Morning Report: Global bond rout on

Vital Statistics:

 

Last Change
S&P futures 2919.25 -12.25
Eurostoxx index 381.23 -2.61
Oil (WTI) 76.03 -0.38
10 year government bond yield 3.20%
30 year fixed rate mortgage 4.87%

 

Stocks are lower this morning in the face of a global government bond rout. Bonds and MBS are down.

 

Global bond yields are sharply higher this morning. There doesn’t appear to be any particular catalyst, but it is affecting Japanese and German bonds as well as the US. The 10 year yields 3.2% this morning after starting yesterday at 3.08%. Interestingly, the Fed Funds futures haven’t changed at all, so this doesn’t seem to be driven by a re-assessment of Fed policy. If you look at the TIPS market (Treasuries that forecast the change in CPI), there is no change in the market’s assessment of inflation. So this has been largely confined to the long end. The short Treasury trade is one of the biggest trades on the Street, and maybe some big funds put more money to work shorting / underweighting global bonds going into the 4th quarter. 2s-10s are trading at 31 bps.

 

Jerome Powell was interviewed on CNBC yesterday, and signaled that more hikes are on the horizon.  “Interest rates are still acommodative, but we’re gradually moving to a place where they will be neutral,” he added. “We may go past neutral, but we’re a long way from neutral at this point, probably.” Interesting to see him characterizing current policy as “accomodative” when the word was taken out of the September FOMC statement. The “may go past neutral” comment has been cited by some in the press as the catalyst for yesterday sell-off, but the Fed Funds futures don’t reflect that.

 

Job cuts rose to 55,000 in September, according to outplacement firm Challenger, Gray and Christmas. This was driven primarily by announced layoffs at Wells Fargo. “As the job market remains near full employment and companies struggle to find workers, large-scale job cut announcements like the one from Wells Fargo will actually provide the workers necessary for companies to gain momentum and sustain growth,” said John Challenger, Chief Executive Officer of Challenger, Gray & Christmas, Inc.

 

Hurricane Florence appears to have had little impact on initial Jobless Claims which fell to 207,000 last week. As companies ramp up for the fourth quarter, qualified workers are hard to find. That might have been part of the reason for Amazon’s announcement on wages – they have to compete with everyone else for seasonal workers. Note that Fed-Ex is paying pilots bonuses of $40-$110k to keep them from retiring.

 

Lennar reported 3rd quarter earnings yesterday, which were decent, but forward guidance (partially driven by Hurricane Florence) was disappointing, and the stock sold off 2%. Orders increased, but its Q4 forecast was below estimates. The whole sector was hit yesterday as well, as a combination of higher mortgage rates and input costs are creating affordability problems. Most of the metrics were hard to compare YOY because of the CalAtlantic transaction.

 

Factory orders increased 2.3% in August driven by transportation orders. This is the fastest pace since September last year.

 

Investors are bailing on high-yield debt, as spreads to Treasuries are at post-crisis lows and rates are going up. With bond-like upside and stock-like downside, the risk-reward for the asset class is deteriorating. IMO, some of the action we are seeing in the stock and bond markets may simply be a re-emergence of money market investment vehicles which paid so little during the ZIRP years that investors didn’t bother with them. With short term rates pushing 3%, the asset class is making sense again.

 

high yield bond spreads

 

Of course the other asset class that has been moribund since the crisis has been the private label MBS market. While there are governance issues left be sorted out, higher absolute rates will go a long way towards bringing back that sector (and the type of lending that accompanies it). Mortgage REITs who have feasted on MBS thrown overboard in 2009 and 2010 will have to replace that paper with new issuance.

Morning Report: Stocks sell off as 10 year breaches 3% level

Vital Statistics:

Last Change
S&P futures 2626.5 -9
Eurostoxx index 379.58 -3.53
Oil (WTI) 67.53 -0.22
10 Year Government Bond Yield 3.02%
30 Year fixed rate mortgage 4.59%

Stocks are lower this morning after yesterday’s interest rate-driven sell-off. Bonds and MBS are down.

The 10 year breached the 3% mark yesterday, which served as a catalyst for a substantial stock market sell-off. Of course 3% is just a round number, but it is the highest rate since 2014. Some pros are looking for a global slowdown in the economy, which could make some corporate borrowers vulnerable. We certainly appear to be in the late stages of a credit cycle. Junk-rated bond issuance has been on a tear over the past few years, reaching $3 trillion as yield-starved investors have had to reach into the lower credits to make their return bogeys. That said, corporate bond spreads are still at historical lows, (investment grade spreads are still half of what they were as recently as early 2016. Let’s also not forget that much of the bond issuance over the past 8 years went to refinance old debt at higher interest rates – in other words it was a net positive for these companies.

We are now going to see just how much of the huge rally in financial assets over the last decade was due to the inordinate amount of stimulus coming out of the Fed. As stocks now have to compete with Treasuries, some changes in asset allocations are to be expected and the riskier assets are going to bear the brunt of the selling. Keep things in perspective, however. Interest rate cycles are measured in generations.

100 years of interest rates

One of the benefits of QE has been to goose asset prices (which was kind of the whole point). Increasing people’s net worth would increase spending and therefore increase GDP. It probably worked, however that hasn’t been costless. One of the problems with increasing real estate prices is that it shuts people out from places where there is opportunity (California in particular). If you already own property in CA and have been experiencing torrid home price appreciation, you can move since your increased home equity can be used to purchase another expensive property. But if you live in the Midwest were home price appreciation has been less, you might not be able to take that job in San Francisco since you can’t afford to live there. That said, negative equity was probably a bigger problem and home price appreciation did mitigate that issue.

Mortgage Applications fell 0.2% last week as purchases were flat and refis were down 0.3%. Conforming rates increased 6 basis points, while government rates increased 1. ARMs decreased to 6% of total applications. A flattening yield curve makes ARMs less and less attractive relative to 30 year fixed mortgages.

Acting CFPB Director Mick Mulvaney has made some changes at the Bureau. First, he is ending the pursuit of auto lenders, which Dodd-Frank prohibited. The Cordray CFPB did an end-around by going after the big banks behind some of the auto financing, and that will end. Second, Mulvaney will no longer make public the complaint database against financial services companies, saying that “I don’t see anything in here that I have to run a Yelp for financial services sponsored by the federal government.” Finally, he plans to change the name from the CFPB to the BCFP. All of this is in keeping with Mulvaney’s commitment to follow the law and go no further.