs estimates of 0.3%).
Manufacturing: The bellwether Chicago PMI was very robust, coming in at a three year high of 65.2 vs estimates of 58.5. Any reading above 50.0 is expansionary and readings above 60.0 are very rare.
Tax Reform: We finally got the official release of Trump’s proposed Tax Reform. Here are some of the key highlights:
– Elimination of the AMT
– Elimination of the “Death Tax”
– Four “tax” brackets – 0%, 12%, 25% and 35%
– Married couples up to 24K pay no taxes (0% tax bracket)
– Most itemized deductions eliminated
– Corporate tax rate 20%
– Company tax rate reported as personal income 25%
– Tax free repatriation on foreign profits
The Federal Reserve
Fed Chair Janet Yellen said that “Without further modest increases in the federal funds rate over time, there is a risk that the labor market could eventually become overheated, potentially creating an inflationary problem down the road that might be difficult to overcome without triggering a recession.”
Game of Thrones: The waiting game as to who the next Fed chair will be got a little excitement after news broke that both President Trump and the Treasury Secretary met with former Fed Board Governor Kevin Warsh yesterday. No news from that meeting has emerged other than it happened. As a result, Wall Street has changed their odds of Warsh getting the nod from 10% to 45%. Meanwhile Yellen’s odds dropped from 32% down to 24%. Still a tight race as there are few more names on the “short list.”
What’s on the Agenda for this Week?
MBS are still trading in a very negative channel and it will be very key to see if they can climb back above the 100 day today or tomorrow. Normally, Friday’s Jobs report would be a big deal, but not so much in this case. It could very well be -25K to only 75K in Non-Farm Payrolls. But the market understands that a low number like that is due to the hurricanes and not a function of the trajectory of our economy. So, a weak reading will have a muted impact on pricing, but a strong reading (in wages mostly) could have a very negative impact on pricing. Until then, the bond market will focus on a string of very strong economic data (today’s ISM Manufacturing is one of the highest readings on record). Global instability overseas (Spain, North Korea) are helping MBS but just about everything domestically is negative for MBS right now (strong economic data, Fed balance sheet tapering, odds of a December rate hike increase are growing, Tax Reform and speculation of who will lead the Fed in 2018). As a result, these two opposing forces will slug it out this week. But the upside towards better pricing is very limited this week and does not support any type of risk taking. Look for an intra-day range of -3 to + 15.
The three areas that have the greatest ability to impact back-end pricing this week are. (1) Geo-political, (2) The Talking Fed and (3) Domestic Flavor.
(1) Geo-Political: The bond market is very much interested in the fallout of the Catalonia referendum which saw over 2 million votes with 90% opting to leave Spanish control. This has the potential to push back the EU’s tapering of their bond purchases which many have been speculating would begin soon. There will also be the Minutes from the last European Central Bank meeting.
(2) The Talking Fed: While Fed Chair Janet Yellen will speak again this week, the bond market is probably more influenced by shifting odds of who the next Fed Chair will be. Last week, Warsh got some traction which pressured MBS as he is viewed as being more “hawkish” than Yellen.
10/02 Robert Kaplan
10/03 Jerome Powell
10/04 James Bullard, Janet Yellen
10/05 John Williams, Patrick Harker
10/06 Raphael Bostic
(3) Domestic Flavor: Big Jobs Friday is this week, which of course will get a lot of attention by the markets, but there will also be some very important reads with ISM Manufacturing and Services.
There will continue to be reaction to any movement in the Tax Reform front as we hear from key members of the House and Senate.
MBS have traded in a very narrow range as the very strong ISM data put pressure on trades while geo-political events (Vegas, Catalonia) kept MBS in the black.
Manufacturing: Just like the regional Chicago PMI report on Friday, the September ISM National Manufacturing report was much better than expected and hit its highest levels in 13 years with a 60.8 reading. New Orders rose to a 4 month high and Employment broke 60.0 for the first time in 6 1/2 years.
Construction Spending: Was a mixed bag. The August reading was much stronger than expected (0.5% vs estimates of 0.2%) but that is mostly due to the fact that July was revised much lower from -0.6% down to -1.2%. YOY, it moved from 1.9% to 2.5% which is pretty good.
On Deck for Tomorrow: It’s a light day with only Total Vehicle Sales and a speech by Jerome Powell.
The Talking Fed
Dallas Fed President Robert Kaplan said he remains “open-minded” about a December rate hike, but the Fed “can afford to be patient.”