Stocks are flattish this morning on no real news. Bonds and MBS are down small.
Kevin Warsh spoke in Bangkok yesterday and declined to give any guidance on the upcoming meeting. He did praise the coordinated global tightening and said there were no “free riders.” The brutal sell-off in Treasuries has been mirrored in other global sovereigns including Bunds, Gilts, and JGBs.
On the subject of the next meeting, he said: “I don’t prejudge meetings. I don’t believe in saying now what I might do at the meetings that we have in the balance of this year. It’s a new chapter at the Fed [and] we’re not in that business anymore. But we can go in any direction you’d like.”
Warsh is simply returning the Fed to the pre-GFC norm, where the Fed did not spoon-feed the markets. Forward guidance was a tool the Fed used when deflation was a threat in order to prevent a liquidity trap and encourage consumers to spend. Deflation is no longer a threat in the West (thought it is in China).
Despite the hotter-than-expected PPI and CPI, the Fed Funds futures continue to discount the chance of a rate hike at the end of the month. The futures are pricing in a 15% chance of a hike. They still see a 90% chance of a hike in December however.
Global sovereign yields have taken a break from rising for the moment. The problem child – French OATs – is also stabilizing. The Merrill Lynch Bond Volatility Index is also falling which is important since volatility spikes cause MBS spreads to widen. If rates and volatility stabilize we should hopefully see mortgage rates closer to 7%.
The spike in yields has increased non-QM’s share of the market. ARMs are also reaching a multi-year high. “What stands out in September is how much product mix is doing the work of keeping purchase activity moving,” noted Brennan O’Connell, director of data solutions at Optimal Blue. “Conforming lost share while non-QM volume grew and ARM usage reached its highest level seen in our report. That tells lenders there is still purchase demand to serve, but increasingly it may not fit neatly into the traditional conforming box. In this rate environment, production opportunity is going to depend in part on how broadly lenders can meet borrowers across different credit, income and payment scenarios.”
