Prior to 8:30 this morning the 10 yr note at 2.01% down 2 bps frm yesterday’s huge increase; 30 yr MBS price up 26 bp after falling 98 bp yesterday. 8:30 we got weekly jobless claims, always important but now even more so after the Federal Reserve confused markets (and likely themselves) with conflicting comments frm Bernanke’s testimony and the FOMC minutes of the 5/1 FOMC meeting. Bernanke’s comments in the hearing implied that some tapering was being discussed, saying the Fed may begin thinking about ending in the next three or four meetings. The FOMC minutes indicated there is a growing discussion within the group about reducing the QEs, maybe at the June FOMC meeting. Either Bernanke is testing the waters on reaction to unwinding QEs, or he and the other Fed officials are on different pages. Regardless, the Fed clearly upset markets yesterday; another huge spike in rates and what may be the beginning of a major correction in the stock markets.
Weekly jobless claims at 8:30 were about in line with estimates; claims were expected to have declined 15K to 345K, as reporte4d claims were down 23K to 340K with last week’s claims revised to 363K from 360K. There was no noticeable reaction to the data. The 4 week average, a smoother look at claims, was down 500 to 340K filings; continuing claims declined from 3.04 mil to 2.91 mil.
Most all major stock markets around the world are declining today after the confused comments from the Fed yesterday. Japan’s key index down 7.3%, all Europe’s stock markets taking huge hits. At 9:00 this morning based on US futures trade the DJIA looked like an open down 77 points frm yesterday’s decline. The 10 yr at 9:00 at 2.20% -2 bp and 30 yr MBSs -3 bp after being up 26 bp at 8:20 am. Already markets have exhibited increased volatility; at 9:30 the DJIA opened -40, NASDAQ -40, S&P -16; the 10 yr note declined to 1.98% and 30 yr MBS prices back to +25 bps frm yesterday’s close.
So, what can we take away from yesterday’s events that have led to increased uncertainty about the Fed? First; the Fed is not likely to end its QEs or taper them back until there is more evidence that the US economy is actually gaining momentum. Recall that the current run-up in rates began when the April employment report was released on May3rd, since then the various reports on the economy from April and May data reported so far have not been very strong; manufacturing reports have weakened, home sales while better so far may slip as mortgage rates have increased (re-financing has declined substantially based on recent data), business activity frm the Philly Fed index actually turned negative in May. Second; we have to accept the reality that there is increasing discussions within the Fed about at least thinking about how and when, the debates have accelerated recently. Third; as we have noted many times, by the time the Fed actually announces its intentions to reduce monthly purchases, the markets will have already discounted the decision in prices and yields. Fourth; regardless of how markets are reacting now, the Fed is unlikely to back off the current $85B a month of purchases until the end of the year or early Q1 2014.
At 10:00 April new home sales were expected down 1.8%, sales increased 2.3%. The annual increase on prices up 15%, the largest increase since 1963 at $271,600. Based on the sales pace there is only a 4.1 month supply on the market. Builders are able to increase prices, a positive sign; now markets will look to May sales data on both existing and new home sales as mortgage rates have risen since April. Stock indexes improved on the better report.
The next two weeks are likely to see increased volatility, as if we haven’t had enough already; between now and June 7th when the May employment report is due there are a number of data points that while always important, will carry increased importance in the face of Bernanke’s remarks and the FOMC minutes released yesterday. Each US and global economic reading has the potential to move markets. We expect market volatility will remain at high levels. And it isn’t just US data; China this morning reported its manufacturing sector is continuing to decline. Bottom line; if the economy isn’t moving forward, the Fed isn’t going to change its easing policy.
Once again, do not fight the tape now; the bond market is bearish---period. From our perspective it will continue bearish until the 10 yr moves below 1.85%, the first resistance is at 1.97% but even that level will not change the technical bearish outlook. The prolonged decline in interest rates is very likely over, suggest taking advantage of any market improvements. There is little reason now to anticipate interest rates will re-test the recent low yields.