Morning Report: Janet Yellen spooks the bond market

Vital Statistics:

	Last	Change
S&P Futures	2334.8	-2.3
Eurostoxx Index	371.3	1.1
Oil (WTI)	53.1	-0.1
US dollar index	91.4	0.1
10 Year Govt Bond Yield	2.50%
Current Coupon Fannie Mae TBA	102.1
Current Coupon Ginnie Mae TBA	103.2
30 Year Fixed Rate Mortgage	4.11

Markets are flat this morning as Janet Yellen continues to speak. Bonds and MBS are down.

Mortgage Applications fell 3.7% last week as purchases fell 5% and refis fell 3%. The average conforming rate fell 3 basis points, which makes this a surprise, but it could just be the vagaries of the slow season, which is pretty much over.

The consumer price index rose more than expected, increasing 0.6% month-over month and 2.5% year-over-year. The core rate, which excludes food and energy rose 0.3% MOM and is up 2.3% YOY. Both numbers are above the Fed's 2% inflation target, which is why bonds are selling off further this morning. Higher motor vehicle prices drove the increase, which is the highest reading in 4 years. Note that yesterday's PPI number (which typically leads CPI) showed very little inflation. While the Fed focuses on the Personal Consumption Expenditure index as its preferred method of measuring inflation, wage inflation is what matters. Until you see wage inflation, commodity push inflation will generally be self-correcting.

Retail sales came in better than expected, rising 0.4% month-over-month. Excluding autos and gas, they rose 0.7%.

In manufacturing data, the Empire State Manufacturing Survey increased to 18.7. Industrial production fell 0.3% however, while manufacturing production rose 0.2%. Capacity Utilization fell to 75.3%. Low capacity utilization rates are generally non-inflationary. Business inventories rose 0.4%, and the inventory to sales ratio fell from 1.38 to 1.35. A high inventory to sales ratio is generally bearish for the economy as it portends a slowdown in manufacturing while business works off excess inventory. The ratio is still elevated, but below last year's levels.

The post-election bump in builder confidence was given back last month as higher rates discouraged traffic. The index dropped from 68 to 65, which is still a strong reading.

Janet Yellen testified in front of Congress yesterday, beginning her two-day Humphrey-Hawkins testimony. Here are her prepared remarks. Bonds sold off during the testimony, apparently because of this statement: "As I noted on previous occasions, waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession." Seems to be a pretty benign (and obvious) statement, but there you go. The 10 year added 5 bps in yield but recovered some of those losses later in the day. There was also mention of ending the program of re-investing maturing MBS proceeds back into the market, but that is probably something we won't see until next year. The effect of that on the MBS market is going to be a function of current rates and the average coupon of the portfolio.