The Market Today
FOMC Minutes the Focus after Eventful 24 Hours
by Craig Dismuke, Dudley Carter
Today’s Calendar – Existing Home Sales and FOMC Minutes: April’s Existing Home Sales report is expected to show a 1.1% drop in sales at 9:00 a.m. CT. As we noted yesterday before the New Home Sales report, a minor 1.1% drop would not give any cause for concern. Sales trends are still improving and there is month-over-month volatility. However, if the Existing report matches yesterday’s disastrous New Home Sales report, it may well give investors some pause on housing. More importantly, the FOMC Minutes from their May 3 meeting will be released at 1:00 p.m. The meeting was three weeks ago, before a second consecutive disappointing inflation report and before the Comey drama which has certainly unsettled markets. While we expect the Minutes to show a hawkish bias favoring a hike in June, one more later in the year, and possible balance sheet action later this year, it will likely take even more than that to draw much of a market response. We already know that the FOMC was feeling hawkish three weeks ago. But we also know that there has been some concerning news since then which could derail the hawkish mood. Things have changed since May 3 and more recent Fedspeak is going to matter more now than three-week-old Minutes.
Overnight Activity – China’s Credit Downgraded as Markets Turn to May’s Fed Minutes: A slightly negative tone in European equities has pushed sovereign yields there lower and was preceded by a mostly positive session in Asia. Asian equities showed only a fleeting negative response to a Moody’s downgrade of the world’s second largest economy. Moody’s knocked China’s credit rating down a notch to A1, the first ding to the country’s credit since 1989. The brevity of the market response likely reflects the fact that the headwinds the Chinese economy faces have been well publicized for months. Currencies have been relatively quiet and commodities hovered around breakeven. After five consecutive positive sessions, crude prices stabilized before tomorrow’s OPEC meeting. Following a light European economic calendar, markets will turn their attention back to the U.S. for the release of the Minutes from the Fed’s May meeting. Heading into the U.S. trading session, U.S. equity futures, Treasury yields, and the Dollar were all essentially unchanged from Tuesday.
Yesterday’s Trading – Yields Rise as Stocks Climb and the Dollar Rebounds: U.S. stocks climbed closer to their all-time highs as the Dollar recovered and the yield curve increased by two to three basis points across the curve. U.S. equities improved after strong economic data sent European exchanges higher for the day. Financials led both the S&P and Dow to daily gains of 0.2%. Energy companies were middle-of-the-pack performers as crude moved higher for a fourth consecutive session. The gains in crude prices developed even as the Dollar rebounded. OPEC will meet in Vienna on Thursday to determine if the current cuts will be extended past the current June deadline. The 2-year yields saw the smallest increase, rising 2.1 bps after a solid monthly auction. Various metrics from the auction showed solid demand. A bid-to-cover of 2.9 compared favorably to a 2.7 six-auction average. Indirect bidders took down 57.2% of the auctioned amount, down from last month’s auction but still high relative to recent years. The 10-year yield rose 2.6 bps to 2.28%.
President Trump’s Budget Proposal Long on Optimism: The President’s budget plan, released yesterday, is projected to balance the budget by 2027 based upon two key factors – a dramatic decrease in government spending and a 3.0% economic growth rate in 2021 and beyond. Government spending is cut by $3.6 trillion over the 10-year budget window. Tax reform is included in the proposal but the budgetary effects show almost no change in tax collections as a percentage of GDP (i.e. “budget neutral”). However, because the budget assumes a 3.0% GDP growth rate (versus the CBO’s projection of 1.9% growth), tax revenues are actually $3.6 trillion higher than CBO’s baseline forecast. All told, $3.6 trillion in spending cuts and $3.6 trillion additional tax revenues would certainly help reduce the deficit – but 3.0% growth is very optimistic. As an aside for fixed income investors, CBO projects the 10-year Treasury yield will level out at 3.6% for the next 10-years while the President’s plan projects it to level out at 3.8%.
The budget has already been met with bipartisan pushback and is being dubbed the “reach for the rich” by opponents. This budget and its criticism are not unlike President Reagan’s first budget proposal which was decried as overly optimistic in its growth assumptions in order to justify large tax cuts.
GSE Reform Taking Shape Finally (WSJ): “In an exchange last week … Mr. Mnuchin said he would consider a government backstop for the mortgage market. ‘If there is a guarantee, we would want to make sure that there is ample credit and real risk in front of that guarantee, so that taxpayers are not at risk,’ he said. … These comments suggest the Trump administration’s thinking is in line with a range of compromise proposals put forward by private think tanks, the Mortgage Bankers Association and others. These plans would dramatically restructure Fannie and Freddie, and put in place a federal guarantee on certain mortgage securities. This protection would kick in after private investors have taken initial losses through the new ‘credit risk transfer’ market. … Under most of these plans Fannie and Freddie would still exist, but with a more limited role, perhaps as utility-like mortgage guarantors. … The new government guarantee would ensure a steady flow of investment into the trillion-dollar mortgage-backed securities market, keeping mortgage rates low.”
New Home Sales Take a Puck to the Chin: New homes sales in April fell much more than expected, down 11.4% versus expectations of a mild 1.8% pull back. The weakness came from all four regions, but particularly from the West where sales fell 26%. The month’s supply of homes rose from 4.9 months to 5.7 months and the median home price fell 3.0% MoM, now down 3.8% YoY. The markets did seem to overlook the disastrous results, in part because the data is notoriously volatile on a MoM basis and tends to have large revisions in subsequent months.