Learn from the Past
Mortgage backed securities (MBS) lost 20 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move off of their lowest levels of the year.
There were really strong Retail Sales and Industrial Production reports which helped to pressure MBS to move lower for the week, which pushed mortgage rates up a “smidge.” There was very tame inflation data and continued uncertainty over China/U.S. trade negotiations and Brexit. Those factors provided very strong support for rates and kept rates from rising further.
Retail Sales: Overall, this is a solid report. The Headline Retail Sales MOM for May came in at 0.5% vs. estimates of 0.6%, but April was revised upward significantly from -0.2% all the way up to 0.3%. When you strip out autos, Retail Sales gained 0.5% vs. estimates of 0.3%. April was revised upward from 0.1% to 0.5%.
Production: Industrial Production for May came in at double the market expectations (0.4% vs. estimates of 0.2%). Capacity Utilization hit 78.1% vs. estimates of 78.0%. Overall, a good report.
Consumer Sentiment: The Preliminary June Consumer Confidence Survey results were basically in line with expectations (97.9 vs. estimates of 98.0) but the 12 month and five year inflation expectations dropped lower.
Inflation Nation: The May Consumer Price Index (CPI) did not show any threat of inflation. The Core (ex food and energy) dropped to 2.0% from April’s pace of 2.1% and was below expectations of 2.1%. The headline CPI YOY actually dropped below 2.0% with a 1.8% reading vs. estimates of 1.9%.
The Atlanta Fed’s Business Inflation Expectations for the 12 months remained at 2.0% and longer term (5 years) at 2.7%
What’s on the Agenda for this Week?
This is a HUGE week for Central Bank action. Our own Fed will be the driving force in pricing this week. If they lower rates, then MBS will rally. If they do not lower rates but set the table for a decrease in July, MBS may see a very small improvement. If they continue with their current status quo of being “data dependent” and nothing needs to be done right now nor in the near term, then MBS may shed a few pounds.
The three areas that have the greatest ability to impact backend pricing this week are: (1) Central Bank Palooza, (2) Geopolitical, (3) Trade War
(1) Central Bank Palooza: The focus will be on our Federal Reserve but there is a lot of Central Bank action globally. Starting in the U.S., the FOMC will conclude on Wednesday and will have their interest rate decision, policy statement, live press conference with Fed Chair Powell and the release of their economic projects. It’s the latter that may get the lion’s-share of attention by long bond traders. While everyone seems to be “jawboning” for a rate decrease, the simple truth is that the most recent round of economic data does not warrant a rate cut at this meeting. The market will therefore be looking for any direction in the policy statement or from Powell on the likelihood of a July 31st cut (which the stock market is currently pricing in). The economic projections and the corresponding “dot plot” chart will therefore get a ton of attention to see if the aggregate bias from individual Fed members shifts towards a cut in 2019 at all.
Besides our own Fed, there are very key Central Bank announcements from the Bank of England and the Bank of Japan on Thursday. Rounding out the barrage of interest rate decisions are: Norway, Brazil, Taiwan, Indonesia, Philippines and Colombia.
2) Geopolitical: Brexit will remain a key focus as the list of contenders to be the next Prime Minister (and therefore the fate of Brexit) will be narrowed down to just 2 by the end of the week. Iran will continue to get a lot of attention as each week tensions between Iran and the U.S. rise. They announced that they will have over the maximum allowed of uranium stockpiled in 10 days. Italy, and their threat of creating their own currency and their recent friction with the EU will also be closely watched.
3) Trade War: Every single comment from senior cabinet officials on both sides will get a lot of attention from traders as the G20 meeting is quickly approaching in Japan.
Manufacturing: The Regional Empire State (that’s NY for you millennials) Manufacturing Index was much weaker than expected with a contraction of -8.6 vs. estimates of an expansion of -8.6.
Taking it to the House: The June NAHB Housing Market Index fell from 66 in May to 64 in June. Any reading above 50 is positive and readings above 60 are quite strong.
On Deck for Tomorrow
Housing Starts and Building Permits, the FOMC meetings begin, two Central Bank Presidents speak (Bank of England’s Mark Carney and ECB President Mario Draghi).