Morning Report: The Fed spooks the bond market

Vital Statistics:

S&P futures4,38442.2
Oil (WTI)88.51.13
10 year government bond yield 1.83%
30 year fixed rate mortgage 3.77%

Stocks are higher this morning after a stronger-than-expected GDP report. Bonds and MBS are down.

The Fed maintained the Fed Funds rate at current levels, but cleared the decks for a rate hike at the March meeting. It will continue to lower its purchases of Treasuries and MBS. Bonds and MBS sold off in the aftermath of the statement, and the implementation note indicated that the Fed plans to begin balance sheet reduction. In addition, it plans to eventually hold primarily Treasuries, not MBS: “In the longer run, the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.” IMO that statement about minimizing effect on credit allocation is an indirect statement that the Fed is uncomfortable with 20% home price appreciation. MBS got clobbered on the announcement yesterday, dropping about a point, while the sell-off continues today. MBS investors are understandably gun-shy about catching a falling knife, so it might take a day or two for things to settle down.

Economic growth rebounded in the fourth quarter, as GDP increased at a 6.9% annual rate. Inventory build was the primary driver of growth, especially motor vehicles. Consumption also rose, which was dominated by services. The PCE Price Index rose 6.5%, which is a red flag for the Fed. Ex-food and energy it rose 4.9%, well above its 2% target rate.

So if the economy is growing at such a high rate, why doesn’t it feel like it? The answer is in real disposable income, which decreased 5.8%. Real disposable income reflects the inflation rate and wage increases. If wages don’t keep up with inflation, it creates a surly consumer.

In other economic news, durable goods orders fell 0.9%, while core capital goods (a proxy for business capital expenditures) was flat. Initial Jobless Claims came in at 260k.

Pending Home Sales fell 3.8% in December, according to NAR. “Pending home sales faded toward the end of 2021, as a diminished housing supply offered consumers very few options,” said Lawrence Yun, NAR’s chief economist. “Mortgage rates have climbed steadily the last several weeks, which unfortunately will ultimately push aside marginal buyers.” Sales are down 6.9% YOY. While it is hard to believe if you live in the Northeast, we are close to the beginning of the Spring Selling Season.


Author: Brent Nyitray

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

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