Morning Report: The Fed hikes rates

Vital Statistics:

S&P futures4,257-37.25
Oil (WTI)110.512.69
10 year government bond yield 3.00%
30 year fixed rate mortgage 5.52%

Stocks are lower this morning after the Fed hiked interest rates. Bonds and MBS are down.

The Fed raised interest rates 50 basis point yesterday and laid out the parameters of balance sheet reduction. Starting June 1, the Fed will start letting $17.5 billion in mortgage backed securities and $30 billion in Treasuries mature per month. Any maturing bonds in excess of those amounts will be re-invested back in the market. After 3 months, those ceilings will double to $35 billion in MBS and $60 billion in Treasuries.

The last time the Fed tried to shrink its balance sheet, it caused havoc in the repo market. This was because hedge funds were borrowing heavily in the repo market to fund basis trades (similar to what Long Term Capital Management was doing back in the day). They were exploiting minute mispricings in the Treasury market and leveraging heavily to make it worth their while. All of this blew up when repo rates (which was their cost of borrowing) spiked which threatened the stability of the financial system. The Fed ended up extending emergency loans and ended its experiment in balance sheet reduction. So, just be aware that letting some of these things just run off isn’t necessarily as easy as it sounds.

During the press conference, Jerome Powell said that a 75 basis point hike was not being “actively considered.” The bond market rallied a bit on the news, with the 10 year Treasury yield dropping to about 2.9%. This morning we are back at yesterday’s pre-meeting levels. TBA spreads have been extraordinarily wide for the past couple of weeks, with some coupons experiencing a half point bid / ask spread. It looks like bid / ask spreads are narrower this morning (but still wide compared to historical norms). The MBS market still seems somewhat jumpy despite the guidance the Fed put out yesterday.

Powell’s dismissal of a 75 basis point hike caused the June Fed Funds futures to become markedly more dovish. A week ago, the market consensus was that the Fed Funds rate would be in a 150-175 basis point range. Now, it is looking like the market is handicapping only a 25 basis point increase.

Black Knight is being bought by the Intercontinental Exchange, which owns Optimal Blue, MERS and Ellie Mae. “Since our founding in 2000, ICE’s simple mission has been to make analog and opaque financial transactions more digital and transparent, beginning with commodity markets, extending across a large array of asset classes, and most recently working to help streamline the mortgage industry,” said Jeffrey C. Sprecher, Founder, Chair and CEO of Intercontinental Exchange. “Black Knight shares our passion for leveraging technology to serve customers and households, and, with our expertise in operating networks and marketplaces, our planned acquisition will bring to life a true end-to-end solution for the mortgage manufacturing and servicing ecosystem, benefitting aspiring and current homeowners across the United States.”

I suspect that the Hart Scott Rodino antitrust review will not be a slam dunk, since it would combine loan origination systems Encompass and Empower. I think the LOS market is pretty concentrated and these two are on the bigger side when it comes to market share.

Since ICE also owns the New York Stock Exchange as well as other derivatives exchanges I could see them developing Resitrader into a whole loan trading ecosystem.

Initial Jobless claims rose to 200,000 last week, which was a touch above expectations. That said, 200,000 is extremely low in terms of historical standards. Separately outplacement firm Challenger, Gray and Christmas said that there announced job cuts rose to 24,286 last month.

Productivity collapsed in the first quarter of 2022. Nonfarm productivity fell 7.5%, which was the biggest drop since 1947. Unit labor costs increased a whopping 11.6%. This was driven by a 3.2% increase in compensation and and the decrease in productivity. Since productivity is ultimately the biggest driver of standards of living, this is worrisome. Keep in mind that this is only the first reading for the quarter so it will be revised.

Over the past four quarter, unit labor costs have increased 7.2%, which is the largest increase since 1982. I am not sure whether this troubles the Fed or not. Labor has lagged capital for so long that they might be ok with this. Of course it does indicate that the wage-price spiral is back after a long slumber.


Author: Brent Nyitray

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

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