Morning Report: Powell soothes the markets

Vital Statistics:

S&P futures4,5116.2
Oil (WTI)68.940.35
10 year government bond yield 1.31%
30 year fixed rate mortgage 3.07%

Stocks are higher this morning after Jerome Powell’s speech on Friday contained no negative surprises for the markets. Bonds and MBS are up.

The big takeaway from Powell’s speech on Friday is that tapering (or the reduction of asset purchases) is on the horizon, but rate hikes are not.

We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.

The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis.

Interestingly, MBS spreads remain surprisingly tight given that language. During the 2013 “taper tantrum” MBS spreads widened to 150 basis points as mortgage rates rose 120 bps ahead of the first reduction. I think we are sitting around 70-ish. I am not sure what that implies, however my guess is that in 2013, the markets were anticipating that the Fed could actually sell its portfolio into the market. They never did that, and couldn’t even go as far as to let prepayments do the job. This time around, sales are probably off the table, and the Fed will probably re-invest maturing proceeds from MBS as well, so the anticipated future shock is much l0wer. That is probably the reason why MBS investors are sanguine this time around.

The Fed Funds futures bumped up the probability of no change in rates in 2022 from 39% to 48% on Powell’s speech. Here is the latest handicapping in the markets:

The trend is looking dovish. Note the Atlanta Fed’s GDP Now index is turning down sharply as well. The index is much more bearish than the Street right now.

The upcoming week will have a lot of data, with home prices on Tuesday, ISM on Wednesday and Friday and the jobs report on Friday. The Street is looking for 740,000 jobs to have been created in August.

The Biden Administration’s end-around extension of the eviction moratorium was shot down by SCOTUS last week, so the issue goes back to Congress. It doesn’t look like Congress has the votes to pass legislation on it, so we are at the posturing and finger-pointing stage.

Pending home sales fell in July, according to NAR.

“The market may be starting to cool slightly, but at the moment there is not enough supply to match the demand from would-be buyers,” said Lawrence Yun, NAR’s chief economist. “That said, inventory is slowly increasing and home shoppers should begin to see more options in the coming months. Homes listed for sale are still garnering great interest, but the multiple, frenzied offers – sometimes double-digit bids on one property – have dissipated in most regions,” Yun said. “Even in a somewhat calmer market, a number of potential buyers are still choosing to waive appraisals and inspections.”

Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical

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