The Day Ahead: CPI, Industrial Production, Builder Confidence, TIC Flows

The bond market had another bad day yesterday following a strong read on Retail Sales and an improved outlook from the small business sector.  Treasuries were however seen as cheap in the aftermath and a recovery rally unfolded in the overnight session.  The 10 year note is currently +17/32 at 93-15 yielding 3.405% (vs. 3.50% high). The FNCL 4.5 MBS coupon is +7/32 at 101-15+.

Global equity indexes traded lower as news from Europe dampened the optimistic mood from earlier in the week. The Shanghai Composite was -0.54%. The Hang Seng -1.95%. The NIKKEI -0.07%. BMO Capital Markets blamed the downturn in stocks this morning to developments in Europe. Moody’s warned that Spain faces a potential downgrade Aa1, while in Greece, a nationwide strike against austerity measures has halted public transportation and schools, and left flights grounded for 24 hours. Also, Japan’s Tankan survey, a manufacturing index, fell for the first time in almost two years.

Seventy minutes before the opening bell, S&P futures are 2.75 points lower at 1,234.25 and Dow futures are 34 points lower at 11,387.

Commodity prices are also heading downwards, with light crude oil down 0.93% to $87.45 per barrel, and gold prices down 0.25% at $1,392.15 per ounce.

In the U.S., the just-released MBA Mortgage Applications index showed application volume fell 2.3% in the week ending Dec. 10. Refinancings fell 0.7% in the week, marking the fifth straight decline, while purchase broke a three-week streak and shed 5.0% from one week earlier. 

Michael Fratantoni from MBA said the results were not surprising.

“With rates up more than half a percentage point over the past month, refinance activity has declined sharply,” he said. “Home purchase applications dropped this week following three weeks of increases, but remain near levels last seen in early May.”

He also noted that mortgage rates reached their highest level in more than six months as Treasury rates rose following news that Bush-era tax rates could be extended for another two years. 

The average rate for a 30-year fixed-rate mortgage increased to 4.84% from 4.66%.

Key Events Today:

8:25 ― Dennis Lockhart, president of the Atlanta Fed, speaks on Atlanta regional issues before the Midtown Alliance Annual Meeting.

8:30 ― The Consumer Price Index has been showing annual price changes at 1.1% to 1.2% for the past five months, while core prices are at just +0.6% ― the lowest level in 54 years of data. In November, monthly prices are set to gain 0.2% for the headline, the same pace as October, and 0.1.% for the core, which follows three flat months. Annual price gains are once again anticipated to be 1.1% for the headline and 0.6% for the core, levels that encourage the Fed to continue its QE2 program.

“We expect deflationary pressures to remain in the short- and mid-term,” said economists at BBVA. They noted that the gain in headline prices last month was driven by energy prices ― the rise in gasoline costs accounted for almost 90% of the increase.

Analysts at Nomura said the most important component of the core index to watch will be rent costs.

“In our view, available data suggest rent inflation has begun to pickup after a multi-year slump,” they wrote. “Given their large share (40%), an acceleration in rents could be enough to halt the decline in core inflation.”

8:30 ― The Empire State Manufacturing Survey, the first regional manufacturing report to be released each month, is anticipated to see a major leap forward to 5.0 in December, up from a contractionary -11.1 in November. The reversal is based on the view that the prior month’s plunge must have been a quirk ― the index fell from +15.7 to -11.1, its  weakest reading in 20 months and the biggest one-month decline ever recorded for the index. 

“We expect (and hope) this was a temporary drop, and forecast that the index will rise back to +5.0 for December,” said economists at Nomura. “Another weak reading would raise concerns about the ISM outlook.”

9:00 ― TIC Flows, a measure of what financial instruments are flowing in and out of the U.S., showed net cap inflows of $81 billion in September, with foreign purchases of Treasuries totaling $78.3 billion.  

Predictions for the October report were not available, but economists at Nomura released this note:

“In September, private foreign inflows into US capital markets were relatively weak ― less than half the volume of July and August. We expect private inflows to recover this month. The dollar started to recover during the month, and fund flow data showed a pickup in purchases of US bonds and equities. Separately, Fed custody data points to an improvement in foreign official inflows as well.”

9:15 ― Industrial Production was flat in October as a decline in utilities output offset a solid gain in manufacturing production. The Federal Reserve said warmer weather was the cause of reduced utilities output, so with weather back to normal economists are looking for a 0.3% gain in November. 

“Last month, industrial production was unchanged due to weather-related distortions, but manufacturing production was quite healthy,” said economists at Nomura. “This month, those weather effects should fade and the underlying heath in the manufacturing sector should show through. We look for particularly strong growth in auto production, given available production figures from the major manufacturers. Even stronger growth looks unlikely given the decline in manufacturing employment, the weaker manufacturing ISM, and a decline in electricity output during the month.”

Analysts at IHS Global Insight the electricity component should increase in November after a series of negative prints, while motor vehicle production will fall down after a sequence of strong months. 

“Core manufacturing probably had an average month as hours worked were anemic, but solid productivity growth allows output to rise faster than hours,” they said.

10:00 ― The NAHB’s measure of homebuilder sentiment, the Housing Market Index, is expected to remain stagnant at 16 in November after two months of single-point gains. Any score below 50 indicates pessimism, and while the current score is several points higher than summer levels, it is still below the pre-credit crisis all-time low. It is also below the 17 registered in November 2009. 

“The housing market has started to show some hints of improvement ― e.g., an increase in pending home sales and the week purchase application index ― but homebuilder sentiment remains extremely low,” said economists at Nomura. “We think the index could rise slightly this month as builders see more reason for optimism. We are forecasting a gain to 17 from 16, but see some upside risk to this figure.”

10:15 ― Fed buys $6-8 billion in Treasuries maturing between 12/31/14 and 05/31/16