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MBS Highway - Daily Updates 10/21/2022

Current position: Carefully Floating


Stocks and Bonds are both lower to start the day. Mortgage Bonds are unfortunately setting new local lows, while the 10 - year is setting a new local high, now trading at 4.30%.

Philly Fed President, Patrick Harker, said that hiking rates have done little to quell inflation and that more increases would be needed. The commentary that their efforts have not helped to fight inflation spooked the markets and gave little confidence that inflation would abate.


The rest of his talk is what we already know - He expects the Fed Funds Rate to be well above 4% by the end of the year and that they would stop hiking sometime next year. With a 75bp hike all but certain at the November 2 Meeting, the Fed Funds Rate will be at 4%. And with at least a 50bp hike on December 2, but most likely 75bp, the FFR will be at 4.5% to 4.75% by year-end.


Nick Timiraos, the Fed mole that writes for the WSJ, said this morning, "Federal Reserve officials are barreling toward another interest-rate rise of 75bp at their meeting Nov. 1-2 and are likely to debate then whether and how to signal plans to approve a smaller increase in December. "This shows that the 75bp hike is a lock for November, but 50bp may be on the table for December.


We know it's difficult out there, especially with this week's further rise in interest rates. But things are going to get better, and here's why:


As we have previously covered, when we receive the next Core CPI inflation reading, which will be for the month of October, it will be replacing a high figure from 2022. And from that point, the comparisons from last year are higher on a consistent basis. This lays the groundwork for improvements in inflation going forward, potentially beginning November 10 when we get October 2022 reading.


But of all of the inflation components, shelter costs are hurting the most. They make up 39% of core CPI, and are a lagging indicator. The way the CPI calculates this is by looking at prices every 6 months. They have an adjustment to get it closer to real-time, but it has been increasing while real home prices and rents have been moderating on a year-over-year basis. It's almost like a rollercoaster, that is going over a peak - the back half of the rollercoaster, which is representative of the CPI shelter costs, is going up, while the front part of the cart, representing real shelter costs, is going down. The middle part of the cart looks to be January.


Similar to how we look at the monthly readings for the broader Core CPI index, we did the same exercise with shelter. After January, the readings get much higher from last year on a comparative basis, and we should start to see the lagging shelter in the CPI catch up to what is happening in the real market with prices.


We are also seeing deflationary signs from other industries - Shipping costs, according to the Freightos Baltic Index, are down 68% from their peak and sit now at a 21 - month low. Used car prices are down 2% in September and 10.4% year over year. The Money supply is also an important component, and too many dollars in the system creates more inflation. But over the last 5 months, it has been decreasing, and our good Friend Lacy hunt expects the money supply to get to a point in March where it erases all of the excesses we have seen over the last two years from the stimulus and easy Fed policy. This would clearly be deflationary.

CoreLogic released their Single-Family Rental Index, showing that rents increased by 11.4% year over year in August, which is a slight moderation from 12.6% in July. The increase is still high and more than 3 times the normal market. This report factors in new rents and renewals, and one could infer that renewals are still going up at a large clip, which makes a big difference when comparing a mortgage payment, which is largely fixed, and a rental payment that can go up each month, especially over time.


Next week is action-packed with a lot more housing data, including fresh appreciation readings from Case Shiller and the FHFA House Price Index, New Home Sales, and Pending Home Sales. We will also get the first reading for Q3 GDP and the Fed's favorite measure of inflation, Personal Consumption Expenditures.


Within the PCE report, the Core reading is expected to rise from 4.9% to 5.2% in September on a year-over-year basis, which is going in the wrong direction - Remember the Fed has a target for this metric of 2%. While this is a negative for the Bond market, the reaction may not be too drastic, as the markets already sold off sharply to the higher Consumer Price Index core reading. But as mentioned, we expect this to start improving and moving lower in the months to come.


Mortgage Bonds are making a nice rebound higher from their earlier levels and have a lot of room to run until reaching the next ceiling. The 10 - year is trading at 4.24% after testing 4.34% and is back beneath the 2008 ceiling at 4.279%. After locking 4 out of the last 5 days, and with a nice turnaround in Bonds today, we can begin the day carefully floating.


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