Learn from the Past
Overview
Mortgage backed securities (MBS) gained +37 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move lower for the week.
A very interesting and telling week. If there was any question on what is the most important thing for long bond traders right now, the answer is Tax Reform. There was a Fed Meeting – bonds did nothing. A new Fed Chair was appointed – bonds did nothing. It was some of the strongest economic data that we have ever seen – bonds did nothing. All three of those would normally be very negative for bond trades (pushing mortgage rates higher). But instead bonds traded higher (pushing mortgage rates lower). Why?
Tax Reform
While both sides are debating the merits and impact of the tax cuts on individuals, the bond markets are focusing on Corporate Taxes. The current proposal of a flat 20% corporate tax rate and a 12% rate on money brought back from overseas is very stimulative to our macroeconomic picture and would be something that bonds would not like. However, even Republicans are balking at the changes to SALT deductions; the market sentiment currently is that this tax bill will not pass. And that means no new stimulative reform to our economy and that is very bond friendly.
Manufacturing
The October ISM National Manufacturing Index was very strong, coming in at 58.7 vs estimates of 59.5. Any reading in the upper 50s is huge. Prices Paid hit 68.5 vs estimates of 68.0
The October Chicago PMI was a blockbuster! It hit 66.2 vs estimates of 61.0. Any reading above 50 is expansionary and a reading above 60 is rare and very robust. New Orders were very strong and backlogs hit a 43 year high.
ISM Services: Was a blockbuster, breaking above 60.0 for only the 4th time in 27 years. The October reading hit 60.1 vs estimates of 58.6. This represents more than 2/3 of our economy.
Jobs, Jobs, Jobs – Big Jobs Friday!
It was a mixed bag with the jobs data with real strength in hiring but real wage pressure is once again evasive. You can read the official Bureau of Labor Statistics release here.
Tale of the Tape:
• Non-Farm Payrolls (1st release) for October 261K vs estimates of 310K
• September NFP (2nd release, one more revision to come) revised higher from -33K to +18K (51K swing)
• August NFP (3rd and final release) revised higher from 169K to 208K (39K swing)
• The more closely watched 3 month moving average is now 162K
• Average Hourly Wages MOM was flat at 0.0% vs estimates of 0.3%
• Average Hourly Wages YOY increased by 2.4% which was at a slower pace than in September (2.8%)
• The Unemployment Rate fell to 4.1% vs estimates of 4.2%
• The Participation Rate fell from 63.1% in September down to 62.7% in October
The “Yawning” Fed
They left their key interest rate and asset purchase program alone.
You can read the official Fed release here.
The Fed seemed slightly more positive (and perhaps hawkish) by upgrading the economy from growth “moderately” to “at a solid rate” even as it cautioned that “Gasoline prices rose in the aftermath of the hurricanes, boosting overall inflation in September; however, inflation for items other than food and energy remained soft.”
Here are a few highlights from their statement:
• Economic activity is rising at solid rate despite storms
• Inflation for items other than food and energy remained soft
• Storms unlikely to alter economy’s medium-term course
• The labor market continued to strengthen, unemployment declined
• Spending is rising at a moderate rate, investment picked up
• Repeats market-based inflation compensation gauges still low
• Repeats sees inflation stabilizing around 2% medium term
What’s on the agenda for this week?
Overview
Tax Reform will continue to shape pricing. IF new changes are still good for macroeconomic expansion AND it has the full support of Republicans, THEN MBS will sell off. But right now, the situation is completely opposite of that so it will take a big turnaround there. Barring that, look for MBS to trade in very elevated ranges this week. For an intra-day trade, look for MBS to sniff around the 100 day moving average and then move sideways so probably very small gains today. There is nothing on the economic calendar that can impact pricing this week.
Three Things
The three things that have the greatest ability to impact backend pricing this week are: (1) Tax Reform, (2) The Talking Fed and (3) Geo-Political.
(1) Tax Reform: The House tax-writing committee begins revising the bill on Monday with tweaks and some more substantial changes expected to a number of individual and corporate tax proposals. The changes that the House Ways and Means Committee puts into the revised bill will have a large impact on MBS, not only in terms of evaluating the impact on macroeconomic growth but also on the probability of it actually passing.
(2) The Talking Fed: The bond market made a sigh of relief on the pick of Powell for the next Fed Chair compared to the more “hawkish” options like Taylor and Warsh. But are those two done? Or will we still see them on the board?
With the announcement that NY Fed President William Dudley will be resigning/retiring that leaves just 3 Federal Reserve Board Members slated so far for 2018 which is not enough to operate. There are now 5 open positions. Presumably, if a candidate is worthy of consideration for Fed Chair, then they are also worthy of consideration to be a Governor. Will Warsh and Taylor be nominated? If so, that makes a much different board composition than what the markets are used to and can have a big impact on bonds.
(3) Geo-Political: President Trump’s trip through Asia will get plenty of attention as he talks trade imbalances and North Korea with Japan and China. But there is also a lot of attention on Saudi Arabia as they shot down a missile launched by Yemen. The Saudi’s claim it was really Iran using Yemen as a proxy and are threatening war with Iran. North Korea is saying that they will be launching a new missile “soon.” And Spain is continuing to crush Catalonia’s independence.
Treasury Auctions this Week
- 11/07 3 year note
- 11/08 10 year note
- 11/09 30 year bond (most important of the week)
Market Wrap-up
Overview
As expected, MBS have seen very small gains as they have “hugged” the 100 day moving average. There were no domestic economic reports or Treasury auctions to react to. MBS received downward pressure on rising oil prices (inflationary) but also received terrific upward momentum as Tax Reform appears (for now) to be dying a slow death.
Domestic Flavor
Tax Reform: While the House Ways and Means Committee is fielding every possible idea/amendment to their Tax Bill, the Senate could make this a moot point. Once again Arizona Senator John McCain has announced that he will thwart any Republican progress by voting against basically ANY Tax Reform. That brings the total to 3 confirmed Republican Senators that will vote against it once it leaves the House which would bring the Republican total to below 50.
The Talking Fed: N.Y. Fed President and FOMC Board Member William Dudley announced that he will be retiring a few months early. The term limits are for 10 years and he was slated to hit that in early 2019. He said he would retire in “mid-2018” instead and that the exact timing will be determined by making sure that his replacement is all set before he leaves office.
On Deck for Tomorrow: Small Business Optimism, JOLTS, Consumer Credit and a 3 year Treasury Note Auction.