MBS OPEN: Inventories Account for 59% of GDP Gains. Rates Still Contained in Range

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Good Morning. Mortgage Rates will move higher today after economists got what they were expecting AND MORE from Advance Q4 GDP.

The market was expecting Q4 GDP to increase at a rate of 4.6%.

The actual print: +5.7%

  • Advance Q4 GDP +5.7 % (consensus +4.6), Q3 +2.2 %; final sales +2.2 % (cons +1.6), Q3 +1.5 %
  • Advance Q4 GDP deflator +0.6 % (cons +1.3) vs Q3 +0.4 %
  • Q4 PCE price index +2.7 % (cons +2.6), Q3 +2.6 %; core PCE +1.4 % (cons +1.3), Q3 +1.2 %
  • Q4 consumer spending +2.0 % (Q3 +2.8 %), durables -0.9 % (Q3 +20.4 %)
  • Q4 market-based PCE price index +2.7 % (Q3 +2.8 %), core +1.1 % (Q3 +1.2 %)
  • Q4 business investment +2.9 % (Q3 -5.9 %), equipment/software +13.3 % (Q3 +1.5 %)
  • Q4 home investment +5.7 % (Q3 +18.9 %), bus. Investment in structures -15.4 % (Q3 -18.4 %)
  • Q4 exports +18.1 % (Q3 +17.8 %), imports +10.5 % (Q3 +21.3 %)
  • Q4 GDP ex motor vehicles +5.2 % (Q3 +0.8 %)
  • Q4 year-on-year PCE price index +1.3 % (Q3 -0.7 %), core PCE +1.4 % (Q3 +1.3 %)

This was the largest quarterly increase in GDP since Q3 2003 when GDP moved 6.9% higher. While that is just great news (please note sarcasm), for 2009 overall GDP fell 2.4 %, this was the first annual decline since 1991 when GDP fell -0.2 % and the largest year over year decline since 1946. This further highlights the concept of economic improvements from record low levels of activity. Example: going from 1 to 2 is a 100% gain...

The table below summarizes the data.  I have one major observation to share:

In Q4, business inventories fell $33.5 billion.

When consumer demand is falling, like it has been over the course of the last two years, businesses cut back on production of goods to align their supply with consumer demand. This afffects the entire supply chain as purchase managers stop ordering the raw materials necessary to complete their finished product. This affects consumers in a few ways, the most obvious being LESS JOBS. Why?  When firms slow production, they need less labor to fill orders, so they stop hiring and cut hours and positions. The more businesses are cutting inventory, the worse it is for GDP. Once businesses stop cutting and start adding to inventories, it will be a big contributor to month over month percentage GDP gains.

In the 4th Quarter, business inventories only fell by $33 billion. Last quarter they fell by $139 billion. Less contraction in business inventories in Q4 added 3.39 percentage point to GDP change.

LESS CONTRACTION IN BUSINESS INVENTORIES ACCOUNTED FOR 59.5% OF GDP GAINS!!!!

Do not expect that metric to continue to add such large gains to GDP in the near future....Q1 2010 GDP will not be so friendly, and the market knows it.  However, if Obama can find a way to increase consumer demand (people need jobs), businesses will be ready to expand inventories, which will add to GDP and boost optimism and stock indexes down the road. This is not going to a quick process though, businesses will not start rebuilding inventories until the labor market and consumer spending outlooks improve. (How will enough jobs be created with productivity sky high and consumer demand apathetic? More stimulus???? Government jobs! This is the CHICKEN OR THE EGG DILEMMA)

 

Stripping out inventories, GDP increased at a rate of 2.3%. I have another observation. I highlighted BUSINESS INVESTMENT...check out the expansion in Equipment and Software. This is in line with my thoughts that businesses will be looking to replace some functions of human labor with automated systems. SOME JOBS WILL BE LOST FOREVER. If you are without a job you need to be educating yourself to manage the computer systems that will eventually replace physical labor positions. 

Also note, government spending fell in Q4.

This is the first read on Q4 GDP, there are still two more revisions ahead.

Both stocks and bonds haven't really reacted to the data. Buy the rumor, sell the news is the explanation. The market was expecting a warm GDP read, yes it was much better than expected, but the improvements were not a function of structural improvements in economic activity, they were a factor of LESS CONTRACTION...Q4 GDP WAS LESS BAD THAN Q3 GDP.

S&P futures are up 7.75 to 1087. In the chart below you can see that the market's reaction was muted. Remember 1087 is KEY PIVOT POINT...

 In the rates market, the knee jerk reaction was a clear SELL. However, bargain buying and short covering put a quick stop to that...now we wait and see how the stock lever treats the bond market. We do not want the S&P over 1087. The chart below is the 10yr TSY futures contract. Look at the volume spike at 830...

 In the cash market, the 3.375 coupon bearing 10 year Treasury note is -0-08 at 97-18 yielding 3.673%. Earlier this week I said if 10s break 3.68 that we would be issuing strong lock alerts. I am sticking to that guidance, especially if stocks start to rally, especially if youre getting closer to that 10 day "MUST LOCK BEFORE CLOSING" window. I see benchmark rates settling into a higher range between 3.58 to 3.81

3.68 is still holding at the moment...

In the mortgage market, the FN 4.0 is -0-03 at 97-18 yielding 4.232% and the FN 4.5 is -0-03 at 100-22 yielding 4.438%. The secondary market current coupon is 4.407%.

We are off the lows of the morning...check out how sideways we have been seen yesterday morning.

All markets are somewhat conflicted. We continue to see traders sell into strength and buy on dips. This is an indication of a RANGE BOUND market. This is an indication of mixed perceptions and unclear outlooks...market participants are WAITING FOR MORE GUIDANCE. Hmmmm...what's the next big event on the econ calendar?

NON FARM PAYROLLS NEXT FRIDAY....