Learn from the Past
Mortgage backed securities (MBS) gained just +3 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move sideways for the week.
While a net change of just 3 BPS looks like a boring week, it was anything but. There was a lot of volatility last week with a 50 BPS swing from best pricing of the week to worst pricing of the week. The main focus of the markets was the Central Bank meetings and the Trade War. Of the three main Central Banks that had policy statements (The Fed, European Central Bank and Bank of Japan) only our Fed had any real action.
The U.S. announced $50B of tariffs on Chinese products. This is a 25% tariff rate on 1,102 product lines. The tariffs will be implemented in two tiers, the first one on July 6, and will cover $34B in imports, and a second wave, which will cover the remaining $16B, or 284 product lines, and will undergo further review in a public notice and comment process, including a hearing.
China’s response: They unveiled $50 billion in tariffs against U.S. goods including soybeans, light aircraft, orange juice, whiskey and beef, starting on July 6th which mirrored the U.S. tariffs schedule and tier system. China’s Ministry of Finance is setting a two-tier system with $34B on July 6th and $16B more to follow.
The Talking Fed
As widely expected, the Fed raised their Fed Fund Rate by a 1/4 point to a range of 1.75% to 2.00%. However, there was much that went on.
Here are some Key Points from the Fed Action:
– Raised Fed Fund rate by 1/4 point to a range of 1.75% to 2.00%.
– Raised the Primary Credit Rate (not the same as the headline Fed Fund Rate) to 2.50%.
– Raised the Interest Rate on Reserve Balances by 20 BPS to 1.9%.
– The vote was 8-0.
– FOMC statement says economy growing at “solid rate,” job gains have been “strong,” consumer spending has picked up and investment continued to grow “strongly.”
– The Fed removed the low inflation line: “Market-based measures of inflation compensation remain low.”
– Language about the economy upgraded, line about rates remaining below long-run levels “for some time” was removed.
– The median ‘dot’ for the end of 2018 has been 2.125% since December 2016 and today’s dot plot shifted higher to 2.375%, confirming The Fed’s expectation for two more rate hikes this year, while the 2019 dot rose from 2.9% to 3.1%, suggesting the hiking carries through.
– 2018 is 2.375% vs. 2.125% in March.
– 2019 is 3.125% vs. 2.875% in March.
– 2020 and longer-run medians are unchanged at 3.375% and 2.875% respectively.
– Starting in January all Fed meetings will include a live press conference with Powell.
The May data showed the biggest surge in spending in 8 months. The Headline reading increased by 0.8% which was double the market expectations of 0.4%. Plus April was revised higher. When you strip out Autos, Retail Sales increased by 0.9% vs. estimates of 0.5%. April was also revised higher. Across the board it looked very good with discretionary spending (restaurants, etc.), building materials, department stores, you name it. Just about every category saw strong growth with the exception of furniture.
What’s on the Agenda for this Week?
Compared to last week, this week is pretty tame in terms of what is on the calendar. Wednesday’s Powell speech, the Bank of England and OPEC will get a lot of attention from bond traders. MBS are expected to trade at some very nice levels due to the uncertainty over the Trade Wars, but MBS are moving into an area where they will be “tapped out” as the spreads don’t make any sense to own with just a little improvement over the current levels.
The three areas that have the greatest ability to impact backend pricing this week are: (1) Trade Wars, (2) Texas Tea and (3) Geo Political.
(1) Trade Wars: Is last week’s opening furrow just the beginning? That is what all markets (stocks, bonds, etc.) are concerned about and is a big uncertainty for traders…and traders do not like uncertainty. While the first round of tariffs by the U.S. and China won’t kick in until July 6th, traders will be looking for any movements in trade negotiations.
(2) Texas Tea, Black Gold: A sharp rise in oil prices were a major factor in a multitude of inflation readings over the past month which also pressured MBS pricing. But over the past couple of weeks, oil prices have dropped and it has helped back end pricing. This Friday will be a very important OPEC meeting and their output targets will impact inflation expectations.
(3) Geo-Political: Merkel is on the chopping block in Germany which is very big for the markets. Spain and Italy still are of concern with their very recent leadership change and their huge amount of debt that has no way of being paid back.
While these reports do not generally impact MBS pricing, there will be a ton of housing-related data this week that will give a good understanding of the state of the housing market. This week will be the Home Builders’ Sentiment Index, Housing Starts, Building Permits, Weekly Mortgage Applications, Existing Home Sales and the FHFA Home Price Index.