Morning Report: PIMCO is buying mortgages

Vital Statistics:

	Last	Change
S&P Futures	2116.0	-15.0
Eurostoxx Index	334.4	-4.0
Oil (WTI)	50.0	-0.1
US dollar index	88.4	0.1
10 Year Govt Bond Yield	1.75%
Current Coupon Fannie Mae TBA	103.3
Current Coupon Ginnie Mae TBA	104.2
30 Year Fixed Rate Mortgage	3.54

Stocks are lower this morning after weak Chinese data. Bonds and MBS are up.

The FOMC minutes showed that September was a close call with respect to raising rates, and definitely set up the markets for a December rate hike. The Fed noted that third quarter GDP was stronger than the first half of the year, and the labor market is strengthening. The consensus for a December tightening doesn't necessarily indicate that there is the same consensus for further rate hikes. Interestingly, the Fed views consumer spending as"growing strongly" when the actual data does not suggest much strength at all. Bottom line, it looks like we are getting a rate hike in December, and the November meeting will be a non-event. The Fed Funds futures are assigning a 68% probability of a December hike of 25 basis points. 

Initial Jobless Claims fell to 245k last week, which is the lowest since the early 70s.  Consumer comfort increased last week as well.

Import prices rose 0.1% MOM and are down 1.1% YOY. Export prices rose 0.3% MOM and are down 1.5% YOY. Strategists are warning that the rise in the dollar is going to hit corporate profits.

PIMCO is getting into a defensive posture, buying mortgage backed securities and inflation-linked securities. Mortgage backed securities now account for 55% of the Total Return portfolio from 49% in August. Why mortgages? Think about what will happen to long term bonds as the Fed hikes rates. If long term bonds don't really move all that much (in other words, the yield curve flattens) the yield on mortgage backed securities will be much better than the yield on Treasuries. If the long end of the curve increases in line with the increase in the Fed funds rate, PIMCO is betting that the decrease in prepayment speeds will offset (at least partially) the interest rate effect. You can see over the past 5 tightening cycles, the yield curve has flattened.

John Stumpf is out at Wells. COO Tim Sloan, will take over. While the scandal was in the retail banking are and not the mortgage division, there probably will be fallout there too.