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Monday’s MBS Update – Inflation Remains Elevated

Market Update

MBS Road Signs 8-16-21

Week of August 9, 2021, in Review
Inflation remains elevated at both the consumer and wholesale levels, while Initial, Continuing, and Pandemic Jobless Claims all showed nice declines.

Consumer inflation as measured by the Consumer Price Index (CPI) rose by 0.5% in July while the year-over-year reading remained at 5.4%, which is still the highest year-over-year increase in almost 13 years! Core CPI, which strips out volatile food and energy prices, rose 0.3%. Year over year, Core CPI did decrease from 4.5% to 4.3%, though it is coming off the hottest level in 29 years.

Wholesale inflation also moved higher per the Producer Price Index, which rose 1% in July and 7.8% on a year-over-year basis. The annual reading was up from 7.3% and much hotter than expectations. Core PPI was also hotter on an annual basis than economists had forecasted.

Inflation is critical to monitor because rising inflation can have a big impact on Mortgage Bonds and the home loan rates tied to them. See our important explanation about this below.

Initial Jobless Claims declined by 12,000 in the latest week, as the number of people filing for unemployment for the first time was reported at 375,000. The number of people continuing to receive regular benefits and pandemic-related benefits fell significantly as well. There are now 12 million people receiving benefits throughout all programs, which is a decrease of 920,000 from the previous report. This data does seem to reflect the impact of states that have already ended extended benefits.

On a related note, the JOLTS (Job Openings and Labor Turnover Survey) report showed that job openings were at a record high of 10 million in June while July’s National Federation of Independent Business (NFIB) Small Business Optimism survey showed that optimism moved lower due in part to the new COVID Delta variant, difficulty in filling positions, and higher prices.

However, according to the NFIB data, compensation plans, which can help affordability in housing, are near record highs. Businesses have been passing those costs on to the consumer, with sales price expectations just off a 40-year high. This type of inflation may be stickier and not transitory.

The New York Fed also released its Survey of Consumer Expectations for July, showing that inflation expectations were unchanged at 4.8%. Participants also expect home prices to rise by 6% in the upcoming year, while rents are expected to increase by nearly 10%. A key takeaway is that while both rents and home values are increasing, rents can continue to rise each year while a mortgage payment will remain the same unless you have an Adjustable Rate Mortgage. And while taxes and insurance can rise modestly, this is typically minuscule compared to rental increases.

Lastly, investors were closely watching Wednesday’s 10-year Treasury Note Auction and Thursday’s 30-year Bond Auction, which ended up having differing results. Find out more below.

Consumer Inflation Remains Elevated

The Consumer Price Index (CPI), which measures inflation on the consumer level, rose by 0.5% in July, which was in line with expectations. The year-over-year reading remained at 5.4%, which is still the highest year-over-year increase in almost 13 years.

Core CPI, which strips out volatile food and energy prices, was up 0.3% though this was slightly lower than the 0.4% increase expected. On a year-over-year basis, Core CPI decreased from 4.5% to 4.3%, coming off the hottest level in 29 years.

Within the report, rents rose 0.2% in July, increasing by only 1.9% on a year-over-year basis. However, it’s important to note that the CPI report is not, at least for now, capturing the increases we are seeing in rents that are being reported elsewhere.

For reference, the Apartment List showed that rents rose 2.5% in July and are up 11% just from January of this year. Plus, Zumper reported that rents rose 7% year over year in July for a one-bedroom and 9% for a two-bedroom, while single-family rental homes were up nearly 7% as well. We may see some catch-up in future months from CPI regarding rents but remember their reporting of this data is dragged down by their methodology.

Rising inflation is always important to note since inflation erodes a Bond’s fixed rate of return. In other words, rising inflation can cause Bonds to worsen or lose value. This includes Mortgage Bonds, to which home loan rates are inversely tied. When Mortgage Bonds move lower, be it due to rising inflation or other reasons, home loan rates can move higher. Though many factors influence the markets, inflation remains crucial to monitor in the months ahead.

Wholesale Inflation Hotter Than Expectations

The Producer Price Index, which measures inflation on the wholesale level, rose 1% in July and 7.8% on a year-over-year basis. The annual reading was up from 7.3% and much hotter than expectations.

Core PPI, which again strips out volatile food and energy prices, rose 1% in July and 6.2% on a year-over-year basis. This was also much hotter than expectations and up from the 5.6% annual reading in the previous report.

Though the PPI report is important, it can sometimes be overlooked because it measures wholesale inflation, which isn’t always passed down to consumers. But with the latest numbers coming in so hot, will the Fed be inclined to more quickly taper its purchases of Mortgage-Backed Securities and Treasures, which have been ongoing to help stabilize the markets?

Currently, 10 of the Federal Open Market Committee’s 18 members have now come out in favor of tapering, seven of whom are voting members. Whether this translates to actual votes in favor of tapering remains to be seen. We may get more clarity regarding what the Fed thinks about tapering and the timing for it at their Jackson Hole meeting on August 26-28.

Jobless Claims Continue to Decline

The number of people filing for unemployment for the first time fell by 12,000, as Initial Jobless Claims were reported at 375,000 in the latest week. California (+68K), Texas (+30K), and Illinois (+21K) reported the largest number of claims.

The number of people continuing to receive regular benefits was down 114,000, with Continuing Claims totaling 2.87 million and remaining under 3 million for the second week in a row.

Pandemic Unemployment Assistance Claims (which provide benefits to people who would not usually qualify) and Pandemic Emergency Claims (which extend benefits after regular benefits expire) also decreased by 730,000 combined.

All told, 12 million individuals are still receiving benefits throughout all programs. This is a decrease of 920,000 from the previous report. It’s likely these figures will continue to improve once September comes and all of the extended benefits expire.

On a related note, the JOLTS (Job Openings and Labor Turnover Survey) report showed that job openings were at a record high of 10 million in June. Though the JOLTS report is for June while weekly claims are more real-time, it will be important to see if the number of job openings and jobless claims both declines in the coming months and especially come September once all states will be removing extra benefits. This could potentially alleviate some of the compensation pressures noted above that businesses are facing if so.

Auctions Have Mixed Results

Investors were closely watching Wednesday’s 10-year Treasury Note Auction and Thursday’s 30-year Bond Auction to see the level of demand. High demand, which is reflected in the purchasing of Bonds and Treasuries, can push prices higher and yields or rates lower.

Weak demand, on the other hand, can signal that investors think yields will continue to move higher, which can have a negative effect on rates.

Wednesday’s 10-year Treasury Note Auction was met with above-average demand. The bid to cover 2.65 was higher than the one-year average of 2.40. Direct and indirect bidders took 90.3% of the auction compared to 77.5% in the previous 12.

However, Thursday’s 30-year Bond Auction was met with below-average demand. The bid to cover 2.21 was below the one-year average of 2.30. Direct and indirect bidders took 81.7% of the auction compared to 79.6% in the previous 12.

Family Hack of the Week

Back to school season is here. These tips from our friends at Good Housekeeping will help you stay organized for the new year.

A shared calendar app can help you keep everyone’s schedules straight while keeping track of key details like addresses, notes, and directions. Consider also using a dry erase board for posting everyone’s big events for the week as well, which can be helpful at a glance during especially busy mornings.

Make mealtime easy by planning ahead for the week. A decorative chalkboard in your kitchen is a great way to list each night’s menu and you can invite your kids to post their ideas or requests as well. Noting when someone will be out for the evening will also help with shopping and planning.

Use an over the seat holder in your car to stash breakfast bars, snacks, tissues, and other items that may come in handy in the drop-off line on days you’re running late. Other premade kits that may be helpful to store in your car include a tech kit for chargers and batteries, a first-aid kit with the basic essentials, and a school supply kit. And speaking of kits, save yourself any last-minute trips to the store during the year by keeping a school supply stash at home complete with markers, poster board, index cards, and more.

What to Look for This Week

This week’s calendar contains key reports across a wide spectrum of the U.S. economy. We’ll get news regarding regional manufacturing in August, first on Monday with the Empire State Index, followed by the Philadelphia Fed Index on Thursday.

Tuesday brings the latest news on Retail Sales for July, as well as an update on builder confidence in August via the National Association of Home Builders Housing Market Index.

More housing news follows when July’s Housing Starts and Building Permits are reported on Wednesday. Plus, the minutes from the Fed’s July meeting will be released and there will be a 20-year Bond Auction, and both of these have the potential to move the markets.

On Thursday, look for the latest Jobless Claims figures when they are reported, as usual.

Technical Picture

Mortgage Bonds ended the week above their 50-day Moving Average, which will now act as support. The next ceiling is at the 101.45 Fibonacci level. The 10-year ended the week trading at 1.28% after declining sharply Friday. Yields have broken beneath their 200-day Moving Average at 1.30% and are testing their 25-day Moving Average.

 

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