Learn from the Past
Mortgage backed securities (MBS) lost 1 basis point from last Friday’s close which caused fixed mortgage rates to move sideways for the week, but rates were pressured higher for most of the week.
Everything domestically pressured MBS to move lower (mortgage rates moved higher) with very strong economic data (Durable Goods and GDP) as well as the House passage of the Senate’s budget which clears the way for Tax Reform to begin. This all caused mortgage rates to move higher all week until Friday. That’s when Catalonia voted for independence from Spain and global money poured into long bonds seeking safety ahead of any instability to the Eurozone and caused MBS to rebound off their worst levels of the month.
Durable Goods: The September reading was much stronger than expected. The headline MOM reading hit 2.2% vs estimates of 1.0%. Plus, August was revised upward from 1.7% to 2.0%. YOY, the reading moved from 5.5% in August to 8.3% in September. When you strip out the volatile transportation sector, the data is still really strong. MOM hit 0.7% vs estimates of 0.5% and August was revised higher from 0.2% to 0.7%. YOY, it moved from a 6.8% pace in August to a 7.5% pace in September. This is a strong report.
Gross Domestic Product: The first look at the 3rd quarter GDP was much hotter than expected, hitting 3.0% vs estimates of 2.5%. Just 2 months ago, projections were for this reading to hit only 1.0%. This marks the second straight quarter of 3.0% or above growth. And that is even with the hurricanes! The Price Index was also higher than expected (2.1% vs estimates of 1.8%) which is inflationary.
Consumer Sentiment: The final reading for the University of Michigan’s Consumer Sentiment Index was revised from the early release of 101.1 to 100.7. This is a huge increase over September’s 95.3 reading and is very positive for the economy.
Budget and Tax Reform: The House voted 216 to 212 to adopt the Senate’s FY 2018 Budget. That now lays the ground work for Tax Reform as a simple majority is all that is needed to pass. The President and Treasury Secretary have said that they will submit their Tax Reform Bill on November 1….and then the fireworks start.
The Catalan “government” took center stage as Spain has enacted their “Article 155” scenario to squash the Rebels. Catalonia defied Madrid and voted to pass the motion to establish a new republic independent of Spain with 70 votes (68 were needed for majority).
What’s on the Agenda for this Week?
This is a very pivotal week for MBS. The announcement of the next Fed Chair will be key. If it is Yellen, then MBS will rally, if it is Powell, MBS will remain in the same channel and if it is Warsh or Taylor, MBS will sell off. Tax reform is also very key on Wednesday along with the Fed meeting. Friday’s Jobs data will also be very important with focus on the wage data. Look for MBS to stay below the 200 day moving average unless Yellen is Fed Chair. And since the 200 day is just overhead the current pricing levels, there is no upside unless she gets the nod.
The three areas that have the greatest ability to impact back-end pricing this week are: (1) Central Bank palooza, (2) Geo-Political and (3) Domestic Flavor.
(1) Central Bank Palooza: Believe it or not, there is a Fed meeting this week. The market keeps talking about a potential December meeting rate hike, but you never hear about the November 1 meeting. That is because unlike the December meeting, this one is not followed by a live press conference with Janet Yellen. Since they just announced their “taper” last time around, look for no change to that plan. The bond market will be looking for forward guidance on rate hikes. The Bank of England (B of E) will also be in the spotlight as they are widely expected to raise their rates.
(2) Geo-Political: Spain/Catalonia as well as North Korea are still providing upward momentum on long bonds.
(3) Domestic Flavor: We are supposed to get the official Tax Reform bill and will learn what the proposed plan includes. This can have a large impact on pricing depending on how stimulative it is perceived by bond traders.
While the markets are expecting a “pass” by the FOMC this week, there is plenty of economic data with the gravitas to shift expectations of their next action: ISM Manufacturing and Services, PCE and Consumer Confidence. But its Friday’s Jobs report that will carry the most weight as a major rebound is expected from -33K jobs in the last report to +300K in this report. As usual, Average Hourly Wages will get a lot of attention.
Game of Thrones: We are supposed to learn who President Trump’s nomination is for Fed Chair on Thursday.
A very interesting day. MBS moved higher as proposed tax reform was reportedly to set the corporate rate at 20% but that it would “gradually” get there by 2022 which would provide very little (if any) financial stimulus in the next year. This “phase-in” plan may not make it to the final bill but it has markets spooked nonetheless.
Personal Income and Outlays: One of the key measures of inflation that the Fed uses when it says “target inflation rate” is the PCE (Personal Consumption Outlays). And while this did make a large move from the August pace of 1.30% to a pace of 1.6% in September, it is still well below their target rate of 2.0%. Personal Spending improved more than expected (1.0% vs estimates of 0.8%). Personal Income matched expectations with a 0.4% reading.
On Deck For Tomorrow: Two days of FOMC meetings start, Case-Shiller, Chicago PMI and Consumer Confidence.