Market Interest Rates Change

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Prior to 8:15 the 10 yr was +8/32 at 2.12% -3 bps; US stock indexes were slightly weaker. At 8:15 ADP reported private job growth in May increased by 135K, the consensus estimate was +170K; April private jobs were revised lower, to 113K frm 119K. It was all in the service sector increasing 135K, construction gained 5K jobs, financial services +7K, manufacturing lost 6K. Small businesses added 57K jobs. The initial reaction improved the bond market, the 10 yr at 8:30 +13/32 at 2.11% -4 bps, 30 yr 3.5 FNMA MBSs struggling at 8:30 up 14 bp---not much as the MBS market remains more bearish than treasuries. At 8:30 Q1 productivity was in line with forecasts, +0.5% however unit labor costs declined 4.3%on forecasts of +0.5%. In Europe this morning the German bund yield declined 3 bps to 1.51% after hitting 1.57% on Monday, the highest rate since late February. Gross domestic product in the euro area fell 0.2% in the first quarter, while separate reports showed retail sales in the region fell in April and services shrank last month. All of Europe’s stock markets were weaker today on continued concerns the region is still struggling to grow. Dallas Fed President Richard Fisher talking about the end of QE yesterday. He focused a comment on the MBS purchases the Fed is doing; “It would be prudent to dial back the rate of purchases we are making in mortgage-backed securities” now that “the housing market is in a good state, construction has started again, housing prices are appreciating significantly.” It isn’t news that the Markets are actively talking about the Fed ending its QEs; most believe when the time comes it will be a slow unwinding. When will the Fed actually begin stepping aside? The question of the year so far. When is totally data dependent over the next couple of months, recent measurements of the state of the economy are inconclusive; housing markets better but manufacturing still struggling as evidenced by the ISM data on Monday, unemployment still high. As months pass it is becoming more clear that the Fed’s QEs are not doing the job the Fed was expecting. At 9:30 the DJIA opened -44, NASDAQ -13, S&P -5. 10 yr note at 2.11% -4 bp while 30 yr MBS price up just 7 bp on 3.5 coupons and +19 bp on 3.0 coupons. More data at 10:00; April factory orders expected up 1.5% increased just 1.0% and March orders revised to -4.7% frm 4.0%. The May ISM services sector index was fractionally better than expected at 53.7 53.2. The interior components, new orders at 56.0 frm 54.5 in March but employment index fell to 50.1 from 52.0; the employment component in January was 57 and has been slipping since. More weaker than expected data on employment may cause traders to lower their expectations for job growth in Friday’s employment report. The market reaction to the weaker data improved the level of decline in the stock indexes and didn’t cause any immediate improvement in the bond and mortgage markets. As previously noted, the stock market is taking any data---good or bad---as a positive. Weak economic data keeps the Fed in play, strong data implies the economy is improving. We should be seeing better bond and mortgage prices frm prior to 10:00 but that hasn’t occurred, fortifying the view that bearishness in the bond market remains very high. Over the last week we have recommended floating unless the 3.5 FNMA coupon for June closes under 103.00; yesterday the price closed right on 103.00. This morning so far it is holding but I am not impressed with it at the moment; what to do? Likely if the MBS markets do hold and improve frm here it will not begin until the May employment report is released on Friday, and the report has to be softer than what is presently expected (178K private jobs). The ADP weaker this morning than what was expected, unfortunately we can’t make much of it as the differences between ADP and the BLS data usually are a lot different. The BLS data trumps the ADP every time. Last month ADP said 119K private jobs, the BLS reported 176K private jobs. The bond and mortgage markets are overdue for some kind of correction but that has been the case for almost two weeks and the selling has continued. Unless the markets find support on the May employment report on Friday we then would expect the 10 yr to move to 2.25% and mortgage rates will increase more.