Morning Report: Markets await the Fed

Vital Statistics:

S&P futures3,77439.25
Oil (WTI)118.21-0.64
10 year government bond yield 3.37%
30 year fixed rate mortgage 6.06%

Stocks are higher this morning as we await the FOMC decision at 2:00 pm. Bonds and MBS are up.

The FOMC decision will be released at 2:00 pm today. The market is predicting a 75 basis point increase in the Fed Funds rate. One week ago, the market was certain that the Fed would hike 50 basis points, so we have had a pretty sizeable jump in expectations in a short period of time. We will also get a fresh set of economic projections as well as a new dot plot.

Volatility in global bond markets has made predicting the reaction to the Fed decision pretty much a fool’s errand. I suspect the dot plot will be the main thing traders focus on, with an eye to predicting whether the Fed moves 50 or 75 in June. Note that European sovereign yields are down hard this morning as the ECB has called an emergency meeting to discuss volatility.

Retail sales fell 0.3% in May, according to the Census Bureau. This was below consensus. April’s numbers were revised downward as well. Ex-vehicles and gas, retail sales rose 0.1%. Motor vehicles were a big drag on the numbers. That said, it looks like consumers are beginning to pull in their horns, which can be a either a blessing or a curse for the Fed. If the drop in spending cools off inflation, then we have a better chance for a soft landing. If not, then we are looking at stagflation all over again.

Mortgage applications rose 6.6% last week as purchases rose 8% and refis rose 4%. This was the first increase in apps in 5 weeks. “Mortgage rates followed Treasury yields up in response to higher-than-expected inflation and anticipation that the Federal Reserve will need to raise rates at a faster pace,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Despite the increase in rates, application activity rebounded following the Memorial Day holiday week but remained 0.29 percent below pre-holiday levels. With mortgage rates well above 5 percent, refinance activity continues to run more than 70 percent lower than last year.”

Separately, Wells Fargo’s CFO said at a conference yesterday that he expected Q2 mortgage banking income to be down about 50% from Q1.

The increase in mortgage rates this year has been the biggest since 1981. Between the increase in home prices and the rise in rates, the typical principal and interest portion of a mortgage is up big as well. This is cooling down the housing market, and Moody’s is predicting that home price appreciation will be flat over the next year, and some markets might see a drop in prices.

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