Morning Report: The next test for the Fed

Vital Statistics:

 LastChange
S&P futures4,1720.8
Oil (WTI)61.04-1.17
10 year government bond yield 1.57%
30 year fixed rate mortgage 3.14%

Stocks are flattish this morning as we head into Fed week and the meat of earnings season. Bonds and MBS are down small.

Flagstar Bank reached a deal to be acquired by New York Community Bank in an all-stock merger. Based on Friday’s closing prices, the deal is a 6% premium, which isn’t massive. It sounds like the rationale for this merger is not the typical cost-cutting one since there is no overlap of branches. It look like more of a strategic deal where NYCB wants to transition away from its roots as a thrift bank and add commercial banking heft. Lee M Smith of Flagstar will continue to run the mortgage operations, so it sounds like NYCB envisions keeping everything there. NYCB stock is up pre-open so it looks like the Street likes the deal.

The week ahead will have quite a bit of economic data with GDP on Thursday and Personal Incomes / Personal Spending on Friday. We will also have the FOMC meeting on Tuesday and Wednesday. No changes in policy are expected, however if the statement is unusually positive on the economy, bond prices could be vulnerable.

The next test for the Fed will be introducing the idea of returning to a more normal policy. The Fed wants to avoid a repeat of the “taper tantrum” when it made its first attempt to get off the zero bound. In the statement from the March meeting, it said that it wanted to see “substantial progress” towards full employment, and if you look at the employment-population ratio, it gives you kind of an idea what they need to see.

Pre-COVID, the employment-population ratio was 61.1% and it is now 57.8%. To get back to that level, we need to see about 11 million more jobs created. Given that inflation was still below the Fed’s target rate at that level, I think we have to assume that they are probably targeting that level again before they even think about increasing rates (or perhaps even tapering). I think the Fed feels like they were too aggressive last time around and will be less fearful of an inflationary surge. FWIW, CPI inflation was routinely in the 3% – 4% range during the mid- 1980s and 1990s, and most of us remember that period as pretty comfortable economically.

Durable Goods orders rose 0.5% in March, following a 0.9% decline in February. This was below the Street consensus of a 1.5% gain. Core Capital Goods orders (which are a good proxy for business capital expenditures) actually fell by 4.7% (excluding national defense). Inventory build was also minimal, which was another surprise.

The Biden Admin signed a mortgage relief bill that helps delinquent borrowers with their taxes and insurance bills. It will be distributed to states based on their unemployment rates.

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