Learn from the Past
Mortgage backed securities (MBS) lost 54 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move higher for the week.
The threat of inflation continued to pressure MBS as we saw the worst levels in several years (highest mortgage rates in several years). CPI is back above 2.0%, Oil is up which is very inflationary (WTI 68.21, Brent 73.88), there is steady economic growth above 2%, the Fed is trimming down its colossal balance sheet and looks to hike at least two more times this year alone. That is the perfect petri dish for bonds to sell off.
Manufacturing: The Philly Fed Manufacturing Survey and Outlook came in better than expected, at 23.2 vs estimates of 21.0. Prices Paid jumped nearly 14 points to 56.4 for the highest reading in 7 years. And Prices Received jumped more than 9 points to 29.8, which is a 10-year high and an echo of yesterday’s Beige Book which said higher metal prices are being passed through, at least to some customers.
Industrial Production: Rose by 0.5% in March vs estimates of 0.4%. It was the largest gain in 6 years but much of that was due to energy production. Capacity Utilization improved by 78.0% vs estimates of 77.9%.
Retail Sales: The March Headline Retail Sales report was stronger than expected with a 0.6% vs 0.4% estimate. But when you strip out autos, Retail Sales matched expectations with a 0.2% reading. Department stores continue their free-fall but restaurants and furniture sales climbed higher.
The Talking Fed
The Beige Book was released. You can read it here.
The main message in this report that is prepared exclusively for the May Fed meeting is “tariff.” The word “tariff” appeared exactly zero times in the March Beige book that was used to raise rates at their April meeting. In this Beige Book, the word “tariff” is used 36 times!
– Outlooks remained positive, though contacts in various sectors, including manufacturing, agriculture and transportation, expressed concern about the newly imposed or proposed tariffs.
– Inflation was seen as increasing but at a muted level, with prices increasing across all districts, but at a moderate pace, although there were widespread reports that steel prices rose, sometimes dramatically, due to trade tensions. The Fed also notes that businesses generally anticipated further price increases in the months ahead, particularly for steel and building materials.
– Most Districts reported wage growth as only “modest” while reports of labor shortages over the reporting period were most often cited in high-skill positions, including engineering, information technology, and health care, as well as in construction and transportation.
What’s on the Agenda for this Week?
After being stuck in the same channel since mid-February, MBS finally broke out of that channel on Friday. Barring any significant military escalation, breaking above that channel was not possible, so if MBS were going to break out of it, it was going to be to down side. And that has finally occurred. This week starts in a new and lower (higher rates) channel. For today, MBS moved lower out of the gate directly due to very strong PMI from across the pond as Japan, Germany and others were hotter than expected (manufacturing growth is bad for long bonds) and will ensure that MBS stay in the new lower channel. For the week, if 1st quarter GDP is at 2.5% or above, then MBS will move into an even lower channel. The press will be all over the 10 year Treasury note at or near the 3.00 level. However, MBS can sell off even if Treasuries improve. Overall, look for MBS to see another week of pressure unless trade talks break down or some other unplanned/unscheduled geo-political event shocks the markets.
The three things that have the greatest ability to impact backend pricing this week are: (1) Central Bank Palooza, (2) Domestic Flavor and (3) Trade Wars.
(1) Central Bank Palooza: On Thursday will be a European Cenral Bank update. The market does not expect them to change their main interest rate but they may move up their deposit rate which is currently -0.4%. They have also been sending conflicting messages to the markets on the timing of their bond purchase wind-down. There will also be an update from Bank of Japan on Friday.
(2) Domestic Flavor: There are several big economic releases that have the gravitas to move pricing this week. But there are none bigger than our first look at GDP for the 1st quarter. Traditionally, the 1st GDP numbers are the weakest of the year. This time, the market is expecting a growth rate of 2.1%. The higher this reading is, the worse it is for bonds and rates.
(3) Trade Wars: For the time being it would appear that the momentum towards an all-out trade war has slowed as talks between China and the US support a wider mood. And geo-politically, signs of improvement in relations between North Korea and the US also help. An historic meeting between the leaders of South and North Korea will also likely garner plenty of attention.
Treasury Auctions this Week
04/24 2 year note
04/25 5 year note
04/26 7 year note
Strong Markit PMI readings in the U.S. and abroad continued the pressure on MBS today as the narrative of stronger growth rates continues to gain traction. WTI Oil prices also increased yet again (now $68.94 and getting very close to the $70 mark) which is inflationary and negative for MBS.
Taking it to the House: The March Existing Home Sales data was stronger than expected, rising 1.1% vs. estimates of 0.2%. Key takeaways: Median Sales Price increased to $250,400 and marks the 73rd straight month of year-over-year gains. Inventories fell to 3.6 months of supply and the average time on market dropped from 37 days in February to 30 days in March with just over 50% of all inventory selling in 15 days or less.
Markit Surveys: Their Manufacturing PMI for April (prelim) hit 56.5 vs. estimates of 55.0 and their Services PMI hit 54.4 vs. est. of 54.0
On Deck for Tomorrow: Case-Shiller Home Price Index, FHFA Home Price Index, New Home Sales, Consumer Confidence, Richmond Fed MFG and 2 year Treasury Note auction.
Across the Pond
Japan: Nekkei Manufacturing PMI 53.3 vs. estimates of 52.6
Germany: Markit Manufacturing PMI 58.1 vs. estimates of 57.5
Eurozone: Markit Manufacturing PMI 56.0 vs. estimates of 56.1