Morning Report: Terrorist attack pushes down bond yields

Vital Statistics:

Stocks are flattish this morning as the bond market re-opens after a long weekend. Bonds and MBS are up.

We don’t have a ton of data this morning, but we do have a lot of Fed-speak with Raphael Bostic, Neel Kashkari, Christopher Waller and Mary Daly all speaking today.

The weekend terrorist attack by Hamas had a muted impact on the US equity markets and is providing a flight to safety in the bond market. So far, it seems to be having an muted impact on oil prices. While international instability usually causes interest rates to fall, the strong labor market is the biggest factor and will probably remain so, especially after Friday’s big number.

The Mortgage Bankers Association, the National Association of Realtors and the National Association of Homebuilders sent a letter to the Fed, urging them take actions to support housing and the mortgage market. Increased uncertainty about monetary policy have pushed out MBS spreads and increased interest rates.

They point out that shelter accounted for 90% of the increase in consumer prices during the month of July and that the best way to attack housing costs is to help facilitate new home construction.

The consortium urges the Fed to commit to ending rate hikes and to stop letting its MBS portfolio run off until MBS spreads have stabilized. I suspect wide MBS spreads are due more to bond market volatility than to QT. MBS spreads weren’t materially different from historical levels during the era of QE, so I don’t see why QT (which is much smaller in scope) would matter. MBS spreads are being driven by bond market volatility, and I suspect an all-clear signal out of the Fed would go a long way towards stabilizing them.

Small Business Optimism slipped in September, according to the NFIB. This was the 21st consecutive month with the index below the historical average. Inflation and labor shortages were the biggest drivers of the decrease. Small Business owners were increasingly pessimistic about the outlook six months out.

Consumption remains strong as consumers spend on credit, while small business is dealing with a tight labor market: ” They raised labor compensation at record rates to keep workers and fill open positions which are at record high levels. To manage rising labor, energy, and other costs, they raised prices at record high rates and continue to do so, adding to inflation pressures. But they are investing in their firms at historically low rates, primarily because capital spending is financed from the bottom line, and profits have been squeezed by rising input and labor costs and regulatory compliance. Interest rates on their loans have more than doubled and financing is harder to get now.”

Chinese real estate developer Country Garden defaulted on a HK dollar denominated loan. Sales have collapsed, with the first three quarters of 2023 down 44% from the previous period, and September sales down a whopping 81%. The developer has $187 billion in liabilities.

IMO this remains the biggest black swan event in the financial markets. I find it highly unlikely that the world’s second biggest economy could have a Great Depression-esque real estate implosion without any negative credit consequences outside of its country. Western investors and banks will lose money, and that might be the catalyst for the Fed to cry uncle.

Housing sentiment remains dour, according to the Fannie Mae Home Purchase Sentiment Index. “Mortgage rates persistently over 7 percent appear to be deepening the malaise consumers feel about the home purchase market,” said Doug Duncan, Fannie Mae Senior Vice President and Chief Economist. “In fact, high mortgage rates surpassed high home prices as the top reason why consumers think it’s a bad time to buy a home, a survey first. Notably, the share of consumers expressing pessimism about homebuying conditions hit a new survey high in September, with 84% now indicating that it’s a bad time to buy a home.”

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