Morning Report - Parsing the FOMC minutes

Vital Statistics:

	Last	Change	Percent
S&P Futures	1783.8	4.1	0.23%
Eurostoxx Index	3050.5	3.2	0.10%
Oil (WTI)	94.25	0.4	0.43%
LIBOR	0.238	-0.001	-0.21%
US Dollar Index (DXY)	81.08	-0.035	-0.04%
10 Year Govt Bond Yield	2.81%	0.01%
Current Coupon Ginnie Mae TBA	105.3	-0.4
Current Coupon Fannie Mae TBA	104.3	-0.1
RPX Composite Real Estate Index	200.7	-0.2
BankRate 30 Year Fixed Rate Mortgage	4.38

Markets are higher this morning on no real news. Bonds and MBS continue their post-FOMC minutes sell-off.

Initial Jobless Claims came in at 323k, lower than the 335k street forecast. Inflation at the wholesale level remains muted.

The bond market sold off on the FOMC minutes, as people who had been holding out hope that the September non-move meant QE4EVA were disabused of that notion. The Fed largely dismissed the effects of the government shutdown as "temporary and limited." Given the October jobs report and October retail sales, they are correct - we just didn't see any effect from the shutdown except for a temporary spike in the 1 month T-bill. They again repeated the view that the economy is strengthening, and if things play out as we expect, we should be tapering QE in the next few months. 

Sometimes you have to parse the Fed's characterization of things. On the Fed's scale:

Economic Growth - "moderate"

Inflation - "modest"

Corporate Credit - "robust"

CAPEX - "tepid"

In other words, growth is just ok, inflation is too low, business investment is way too low, and the Fed is beginning to worry about bond investors reaching for yield. This means that QE' days are numbered as the risks of an overheated credit market are becoming larger than the risk of a credit crunch. However, low interest rates are probably here to stay until business investment, inflation, and employment are closer to where the Fed wants to see things.  

One thing to keep in mind is that the Fed's footprint has been increasing in the MBS market as issuance drops. The end of the refi boom meant lower overall MBS issuance but the Fed has been maintaining a constant $40 billion a month. As a percentage of total volume, their footprint has been increasing. You can see it in MBS spreads, which have tightened to Treasuries. While the market has been of the view that the Fed would taper Treasury purchases first, lest it derail the nascent housing recovery, an adjustment in MBS is probably in order. This could mean a double-whammy for mortgage rates - The benchmark (Treasuries) increases in rate, and the spread to Treasuries increases as well. Float at your own peril..

I find it ironic that the Fed worries about people conflating a reduction in QE with a tightening of monetary policy, yet at the same time refers to "fiscal headwinds." Reality Check: fiscal policy is about as loose as it gets, unless you compare it to a completely artificial benchmark of the past 5 years. Post WWII, government spending averaged around 19% of GDP. We have averaged 24% over the past 5 years. We are still at 22%. 5 of the 7 largest postwar deficits as a percent of GDP have been in the past 5 years. Calling a slight reduction in government spending as a "fiscal headwind" makes as much sense as characterizing a reduction in asset purchases from 85 billion a month to 65 billion a month as "tightening monetary policy." It is the dieting equivalent of having a diet coke with your triple whopper value meal.

As home prices rise, negative equity has continued to fall, according to Zillow. The percentage of homes with negative equity dropped to 21% in the third quarter from 23.8% in the previous quarter. Negative equity has been a big reason why existing home sales have been so depressed. Yesterday we saw an annualized pace of 5.12 million, which is slightly below average. IMO, there is pent-up demand that is being held back by negative equity. As that condition rights itself, we should see existing home sales numbers well in excess of historical averages. The mortgage bankers who do purchase activity well will reap the benefit.