Learn from the Past
Overview
Mortgage backed securities (MBS) lost -54 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher from the prior week to their highest levels since July.
MBS sold off (mortgage rates moved higher) as a result of a shift in sentiment among long bond traders regarding Tax Reform and the next Fed Chair. Odds of Tax Reform happening shot up in the marketplace after the Senate passed the FY 2018 budget. You can’t have Tax Reform without a budget, so this makes some sort of reform more likely. Tax Reform can be very stimulative to the economy and bonds simply do not perform well in a strong economy. Also, several polls and reports hit last week that have the short list for the next Fed Chair down to five members with Janet Yellen at the lower end of expectations.
Location, Location, Location
Weekly Mortgage Applications rose by 3.6%, led by a pop in Refinance Applications of 4.0% and Purchase Applications of 3.0%.
New Housing Starts for September were lighter than expected (1.127M units vs estimates of 1.180M).
Building Permits were also lighter than expected (1.215M vs estimates of 1.238M). For both of these, the weakness is mainly in the multi-family sector and not the single family residence sector. This reporting period is during the hurricanes for Florida and Texas which are two of the most populated states.
September Existing Home Sales were a tad better than expected (5.39M vs estimates of 5.30M units) despite the hurricanes. As expected, inventory shortages and rising prices are a problem for faster growth.
The Federal Reserve
The Beige Book was more upbeat than expected. You can read the official release from the Fed here.
Despite major disruptions from Hurricanes Harvey and Irma, all 12 Federal Reserve districts indicated that economic activity increased in September through early October. Several districts noted increased manufacturing input costs, citing storm impacts (with 58 mentions of the word “hurricane”) and labor constraints (employers were having difficulty finding qualified workers). This was certainly reflected in the last JOLTS report.
Game of Thrones: The Politico published a report that Treasury Secretary is said to be pushing for Fed Governor Jay (Jerome) Powell and the WSJ openly endorsed former Fed Governor Kevin Warsh. Both scenarios make Yellen’s re-appoint seem more remote. Also, on Fox News President Trump said that it is “in his thinking” that he could bring in both Powell and Taylor (similar to Yellen and Fischer as Chair and Vice Chair). This was yet another reason for bonds to hedge against a shift at the Fed that could lead to faster rate hikes and growth.
Political
The Senate passed the 2018FY Budget with a 51-49 vote. Kentucky Senator Rand Paul was the only Republican “no” vote. This means that this now moves into reconciliation mode with the budget that the House has already passed, paving the way for Tax reform.
What’s on the Agenda for this Week?
Overview
Crashing below the 200 day moving average last week is a very significant event from a technical perspective. It will be very important to see if MBS can climb back above it today…if not, it is very bad news. Experts don’t expect much movement in MBS until Thursday’s ECB statement and Friday’s GDP data can have a huge impact on pricing.
Three Things
The three things that could have the most impact on backend pricing this week are: (1) Across the Pond, (2) Political and (3) GDP.
(1) Across the Pond: The biggest event of the week is the European Central Bank’s interest rate decision and policy statement on Thursday. Just like our own Federal Reserve did at their last meeting, the ECB is expected to announce a reduction of their monthly bond purchases. The markets will react strongly depending on the scope and term of their “taper.” It is widely expected that they will drop from 60B Euros down to 40B Euros and keep it at that level for the next six months. However, they may cut less or more than that and they may draw out the time line more.
(2) Political: There is plenty for the bond market to digest this week but Tax ReformGDP will continue to get the most attention amid leaks and speculation of what will or will not be in the reconciled Budget Bill between the House and Senate. Already, the White House has come out and said that they will not touch the current 401(k) rules which the media had been reporting would be changed.
Game of Thrones: As we get closer to the supposed November 2nd deadline (subject to revision) where we would get President Trump’s nomination for the next Fed Chair, momentum continues to shift from one of the five short-listers to another. As sentiment shifts to more “hawkish” candidates, it can have a large impact on pricing.
Current Short List:
Powell
Warsh
Taylor
Yellen
Cohn
(3) GDP: Friday’s 1st release of the 3rd quarter GDP could be a real market mover. Originally, it was thought that the hurricanes would drag down economic growth in the 3rd quarter but would more than make that up and sling-shot ahead in the 4th quarter. But we have had a slew of much stronger than expected economic reports from September and now the expectations are that the first print of the GDP data could be as high as 2.5%.
Market Wrap-up
Overview
Today was a nice and quiet session. There were no economic data points today and there was nothing new geo-politically to change the bias among long bond traders. As a result, MBS listlessly drifted sideways.
Domestic Flavor
On Deck for Tomorrow: 2 year Treasury auction and the Richmond Fed Mfg Index.