The Market Today
Fed Expected to Cut Rates; Concerns Grow About Financial Market Liquidity
by Craig Dismuke, Dudley Carter
Housing Data Shows Big Jump in Construction Activity with Particular Strength in Multi-Family Activity: Housing starts and building permits both beat expectations handily in August, rising 12.3% and 7.7%, respectively. Mortgage rates have continued to decline with the 30-year mortgage rate, as reported by Freddie Mac’s Mortgage Market Survey, down to 3.58% by the end of August, and down 136 basis points from the peak back in November. Driving August’s activity, single-family starts rose 4.4% while multi-family starts rose 32.8%. Single-family starts are now up 2.1% year-over-year, multi-family starts are up 16.7%, and total starts are solidly back into positive territory, up 6.4% year-over-year. Likewise, building permits have been boosted materially by multi-family activity. Single-family permits rose 4.5% in August while multi-family jumped 13.3%. On a year-over-year basis, single-family permits remain fractionally negative, down 0.6%; but, multi-family permits are up 22.2% bringing total new permits up 7.4%.
FOMC Decision – Another Cut with All Eyes on Forward Guidance: Against a backdrop of some stronger economic data, the Fed is expected to cut its target rate 25 basis points to 1.75-2.00% at its 1:00 p.m. CT policy decision. Fed funds futures are pricing in a 100% likelihood of a 25 basis point cut and the adverse market reaction to the Fed not cutting would be significant, potentially forcing the Fed to cut even more. How the Statement, Summary of Economic Projections, and Powell’s comments guide future expectations will likely be the story by the end of the day. We expect the Committee to keep its language that they “will act as appropriate to sustain the expansion.” This noncommittal language provides them flexibility to take action in either direction as conditions continue to evolve. Made more interesting by the last 48 hours of liquidity pressure will be Powell’s response to presumed questions about the likelihood of resuming quantitative easing to increase the level of reserves in the financial system.
OVERNIGHT TRADING ACTIVITY
Yields Decline Ahead Of The Fed: Sovereign bond yields were exclusively lower ahead of the widely-expected Fed rate cut later in the afternoon, while global equities held close to unchanged. Stocks were mixed across Asia and while every major national index in Europe was trading higher, the broader Stoxx Europe 600 had moved up less than 0.1%. Just before 7:30 a.m. CT, the Treasury curve was lower but longer yields were lagging modestly larger drops in Europe. The 2-year and 10-year yields had both dipped just over 2 bps. Germany’s 10-year yield had declined 2.3 bps while France’s was 3.3 bps lower. The U.K.’s 10-year note fell further, dropping 4.0 bps on the heels of a softer-than-expected CPI report.
Oil And Overnight Funding Rates Remain In Focus: Following Tuesday’s sharp declines, global oil prices continued to drift lower and cut into Monday’s historic jumps that were sparked by the weekend attack on Saudi oil facilities. This week’s other major story, dislocations in overnight funding markets that has led to a spike in the shortest tenor of interest rates (more below), will also remain in the headlines Wednesday. For just the second time since 2008 the Fed has conducted an overnight repurchase operation, offering up to $75B of daily liquidity in order to maintain control of its key policy rate. This morning’s operation was fully accepted, with the Fed receiving $75B of securities (Treasuries, agencies, and MBS) as collateral for overnight funds.
YESTERDAY’S TRADING ACTIVITY
Funding Pressure In The Overnight Market Forced The Fed Into Action: The Fed headlines were expected to start with Wednesday’s rate decision, but the flow began early. The U.S. central bank was forced to intervene in money markets Tuesday, with its first open market operation in a decade in an attempt to regain control over its key policy rate. Signs of stress in the overnight funding market emerged Monday and persisted Tuesday, pushing key short rates such as repurchase rates and the effective fed funds rate up to levels not seen in a decade in some cases.
Treasury Auctions And Tax Payments Tighten Money Market Liquidity: Analysts suspect the unusual disruptions were caused by a couple of events that combined to lower the level of reserves in the financial system, while simultaneously increasing the amount of securities that are being held by institutions that need a higher level of reserves to fund their holdings. Treasury refundings settled Monday at the same time that U.S. corporations transferred funds to the Treasury to settle tax bills.
Coincidence Or Cause For Alarm?: While the squeeze was seen as a possible fleeting coincidence of unfortunate timing, it was serious enough to force the Fed into action. Presuming the pressures persist, it could also intensify speculation about whether the level of reserves in the financial system is adequate, reserve created through the Fed’s QE program after the crisis and recently reduced during the recently-ended run-off of their balance sheet.
Other Markets Not Shaken: Providing further evidence of the lack of broader worries, at least for now, stocks rose modestly Tuesday while Treasury yields wandered lower ahead of today’s Fed decision. The 2-year yield fell 3.5 bps while the 10-year yield dropped 4.5 bps. Keeping an eye on this week’s other major story, oil prices gave back roughly half of Monday’s rally on reports Saudi Aramco may be able to return operations to a relatively-normal level rather quickly.
Better-Than-Expected Manufacturing Output Lifted Industrial Production Past Expectations: Industrial production was stronger-than-expected in August as utilities and mining output rose and manufacturing output rebounded more than expected from a July decline. Industrial output recovered 0.6% after falling 0.1% the month before, while manufacturing activity recovered 0.5% from a 0.4% drop-off. The trade tensions between the U.S. and China have weighed notably on global manufacturing activity, including in the U.S. On a three-month-over-three-month annualized basis, manufacturing output bottomed in May at -4.3%. After a couple of firmer months in June and August, however, that rate has picked up to 1.3%, the best of the year but still half of the 2.6% average rate from 2018.
Housing Market Index Rose On Current Sales As Mortgage Rates Decline: The NAHB’s Housing Market Index rose unexpectedly in September from an August level that was revised stronger. With the 1-point gain to 68, the headline index matched its best level since May 2018. The uptick was driven entirely by an improvement in the present sales index, as the index tracking future sales expectations actually eased 1 point and buyer traffic was unchanged. The recovery this year in home builder confidence has occurred alongside a rapid drop in mortgage rates. The 30-year mortgage rate from Freddie Mac’s mortgage survey has dropped from 4.94% last November to 3.56% as of last week, a near-three-year low. The NAHB’s chief economist highlighted the correlation, but also acknowledged that uncertainty is weighing somewhat. “Solid household formations and attractive mortgage rates are contributing to a positive builder outlook,” he said, “However, builders are expressing growing concerns regarding uncertainty stemming from the trade dispute with China.”