Morning Report: Manufacturing still constrained by supply

Vital Statistics:

 LastChange
S&P futures4,5074.2
Oil (WTI)87.12-0.33
10 year government bond yield 1.77%
30 year fixed rate mortgage 3.77%

Stocks are up this morning as the bond market stabilizes. Bonds and MBS are flat.

The manufacturing economy expanded in January at a slower rate than December, according to the ISM Manufacturing Report. The New Orders and Production indices fell, however prices rose substantially. The employment index also ticked up marginally.

“The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment, but January was the third straight month with indications of improvements in labor resources and supplier delivery performance. Still, there were shortages of critical intermediate materials, difficulties in transporting products and lack of direct labor on factory floors due to the COVID-19 omicron variant. Quits rate and early retirements hinder reliable consumption. Panel sentiment remains strongly optimistic, with seven positive growth comments for every cautious comment, up from December’s ratio of 6-to-1.

Shortages of skilled labor and materials remain big issues. We did see some evidence that backlog is getting cleared, but overall the brake on the economy is from the supply side, not the demand side.

Speaking of labor shortages, the JOLTs job opening report showed 10.9 million unfilled jobs in the US. The quits rate edged down to 2.9%, and hiring slowed compared to November. I suspect this is pandemic-driven and not really economy-driven.

Construction spending rose 0.2% MOM and 9% YOY, according to Census. Residential construction rose 15% YOY, and this offset weakness in office building. Public construction was down 1.6% MOM and 2.9% YOY. I guess the infrastructure bill passed last year hasn’t had a chance yet to be reflected in the numbers.

Mortgage REIT AGNC Investment reported earnings yesterday, and book value per share fell 4% as mortgage backed security spreads widened. MBS spreads are the difference between the yields on Treasuries and mortgage backed securities. When spreads are “widening” it means that mortgage rates are increasing relative to Treasuries.

“Investor sentiment turned negative in the fourth quarter as the Federal Reserve signaled a very significant shift toward aggressive monetary policy normalization,” said Peter Federico, the Company’s President and Chief Executive Officer. “With inflation running well above its long run target and the labor market nearing full employment, the Fed reduced its asset purchases more quickly than its initial guidance, signaled a more aggressive series of short-term interest rate increases, and discussed a more rapid approach toward balance sheet normalization. This abrupt shift by the Fed led to an uptick in interest rate volatility amid greater monetary policy uncertainty. Against this backdrop, Agency mortgage-backed securities underperformed in the fourth quarter as spreads to benchmark rates widened moderately and valuations declined relative to interest rate hedges.

The increase in mortgage rates means that refinance possibilities are decreasing, however the flip side is that prepayment speeds are falling. This mirrors what we are seeing at mortgage originators right now: refi activity is falling, while servicing multiples are increasing. This is why servicing is thought of as a natural hedge for the origination business.

Author: Brent Nyitray

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

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