Morning Report: Bonds rise on tame consumer price growth

Vital Statistics:

	Last	Change
S&P Futures	2803.0	14.0
Eurostoxx Index	378.4	-0.8
Oil (WTI)	61.0	-0.4
US dollar index	83.7	0.0
10 Year Govt Bond Yield	2.84%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	102.714
30 Year Fixed Rate Mortgage	4.46

Stocks are higher this morning after the CPI came in lower than expected. Bonds and MBS are up. 

Consumer prices rose 0.2% MOM and 2.2% YOY, however the core rate, which excludes food and energy rose 0.2% MOM and 1.8% YOY. Communications (cell phones, data) costs were a drag on the index, while apparel prices pushed it higher. Owner-equivalent rent moderated as well, which is a proxy for house prices. 

The NFIB Small Business Optimism Index just missed the record high set in 1983, rising 0.7 points to 107.6. Lack of qualified workers was the #1 problem again, and reports of compensation increases were the highest since 2000. Reports of CAPEX spend were the highest since 2004 as well. For all of the talk about how things are going on Wall Street, Main Street has switched into a higher gear. Probably the biggest constraint to higher growth right now is a lack of qualified workers. Of course, if the labor markets were truly tight, we would see widespread wage inflation. There are pockets of strength as noted below, but some parts of the labor market are still relatively stagnant. 

Separately, the Conference Board's Employment Trends Index rose in February, and is up 5.6% YOY. The six month growth rate is the highest in 4 years, when the labor market was still in recovery mode. 

One of the strange things in this labor market has been wage growth at the lower end of the wage scale, but not in the upper half. Between minimum wage laws and voluntary raises provided by companies like WalMart in the aftermath of tax reform have boosted wages at the lower end of the scale. This is squeezing the middle to upper middle class, as things like child care and entertainment, become more expensive, while their own disposable income remains relatively unchanged. This might just be a delayed reaction, and we will see more widespread wage growth. However, it might also crimp demand for housing as people feel like they don't have the disposable income for homeownership. More issues for the first time homebuyer. 

Rex Tillerson is out as Secretary of State. CIA Director Mike Pompeo has been appointed to the role. Meanwhile, Larry Kudlow is seen as the favorite to replace Gary Cohn, who is leaving the Admin as well. 

While most people in the mortgage markets are focused primarily on long rates, rising short term rates are having a large impact as well. Short rates (LIBOR / 1 year T-bill) are the highest in 10 years. This affects ARMs and their relative attractiveness to the 30 year fixed rate mortgage. As the yield curve steepens (in other words, the difference between the 30 year bond yield and LIBOR increases) the more attractive ARMS become. As that spread falls, the 30 year fixed becomes more attractive. While ARMS provide a borrower with a lower monthly payment out of the box, paying the extra yield may be a better bet this time around. ARMs perform best in secular bond bull markets, like we experienced from 1981 to a couple of years ago. In a rising rate environment, they won't be as attractive.

The rise in short term rates is also going to have knock-on effects in the stock and bond markets. For the past 10 years, short term bonds have paid next to nothing, so stocks and longer duration bonds have had no competition. That is changing, and we will see an effect on stocks as funding costs for companies increase.