Learn from the Past
Overview
Mortgage backed securities (MBS) lost 17 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher for the week.
MBS dropped for the third straight week which has caused fixed mortgage rates to slowly rise during that period. GDP and Trade Talk were the main focus of the markets, with the European Central Bank also receiving some attention.
Domestic Flavor
Gross Domestic Product: The 1st quarter GDP had its final revision and it moved up from 2.0% to 2.2%. The first reading of the 2nd quarter GDP (we will see this number revised several times) basically matched expectations with a 4.1% reading, which is very strong. The surprise came in the Price Index which jumped 3.2% vs. estimates of 2.3%. Consumer Spending “popped” with a huge surge of 4.0% vs. estimates of 2.9%.
Consumer Sentiment: The final July University of Michigan reading came in at 97.9 vs. estimates of 97.1.
Durable Goods: The very volatile report showed that the June data increased and had major upward revisions to May’s data. The Headline reading showed a 1.0% MOM gain vs. estimates of 3.0%. But the reason for the miss was the large revision from -0.6% to -0.3% in May. When you strip out the transportation sector, orders rose by 0.4% which was close to expectations of 0.5%. May was revised upward from -0.3% all the way up to +0.3%. So actually that ex-transport number was a beat.
Central Bank Palooza
The European Central Bank and its President Mario Draghi kept their rates unchanged and basically used the exact same policy statement as their last one. They continued to pledge that their QE bond buying program would end this year (unless they needed it to go longer) and that they would keep rates as-is until next summer. In his live comments, Draghi said that there is still uncertainty over trade issues but that the direct effects of implemented tariffs is limited.
Trade Wars
On the other trade front, President Trump met with Jean-Claud Junker, the EU Commission President face-to-face to talk trade. During their joint press conference Junker said that the only reason that he traveled to the White House was to make a trade deal. Here are some of the highlights:
• EU agreed to work on more U.S. LNG exports
• EU agree on lowering industrial tariffs
• EU agrees to align regulator standards on medical products
• EU agrees to import more U.S. soybeans
China announced a fiscal stimulus plan that is designed to front-run an excepted economic slowdown due to the trade war with the U.S. The fiscal package contains measures that included giving an additional tax cut of 65 billion Yuan ($9.6 billion) to companies with R&D expenditure, expediting non-budgeted special bond sales to assist local government infrastructure financing and easing restrictions on banks’ issuance of financial bonds for small firms.
In what seems like a direct response to China’s stimulus plan, the White House announced a $12 billion “short-term” stimulus plan to help US farmers hurt by China’s retaliatory tariffs. The package will consist of direct payments, food purchases and trade development under a program already authorized under the Commodity Credit Corp act, which means Congressional approval is not required. Further details on the program will come by Labor Day.
What’s on the Agenda for This Week?
Overview
MBS has been under a very slow and gradual pressure over the past three weeks (a combined -44BPS from July 9th to July 27th). And this week will have several key events that have the gravitas to send MBS breaking below the current floor. While no real action is expected from the Fed and Bank of England, the Bank of Japan is the real wild card. They have been stuck in negative/zero rates for a long time and have recently (twice last week) dumped a ton of money into purchasing their own bonds to drive down their treasury yields. If they raise their target yield and/or raise their rates, MBS will not react well. And of course, there will be lots of geo-political/trade war news on a slow drip all week. The problem is, that the “drip” has not contained anything shocking or new. More real traction with the EU and/or any traction with China will cause some volatility with bonds.
Three Things
The three areas that have the greatest ability to impact backend pricing this week are: (1) Central Bank Palooza, (2) Inflation Nation and (3) Jobs, Jobs, Jobs.
(1) Central Bank Palooza: There will be interest rate and policy decisions from three of the world’s top five Central Banks. It all starts on Tuesday with the Bank of Japan. There has been a growing speculation that they may finally be ready to increase their interest rate (if not at this meeting, the next one). The BofJ has stepped in twice last week and already once this morning and snapped up all their 10Y bonds that they can to drive the yield back down (which the market keeps driving up). The market widely expects some change in policy over their yield targets. Next up is our own Federal Reserve. The market is not pricing in a rate hike at this meeting but that is primarily due to the fact that this meeting does not have a live press conference associated with it. The markets have been trained that “live” meetings can only be the ones with a live press conference. However, next year Fed Chair Jerome Powell said he wants ALL meetings to be “live” which will keep the market more on their toes. Regardless, the bond market will be looking for commentary on our recent 4.1% GDP print as well as inflation and tariffs. Rounding off the week will be the Bank of England which is expected to raise rates by 25 BPS on Thursday.
(2) Inflation Nation: Tuesday’s release of the latest Personal Consumption Expenditures (PCE) along with the corresponding Personal Income and Spending will get a hard look from our Fed and bond traders alike. The consensus is that the Core PCE YOY will actually dip back below 2.0% to 1.9%. But the headline PCE YOY will remain strained at 2.2%. A beat to the upside (higher readings) is something that is typically very negative for bonds.
(3) Jobs, Jobs, Jobs: There will be a ton of jobs/wages related data this week. But the bond market will be focusing on Big Jobs Friday and will largely ignore the Non-Farm Payrolls and Unemployment Rate and hone right in on Wages. The YOY Average Hourly Earnings is expected to remain at the 2.7% pace but is long overdue for a spike given the economic data over the past quarter. If wages march closer to the 3.0% mark, then look out – MBS will sell off. It will take a severe drop in wages for MBS to have any chance at a rally.