What Happened Last Week?
Mortgage backed securities (MBS) gained 17 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move sideways from the prior week.
It was a very big week with a lot of big name economic data and longer term Treasury auctions. But it was falling oil prices and low inflation that drove rates for the week.
Black Gold, Texas Tea: Old Jeb is not going to be a millionaire very much longer. Oil prices resumed their slide with U.S. crude falling below $37 per barrel and Brent breaking below $40 for the first time since early 2009, amid fears the world was running out of capacity to store crude as a global glut intensifies. With falling commodity prices, this is very anti-inflationary and therefore good for long bonds.
The bond market largely ignored our domestic economic data and focused on oil as bond traders are shifting their bets (but it’s a small shift) into the “no rate hike camp” as they view the collapse of oil prices as offsetting any previous signs of inflation and making it difficult for the Fed to say that the dip in oil prices is “transitory” as they have in the past. This is shifting bond trader sentiment away from the “it’s a lock that the Fed will raise rates” to “yikes…we might be on the wrong side of this trade and it’s time to start shifting our positions.”
Domestic Flavor
Inflation?
The Producer Price Index was higher than expected, showing upward inflationary pressures. The more closely watched Core (ex food and energy) YOY (year over year) reading hit 0.5% which was more than double the market forecasts of only 0.2%. The MOM (month over month) Headline PPI reading was also much higher than expected (+0.3% vs estimates of 0.0%) and the Core MOM reading hit 0.3% vs estimates of 0.1%. This is normally the type of readings that would really pressure MBS. But we have two mitigating factors here: (1) it’s well below the Fed’ target rate of 2.0% on a YOY Core basis, and (2) traders are discounting this data as it was before the massive sell off in oil this month.
Retail Sales
Were a mixed bag but still showed an overall improvement in monthly sales. The headline number missed by just one tick (0.2% vs estimates of 0.3%) and the Ex-Auto data was stronger than expected (0.4% vs estimates of 0.3%).
A key discretionary category, restaurants, shows yet another very strong gain, this at 0.7% in the month. Also showing sizable gains are electronics & appliances, clothing & accessories, non-store retailers (once again), and the general merchandise category where, despite a deflationary pull from falling import prices, sales jumped 0.7% in the month.
But there was weakness in Auto sales: Vehicle sales fell 0.4%in the month on top of October’s 0.3 percent decline. These declines are a bit of a surprise given steady readings in unit sales of vehicles which have been holding firmly at 12-year highs.
What’s on the Agenda for this Week?
It’s finally here, the week that the entire world has been waiting for….the release of the new Star Wars movie!!
Oh and that Fed thing too.
It’s All About the Fed
Wednesday may be the most important event of the year.
Here is what you need to know: The Fed will announce their policy statement and interest rate and Janet Yellen will have a live press conference today.
There are a couple of possible outcomes:
(1) The Fed leaves rates unchanged as the Inflation picture simply isn’t there and then Janet Yellen talks up a rate hike in early 2016. MBS reaction – strong rally.
(2) The Fed hikes between 0.375% to 0.500% and Janet Yellen makes is clear that the Fed will wait a long time to see how the credit markets, economy, etc., react and it will be a long time before there is another rate hike, basically laying the groundwork for maybe 1 or 2 hikes in 2016. MBS reaction – big sell-off.
(3) The Fed hikes between 0.125% and 0.25% and Yellen talks up a path for 3 or 4 hikes next year if the inflationary data and economic growth is there. MBS reaction – small to moderate sell-off.
So there you go…it really is that simple. One of those three scenarios is going to happen and only one of them equates to better pricing. While the majority of market participants (note the word PARTICIPANTS, those with money in the long bond market) are hedging for option 3 above, it is not 100% by any means, so there will be a tremendous amount of volatility on Wednesday regardless which option plays out.
Market Wrap-up
Overview: There were no domestic or foreign economic releases today that impacted pricing. MBS have been under pressure all day as Oil is making a rebound and as long bond traders begin to move their money around prior to the Fed announcement on Wednesday.
Consider the analogy of a teenager knowing that a book report is due on a certain day but doing nothing until it’s due. Same thing here. The market widely believes that there will be some sort of rate hike, yet, it is not fully priced in. Today, we are starting to see more of it priced in.
On Deck for Tomorrow: CPI, Home Builder’s Index and Empire Manufacturing. Only CPI has the gravitas to move the needle on your pricing.