The Market Today

ECB Weighing Policy Future while Fed Officials Opine on Best Path of Tightening

by Craig Dismuke, Dudley Carter

Today’s Calendar – Mortgage Applications Yield Continued Optimism; Import Prices Rise: Mortgage applications for the week ending May 5 rose 2.4% on a 1.7% increase in purchase apps and a 3.3% increase in refi apps.  According to the report, 30-year mortgage rates were unchanged for the week at 4.23% (up 41 bps from year-ago levels) and 15-year mortgage rates fell 1bp to 3.50% (up 44 bps from year-ago levels).  Despite the YoY rise in rates, purchase apps continue to push higher to new highs for this cycle.  This is a positive development, of late, after purchase apps appeared to plateau in 2016.  Also released this morning, import prices for the month of April rose more-than-expected, up 0.5% MoM at the headline level and, more importantly, up 0.4% MoM at the core level.  Auto imports rose 0.5% MoM while imports from Mexico rose 2.2%, the largest monthly increase since 2011.  After peaking simultaneous with the December FOMC hike, the U.S. Dollar has been in a slow grind lower and is now down 3.7% from December’s peak, potentially pressuring import prices higher.  Going forward, the performance of the Dollar will be dictated, largely, by the changes in ECB policy.  The FOMC path appears fairly well set and the BOJ sounds content to remain accommodative.  The ECB is the wildcard with improving economic data and less geopolitical risk following the French and Dutch election proceedings.


Overnight Activity – Global Yields Fall as Stocks Pull Back: An overnight bid for safety has pushed Treasury yields, U.S. equity futures, and the Dollar all lower ahead of Wednesday’s session. The moves mirror trends in Europe where yields are lower across the region, most national equity exchanges are negative, and the euro is weaker against a broad basket of currencies. Asian equities finished mostly higher; shares in China continued to drop and are now down 5% over the last month. Most of the overnight headlines have focused on the firing of FBI Director Comey yesterday after markets closed, with analysts pondering the potential implications or complications for the rest of the President’s agenda. Crude prices are leading a daily rebound in commodities with U.S. crude up ahead of official weekly inventory data. In Europe, ECB president Draghi was cautiously optimistic in an appearance before the Dutch Parliament. Draghi said, “The economic recovery has evolved from being fragile and uneven into a firming, broad-based upswing. …Nevertheless, it is too early to declare success.” U.S. equity futures are lower by 0.1% to 0.2%, the 2-year yield is unchanged with the 10-year yield 1.8 bps lower, and the Dollar is down 0.2%.


Kaplan Expects Two More 2017 Hikes, Understands Inflation is Muted: Dallas Fed President Kaplan continues to expect three total hikes in 2017 in response to his assessment that risks to the economic outlook appear balanced. However, Kaplan noted that he is cognizant that inflation pressures remain muted and that activity could unfold faster or slower than he expects, resulting in a faster or slower path than his base case. He said that keeping rates too low for too long can create economic imbalances; Fed critics would agree. Kaplan’s opinions of potential changes out of Washington were mixed, saying some of the proposals from the Trump administration are positive while others are concerning. He commented on government debt levels saying that if interest rates rise, the cost of servicing the ever-increasing national debt will go up dramatically.


Rosengren Says GSE Reform Could Hurt Multifamily Sector: Boston Fed President Rosengren continues to harp on real-estate valuations and maintained his call for beginning to shrink the balance sheet this year. He mentioned GSE reform in his speech at NYU saying significant changes to the current structure could impact the multifamily sector given that Fannie and Freddie own or insure just under half of total multifamily borrowings. He isn’t concerned about a sequel to the 2013 taper tantrum when the Fed starts to adjust its balance sheet. Rosengren believes the market is able to absorb the excess supply if reinvestments are tapered gradually. The recent drop in the unemployment rate to 4.4% spurred Rosengren to caution about a potential pickup in inflation if the actual rate moves much further below the Fed’s NAIRU estimate.


George Sees More Economic Green Lights than Yellow: Kansas City Fed President George again called for additional rate hikes and beginning the process of normalizing the balance sheet this year. She said that the weakness in the first quarter GDP report shouldn’t keep the Fed from continuing to gradually tighten policy. George said the weaker first quarter growth and slower auto sales might be “flashing yellow” but didn’t seem overly concerned as other indicators continue to be “solid green”. She speculated that the March decline in core inflation may have been the result of “one-off” occurrences. George also noted that with the unemployment rate at 4.4%, below the Fed’s NAIRU projection, the base case should be further removal of accommodation. On the balance sheet, George said once the plan is decided upon, that should be the plan; it shouldn’t be revisited at every subsequent FOMC meeting.

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