Morning Report: Demand is falling for Treasuries 3/12/18

Vital Statistics:

Last Change
S&P Futures 2794.5 6.0
Eurostoxx Index 379.2 0.9
Oil (WTI) 61.5 -0.6
US dollar index 83.8 0.0
10 Year Govt Bond Yield 2.89%
Current Coupon Fannie Mae TBA 102.25
Current Coupon Ginnie Mae TBA 102.5
30 Year Fixed Rate Mortgage 4.4

Stocks are higher on no real news. Bonds and MBS are flat

This week will have some important economic data with housing starts on Friday and inflation data on Wednesday and Thursday. No Fed-speak as we are in the quiet period ahead of next week’s FOMC meeting.

As part of Dodd-Frank reform, Congress is looking at broadening the credit box for a qualified mortgage. Rural buyers, who typically use a smaller community bank, tend to have the biggest issues in getting a mortgage. Banks with $10 billion or less in assets could still get QM protection provided they meet some of the requirements and also hold the loan on their balance sheet. This change has bipartisan support – most everyone agrees that Dodd-Frank was too onerous for smaller banks.

Investors are beginning to have less of an appetite at Treasury auctions. Treasury auctions are generally non-newsworthy events that happen every Monday. While there is no real risk of a failed auction, we are starting to see less demand for Treasuries, which is to be expected in a rising interest rate environment. That said, you might start to see interest rates move on auction results. Bid / Cover ratios are not yet part of the business press vernacular, but we could be heading there. Something to keep in mind if rates suddenly move on a Monday afternoon.

Demand for Treasuries will drop if we see an honest-to-goodness trade war. Politicians make a big deal out of trade deficits, which sound worse than they really are. I run a massive trade deficit with my local deli: I buy lunch from them every day, and they never so much as buy a cup of coffee from me. China has chosen to accept Treasuries instead of our goods and services. If we buy less from them as the result of a trade war, they will buy less Treasuries, which would imply higher interest rates at the margin.

That said, China (and to a less extent Canada) have real estate bubbles on their hands, and residential real estate bubble generally lead to banking crises. What happens when you have banking crises? Demand for risk-free assets rise. In China especially, we should see the trade deficit balloon if that happens, as they will try and export their way out of the recession, and their own workers will have less disposable income to buy US goods and services. A burst China bubble could recreate the economy of the 1990s, where the US gets a free lunch with non-inflationary low interest rates. In the 90s, Japan and China were “exporting deflation” to the US, which is part of the reason why the 90s felt so good. Of course instead of price inflation, we got asset bubbles instead which caused their own headaches. This time around, we won’t have the same problem. People know that stocks and real estate aren’t special assets that can only increase in price.

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