Morning Report: The Fed maintains rates as expected

Vital Statistics:

			Last	Change
S&P futures			2622	-5.75
Eurostoxx index			385.94	-1.5
Oil (WTI)			67.7	-0.21
10 Year Government Bond Yield				2.94%
30 Year fixed rate mortgage				4.58%

Stocks are lower after the Fed maintained interest rates. Bonds and MBS are up. 

As expected, the Fed maintained its current Fed Funds target yesterday. The money quote: Inflation on a 12-month basis is expected to run near the Committee's symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced. The "symmetric" characterization of their inflation target (as opposed to treating the 2% target as a ceiling) gave markets some comfort that the Fed is going to continue its slow upward march in the Fed Funds rate as long as inflation remains around these levels. Bonds initially fell on the news and then rallied. 

The Fed Funds futures are pricing in a 100% chance of a tightening at the June meeting, and the December futures are pricing in one more tightening this year, with a smaller chance of 2. 

Job cuts fell in April after an unusually strong March, according to outplacement firm Challenger, Gray and Christmas. Retail has accounted for the largest share of job cuts this year, followed by health care. For the year, companies have announced around 175,000 job cuts, while announcing 210,000 job plans. C&G uses press releases to count job cuts and hirings, so it necessarily relate to the payroll numbers being put out tomorrow by BLS. 

Productivity rose 0.7% while unit labor costs rose 2.7% in the first quarter, according to BLS. Weak productivity growth has been an issue for a while and is one of the reasons why wage growth has seemed muted. Increases in standards of living are driven by increases in productivity. The increase in unit labor costs may be related to many of the minimum wage hikes we saw at the beginning of the year. Theoretically, the lower the productivity, the less room the Fed has to maneuver. 

Initial Jobless Claims rose slightly to 211,000 which is still close to 50 year lows. 

The service sector continues to expand, albeit at a slower pace than March according to the ISM Non-Manufacturing Index. The respondents echoed the same trade fears as the manufacturers did. Some snippets:

• “Economy is humming along. [Activity in] both residential and commercial construction [is] apparent. Agriculture sector seems to be moderating at these commodity price levels. The international trade situation appears to be shifting on a minute-by-minute basis, which has folks nervous.” (Finance & Insurance)
• "National shortage of Class-A drivers and the increased demand for logistics is resulting in an increase in the cost of goods." (Accommodation & Food Services)
• Construction activity continues to remain strong in the region, resulting in capacity issues and shortages of labor, materials and subcontractors.” (Public Administration)

Bill Gross thinks the upward move in interest rates is pretty much done, and he doesn't see much more of a move from here. “Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV. “I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”Of course Bill is talking his book a little, but he is probably right, with the caveat that inflation remains around the 2% level.

Beware of cult stocks once they lose favor with the Street. Tesla's conference call was supposedly a disaster last night, and Elon Musk decided to take questions from You Tube people instead of analysts who were interested in things like cash burn. Comparisons are being drawn to Enron's conference call in the early 00s when Jeff Skilling blew up at analysts which caused people to take a more critical look at the company. Don't forget TSLA bonds have been getting slammed, and that is toxic for a stock with negative cash flow trading over 4x revenues. 

Fannie Mae results are out. The company made $4.3 billion in the first quarter. 

Big fixed income money managers have not had much of an appetite for MBS as QE pushed down returns. That may be changing, as BlackRock and BNP Paribas are allocating more funds to the sector. One big advantage of MBS is liquidity. What does this mean for mortgage originators? Lower rates, at least at the margin.