The Market Today

Fed Prepares Long-Term Solution for Funding Crunch


by Craig Dismuke, Dudley Carter

TODAY’S CALENDAR

Mortgage Applications Rise As Rates Continue Lower: Mortgage applications for the week ending October 4 rose another 5.2% at mortgage rates fell further, sparking another good week for refinances.  Refi apps rose 9.8% but purchase apps pulled back 0.9%.  The average 30-year fixed rate fell to 3.90% during the week according to the MBA report, down from a cycle peak of 5.17% last November.  For the third quarter, mortgage rates averaged their lowest quarterly average since 2Q16 and 3Q16.  With the average outstanding mortgage rate for all homeowners with mortgages (Federal Reserve data) currently at 3.87%, rates have now fallen sufficiently low to be a catalyst for both purchase and refinance activity (see Chart of the Day).

FOMC Minutes, Job Openings: The August Job Openings and Labor Turnover Report is scheduled for release at 9:00 a.m. CT.  Openings are expected to tick up 33k after having fallen 408k to 7.22 million since January.  Also at 9:00 a.m., August’s wholesale inventories report will be finalized.  At 1:00 p.m., the Fed will release the Minutes from the September 18 FOMC meeting at which they cut rates for a second time and tabled the market-funding topic, a topic Chair Powell addressed yesterday (more below).  The Minutes have not moved markets nearly as much as the Fed Chair’s post-FOMC press conferences recently.


OVERNIGHT TRADING ACTIVITY

Headlines Lift Hopes This Week’s Trade Talks Could Still Make Some Progress: The market’s tone has turned more upbeat during the European session on a handful of headlines that indicated this week’s trade escalation hasn’t completely derailed chances of some progress in the negotiations set to start tomorrow. Fears that the U.S. blacklisting more Chinese companies had lowered the odds of any breakthroughs weighed on markets Tuesday (more below). However, Europe’s Stoxx 600 and U.S. futures jumped sharply on a headline that said China was still open to a partial deal despite the new entries on the blacklist. Adding to the optimism, the Financial Times followed up with a report that China had offered to buy 10 million additional tons of soybeans and an editor from a Chinese state media outlet said the negotiations would run through Friday as expected. Reports out yesterday said the Chinese delegation had decided to cut off the talks a day early.

Markets Stabilize On First Positive Trade Developments This Week: Europe’s Stoxx 600 increased its daily gain to 0.6% just before 7 a.m. CT and futures on the S&P 500 were 0.9% stronger. Bond yields around the globe were also higher on renewed hopes around trade. European curves were slightly steeper with Germany’s 10-year yield 2.6 bps higher and the U.K.’s up 3.2 bps. Treasury yields also recovered a portion of yesterday’s declines as the 2-year yield pushed up 1.0 bps and the 10-year yield added 2.6 bps.


YESTERDAY’S TRADING ACTIVITY

Stocks Opened Lower On Less Optimism Around Trade Talks: U.S. equities sold off quickly at the open as market sentiment had soured during European trading in response to waning optimism about this week’s U.S.-China trade negotiations. A drove of developments since the weekend have led investors to pare back expectations for much positive progress during the talks that are set to begin on Thursday. Most recently, the U.S. Commerce Department announced numerous new entrants to the Entity List late Monday, to which China responded “stay tuned” when asked about potential retaliation.

Gradual Recovery Put Equities At Peak After Powell Said Fed Will Begin Buying Treasury Bills: After falling as much as 1.4% amid the resurgent uncertainty, the S&P 500 turned higher and recovered to down just 0.4% during Fed Chair Powell’s afternoon speech. The high mark came after Powell announced that the Fed will soon divulge details of a more permanent fix involving Treasury bill purchases that will replace the ongoing temporary operations aimed at ensuring ample reserves in the financial system (more below). At the same time, shorter maturities led a dip of the Treasury curve on prospects of increased demand for near-term maturities.

Visa Ban Announcement Sent S&P Lower: However, stocks reversed to the downside just before 2 p.m. CT after the U.S. State Department announced it was banning visas for Chinese officials it believes are involved in “a highly repressive campaign” against certain Muslim groups in Xinjiang. The same rationale was behind the Commerce Department’s blacklisting of new Chinese companies on Monday. Stocks weakened throughout the remainder of the session and pushed the S&P 500 down 1.6% to a close near its lowest tick of the day. The 2-year yield dropped 4.2 bps to 1.42% and the 10-year yield slipped 2.9 bps to 1.53%.


NOTEWORTHY NEWS

Powell Said Solid U.S. Economy Faces Risks From Abroad: In his prepared remarks, Fed Chair Powell said “the jobs and inflation pictures are favorable” but “there are risks to this favorable outlook, principally from global developments” tied to trade policy and Brexit, among other issues. He again said policy is not on a preset course and officials will be watching incoming data and will “act as appropriate” to sustain the expansion. In the subsequent Q&A, he acknowledged that “clearly things are slowing a bit” but “there’s no reason why the expansion can’t continue.” However, the bigger news were his remarks on how the Fed expects to more permanently address recent funding market volatility that has forced the Fed into a series of repurchase operations since the middle of September.

Treasury Bill Purchases Will Be Part Of More Permanent Funding Fix To Be Announced Soon: Powell reminded the audience that in March the Fed signaled that at some point the dynamics of its liabilities profile would eventually force it to begin increasing its portfolio holdings again. “That time is now upon us,” Powell said. He added, “my colleagues and I will soon announce measures to add to the supply of reserves over time,” later noting the current temporary market operations will likely be replaced with outright purchases of Treasury bills. He stressed that the “growth of our balance sheet for reserve management purposes should in no way be confused with” crisis-era quantitative easing.

Evans Said Stronger Downside Risks Warranted Recent Policy Recalibration: Chicago Fed President Charles Evans, who will vote on policy decisions for the remainder of the year, said the U.S. economy is “actually doing quite well right now.” However, he believes “the downside risks are stronger than the upside risks, and that’s a good rationale for why we’ve repositioned, recalibrated monetary policy.” “There could well be reasons to take out another insurance — 25 basis points – cut,” Evans noted, adding, “I wouldn’t mind another cut. I could see it either way.”


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