Post Payrolls Letdown
The week after the jobs report is generally pretty data-light, and this week was no exception. With a dearth of data, market movement hinged on “Fed speak” and consumer sentiment. We saw some volatility return to bond markets as investors built in expectations for a more hawkish Fed. As a reminder, the Fed raised its benchmark rate last week to a range of 4.5% to 4.75%. Let’s run through what we’ve learned in the wake of that policy decision and a robust U.S. payrolls report that took some wind out of those investors’ sails hoping for rate cuts by summer.
Last week’s strong jobs report caused a more hawkish move in the fed funds futures. The March FOMC meeting is a lock for another 25 basis points, and there is roughly a three-in-four chance for another 25 basis points in May. Before the jobs report, investors saw a 40% chance of another hike this year. That said, the December futures still see rates at the end of the year between 4.75% and 5%, which is 25 basis points higher than here and implies a cut at some point if there are multiple rate hikes over the next couple of Fed meetings.
Did you miss it? This week’s Market Commentary – Special Feature post reviewed changes to the Loan Level Price Adjustment (LLPA) matrix, Wells Fargo’s exit from the correspondent lending space, and the U.S. breaching its debt ceiling.
“Fed Speak” Highlights
Highlights from this week in Fed speak included Minneapolis President Kashkari saying that the Fed still has to raise rates “aggressively” (read: up to 5.25%-5.5%) in order to cool off the labor market and get inflation under control, and Chair Powell continuing to be bombarded with the same questions on when the Fed will pause its rate hikes and begin to cut rates again (he is firm and insistent that it will not do so this year).
There exists a raging debate among economists over whether we’ll need a sharp rise in unemployment to keep inflation low.
Fortunately, the rate at which prices have been rising, aka inflation, has now cooled for six straight months. But inflation is still high: the Fed targets an annual rate of roughly 2%, and its preferred inflation measure is still closer to 5%. The primary driver of that figure has shifted from pandemic-related supply chain issues to a very hot labor market that continues to drive up wages (last week’s jobs report pegged the unemployment rate at its lowest level since 1969).
The result for MBS has been solid, but not overwhelming, demand from end accounts on origination lists, with strong REIT demand a notable highlight. Despite the heavy selling, basis tightening, and recent increase in dealer balance sheets, two-way flows remain from the money manager community and the spec market continues to operate in a very healthy fashion. Payups have come off in lower coupon specs, reflecting sympathy with the basis tightening and shorter spread durations of these pools and value derived from faster speeds for deep discount dollar prices. Rate volume has come off substantially this year, which could dampen some demand for specs versus TBAs, but things should keep trading fairly well. Eyes remain on the potential re-emergence of bank demand in conventional MBS, which hasn’t come yet in Q1 2023, but will be an eventual large source of support for the market.
Volatility and Affordability
FOMC members have admitted that they are not seeing much of an imprint of the tightening to date on the labor market, albeit beyond a pretty muted effect. Debate this week surrounded whether or not last week’s blockbuster job report is an indication that employers will need to raise wages to attract workers, which could counter some of the recent progress made on the inflation front. For now, “we’ll see how the data comes in,” is how the Fed is playing it. Not great for volatility.
Switching the “ity” suffix from volatil to affordabil…to square the affordability circle, either mortgage rates must fall, home prices must fall, or wages must (continue to) increase. A dramatic move in at least one of those categories is required to fix the issue and help mortgage origination volumes tick back up. With mortgage rates now at a four-month low, we have seen a healthy pickup in the mortgage application and lock data (see our latest MCTlive! Lock Indices). Lower rates and inventory increases will help affordability as we enter the beginning of the spring buying season.
