Morning Report: FOMC minutes shock the bond market 5/19/16

Markets are lower this morning after the FOMC minutes shocked bond markets yesterday. Bonds and MBS are down.

The sentence that sent bonds reeling: Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.” The FOMC minutes caused a 7 basis point spike in the 10 year and a 6 basis point spike in the 2 year. The Fed Funds futures contracts (which is what the “likelihood implied by market pricing” phrase alludes to) moved from a 10% chance of a June hike to a 25% chance of a June hike and a 60% chance of a hike by September. Earlier this year, the futures were basically betting the Fed would be on hold for the rest of the year. The markets were perhaps a little too complacent about another rate hike. That said, the Fed has set up the markets for rate hikes several times over the past year or two only to get cold feet.

In terms of the economy, the members and the staff noted that the labor market continues to improve despite a deceleration in economic growth. Inflation remains well below the Fed’s target, however they attribute that to commodity price movements, which are transitory.

The minutes also mentioned that residential mortgage credit was getting a little looser on the government side, but also noted that non-traditional and credit-challenged borrowers still face tight credit conditions. The corporate bond market has improved after a slow January and February.

In economic news today, the Chicago Fed National Activity Index rose to .10 from a downward-revised -.55 in March. The 3 month moving average is still negative, meaning the economy is growing slightly below its long-term trend. Separately, the Philly Fed Business Outlook Index fell to -1.8.

Initial Jobless Claims fell to 278k from 294k last week. As a general rule, people are hanging onto their jobs these days.

The Bloomberg Consumer Comfort index was flat last week at 44.5.

The Index of Leading Economic Indicators rose from 0.2% to 0.6% in April. The FOMC minutes mentioned the Fed expects growth to accelerate into the second half of the year.

Interesting stat: The number of homes worth $1 million has doubled in the last 4 years. Of course 2012 was pretty much the bottom of the real estate market, and it has been the big urban areas like San Francisco and Manhattan that have led the charge higher. Heck, in San Francisco, the median home price is over $800k.

And that ties into….a lack of starter homes.  Homebuilders are having a tough time making starter homes work financially. Increased regulatory and compliance costs, mandated open space, lower density, higher land prices, and fees imposed by counties and cities are all combining to make affordable starter homes impossible to build. Indeed, the number of starter homes is at a historical low and falling. Here are some industry quotes: “When you start with a high land basis, it’s very hard to end up with a purchase price that the first-time buyer finds affordable,” said Stuart Miller, CEO of Miami-based Lennar. “No. 1, you see it in just the pure requirements. Those requirements can be a very lengthy list of things you maybe wouldn’t have seen 10, 15, 20 years ago. But you’re also seeing it in fees that counties and cities impose on new home construction. Fees can be anywhere from $50,000 to $100,000 per home to build,” said Taylor Morrison’s Bodem. “Things like that ultimately get passed on to the consumer and the price of housing. That’s one reason why you see the cost of housing so expensive, especially here in Southern California.” I have said it before, housing is the #1 thing keeping GDP growth around 2% instead of 3%.

Turn times increased for refis last month, according to the Ellie Mae Origination Insight Report. Time to close all loans was steady at 44 days, but refis increased from 41 to 44. Turn times are now below where they were pre-TRID.

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