While investors await the FOMC rate decision and forecasts this afternoon we received the latest inflation information in the form of November CPI this morning. To be frank, inflation is taking a back seat right now to other factors in driving Fed policy so the report’s importance is a little less than is typical, but it still warrants close inspection. For the month, inflation increased 0.3% (actually 0.258%) versus 0.2% expected but that was down from the 0.4% (actually 0.356%) pop in October. More importantly, core inflation (less food and energy) increased 0.2% which matched both forecasts and the prior month. On a year-over-year basis, inflation was 2.1% versus 1.8% the prior month while core was 2.3%, matching expectations and October’s print. The 3-month annualized average for core is 2.1% versus 2.2% in October and 2.8% in September so the trend in core is decidedly lower. Meanwhile, core PCE (the Fed’s preferred inflation measure) lags behind at 1.6% YoY, and that allows the Fed to remain on the sidelines well into 2020 as they await possible trade deals, impeachment proceedings, Brexit and other uncertainties. As for what we expect from the Fed today, read on below.
- Like everyone else we expect the FOMC to leave the fed funds rate unchanged while the real drama will come from the updated economic and rate forecasts. The economic piece is not likely to change much from the September numbers that had 2019 GDP at 2.2%, and 2020 at 2.0% with a long-run rate of 1.9%. Unemployment may come in for some downward tweaking to acknowledge the latest results, but that’s not likely to impact trading direction. Finally, core inflation may also come in for a downward tweak in a nod to the current level of 1.6% core PCE versus the forecast of 1.8%. Again, this is not likely to alter trading direction or ranges but speaks to the docile inflation picture and the room it gives the Fed to be exceedingly patient in 2020.
- The rate forecast, however, will be what everyone looks to first but here we don’t expect much alteration from the September forecast either. Recall, the September dot plot had 2020 year-end fed funds at 1.875% (1.75%-2.00% range). Compared to our current range of 1.50%-1.75% that would imply one rate hike at some point in 2020. The Fed could very easily retain that outlook, or it could adjust it lower to match the current level and imply a Fed in pause mode for all of 2020.
- The fed funds futures market is projecting a year-end 2020 rate of 1.33%, which implies one rate cut at some point in 2020. Given the strength of the November jobs report, however, many Fed members may feel less inclined to project rate cuts at today’s meeting. With the aforementioned geo-political uncertainties still clouding the picture, the projected moderation in GDP, and tame inflation, telegraphing no-change next year is our most likely scenario.
- What we don’t expect to see is a projection that matches fed funds futures at 1.33%, nor do we see them striking a more aggressive hiking posture either. Given the docile inflation readings and moderating growth, the Fed probably sees little upside in projecting hikes today. The trauma that last December’s rate hike had on markets is no doubt fresh on their minds. Thus, think of it like this: the bar to rate cuts is pretty low while the bar for rate hikes is pretty high. In any event, we’ll be back later this afternoon with a recap of the FOMC rate decision and forecasts.
30yr MBS Yield Spreads to Treasuries Near Multi-Year High
We’ve been highlighting various MBS product in the last couple months as Treasury yields remain range bound and look to stay that way for the foreseeable future. In the typical universe of bank investments, longer-duration MBS product provides some of the best yields versus competing securities and we have seen a definite increase in purchases recently.
Today, we thought we would look at the market from 30,000 feet rather than get cusip-level specific to show the value is more sector than product specific. The graph illustrates the current coupon FNMA 30yr MBS versus a blend of 5yr and 10yr Treasuries that should closely align with the duration of the 30yr MBS pool. As shown, the yield spread is near a multi-year high against the Treasury blend. The spread widening began in the second quarter of 2019 and that has contributed to the increased interest in longer-duration MBS pools.
If you’ve been considering adding some duration to your portfolio in order to improve yields and lessen an asset-sensitive AL position, you may want to consider longer-duration MBS pools given the spread widening in 2019. If you have an interest please contact your CenterState Bank representative to explore your options further.
Agency Indications — FNMA / FHLMC Callable Rates
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