Morning Report: Inflation comes in at 6.6%.

Vital Statistics:

 LastChange
S&P futures4,233-44.25
Oil (WTI)106.721.39
10 year government bond yield 2.89%
30 year fixed rate mortgage 5.36%

Stocks are lower this morning after disappointing earnings from tech leaders Amazon and Apple. Bonds and MBS are down.

Personal income rose 0.5% in March, according to the Bureau of Economic Analysis. February was revised upward from 0.5% to 0.7% as well. The Personal Consumption Expenditures Index (the Fed’s preferred measure of inflation) rose 0.9% in March, which was a big acceleration from February which rose 0.5%. This was driven primarily by increases in food and energy which increased due to the situation in Ukraine.

The core PCE price index rose 0.3% which was flat with February’s numbers. On an annual basis, the PCE price index rose 6.6%. Ex-food and energy it rose 5.2%. Personal Consumption Expenditures rose 1.1% and the savings rate fell.

Overall this report shows that incomes are expanding, which is good for the economy, however the increase in inflation will keep the Fed in a defensive role. This report also seems to contradict the first quarter’s initial read on GDP, which seems out of step with most of the other data out there. I suspect GDP will be revised upward in future releases.

Employment costs rose 1.4% in the first quarter as wages rose 1.2% and benefits increased 1.8%. On a year-over-year basis 4.5% as wages rose 4.7% and benefits increased 4.1%.

Annaly Capital (one of the biggest mortgage REITs out there) reported first quarter earnings. Book value per share fell a whopping 15% as MBS spreads widened, which was offset by increases in the value of the servicing book.

“The market environment during the first quarter of 2022 was one of the most challenging for fixed-income in decades, characterized by exceptional volatility with substantial spread widening and a notable increase in benchmark rates,” remarked David Finkelstein, Annaly’s Chief Executive Officer and President. “While our portfolio continued to generate strong earnings, our book value was not immune to the effects of Agency MBS underperformance resulting from market turbulence.”

Investors like Annaly are the ultimate buyers of the mortgage banking production. They are wary about the Fed’s impending balance sheet reduction and are therefore unlikely to aggressively bid mortgage backed securities. This flows through to TBA prices and finally through to the rates mortgage bankers can offer borrowers.

Mortgage backed securities are driven primarily by two factors: the level of overall interest rates in the market, and the volatility of interest rates in the market. Volatility is a key driver, since mortgage backed securities exhibit what bond geeks call negative convexity. This is because of prepayment risk. The takeaway should be that if Treasuries settle down and find a level, then we should see an improvement in MBS spreads, which will help push down borrowing rates.

Consumer sentiment improved in April, according to the University of Michigan Consumer Sentiment Survey. While sentiment is better than it was in March, we are still well below levels from a year ago. Even if you look at a longer-term chart, you can see that the mood of consumers is quite dour.

The downward slide in confidence represents the impact of uncertainty, which began with the pandemic and was reinforced by cross-currents, including the negative impact of inflation and higher interest rates, and the positive impact of a persistently strong labor market and rising wages. The global economy has added even more uncertainties about prospects for the U.S. economy, including the growing involvement in the military support for Ukraine, and renewed supply line disruptions from the covid crisis in China. Who would not be apprehensive about future conditions, even if on balance they anticipated a continued expansion? 

Author: Brent Nyitray

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

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