The Day Ahead: Bonds Rally Ahead of Housing Starts, PPI, FOMC Minutes

The benchmark 10-year Treasury note yield rose one basis points to 3.62% on Tuesday. Treasuries weakened in early overnight trading amid light volume but are bouncing back this morning. The 10 year note is currently +3/32 at 100-09 yielding 3.593% and the FNCL 4.5 MBS coupon is +4/32 at 101-03.

Equity futures are pointing upwards this morning following a minor sell-off Tuesday and ahead of another packed schedule of macroeconomic data.  S&P 500 futures are up 5.75 points to 1,332.00, extending the 5.6% year-to-date gain, while Dow futures are trading 33 points higher at 12,235.

Commodity prices are mixed. Light crude oil is 0.69% higher at $84.90 per barrel. Gold prices are 0.12% lower at $1,372.50 per ounce, and natural gas prices are 0.33% lower at $3.963 per MMBtu.

Just in, the MBA Mortgage Applications report showed volume fell 9.5% in the week ending Feb 11.

Refinancings decreased 11.4% to the lowest level since early July 3, while purchases slid 5.9% and are 18.2% lower than the same week one year ago.

Michael Fratantoni from MBA continued to blame higher mortgage rates, as the average contract interest rate for 30-year mortgage was 5.12% in the period. 

“Mortgage rates remained above 5% last week, up almost a full percentage point from their October lows, and refinance volume continued to drop,” he said. “Applications for home purchases also declined on a seasonally adjusted basis. Buyers have not returned to the market as rising rates have reduced affordability.”

The report shows “just how sensitive borrowers are to higher mortgage rates and why the Fed will likely complete its current QE program,” said economists from BMO Capital Markets.

Key Events Today:

8:30 ― Look for Housing Starts to improve in January, economists say. The consensus is for the annualized pace of new construction to rise to 540k from 529k, a decent advance after the index shed 4.3% in December. Cold weather hurt the December index and will likely play a role in January too. 

Beyond the headline, the two main components need to be looked at closely given their volatility: in the last index, single-family starts fell 9.0% while multi-family starts jumped 17.9%. Housing Permits, which offer a forward-looking assessment, were similarly inconsistent ― single-family permits increased 5.5% and multi-family permits jumped 53.5%.

In contrast to the consensus, economists at BMO believe snowstorms will pull the index down for a second straight month, to 520,000 units.

“This would be the third lowest level on record and less than half the rate of long-run household formation,” they wrote. “Thankfully, residential construction accounts for a record-low 2.2% of GDP, so the decline will have little impact on Q1 growth, which we currently peg at 3.8% annualized.”

Economists at IHS Global Insight are more pessimistic and expect housing starts to fall to 499k. 

“Permits jumped 15% in December, but pending building code changes in three states ― New York, Pennsylvania and New Jersey ― were responsible for the surge,” they wrote. “A payback should follow in January, when we expect permits to dive 17%.”

8:30 ― Energy prices continue to cause high inflation in the monthly Producer Price Index. The last two indexes yielded jumps of 1.1% (Dec) and 0.8% (Nov), while January prices are anticipated to grow 0.7%. Energy prices rushed forward by 3.7% and 2.1% in the prior two indexes. Core inflation, which excludes volatile energy and food prices, continues to be rather tame: the January index is expected to be 0.2%, the same at in December and lower than November’s 0.3% uptick.

“Energy ― up over 3% again ― will be the bane of the producer price index for the fourth consecutive month, and push overall prices up by 0.9% in January,” predicted economists at IHS Global Insight. “We expect to see some pass-through of higher materials costs pushing up core prices by 0.3%, rather than the 0.2% increase in December. Food prices should also rise, though the steep increases in commodities like wheat, corn and soybeans are only gradually filtering through to the finished goods PPI.”

9:15 ― Industrial Production ended 2010 with a bang: the index rose 0.8% in December, the highest since July, and annual output was +5.7% ― the strongest performance in over a decade. January is anticipated to be less dramatic but still positive. Economists look for a 0.5% increase, with predictions ranging from -0.8% to +0.7%. Utility output played a big role in the December advance as it jumped 4.3%. It’s unlikely to climb as much in January, but storms across the county should keep utility usage positive.

“Rising output of business machinery and automobiles should provide support, while utilities output was probably stoked by the coldest January in 23 years,” said economists at BMO Capital Markets. “Rising production could lift the capacity utilization rate to 76.6%, the highest since August 2008. However, that’s still less than the presumed inflation-safe norm of 81%, suggesting plenty of inflation-dampening slack remains in the industrial space.”

10:00 ― Timothy Geithner, secretary of the Treasury, testifies before the Senate Finance Committee on the 2012 budget. He speaks at 2pm before the House Budget Committee.

2:00 ― FOMC Minutes from the first meeting in 2011 could of interest to Fed-watchers because the committee lineup changed, but markets were content to ignore the report when it came out and will likely pay little attention to details released here. The statement from the meeting contained few changes save for an economic upgrade, and not one of the voters dissented.

Economists at Nomura said the minutes will look stale next to Ben Bernanke’s congressional speech on Feb 9. Still, they said two items could be of importance.

“First, they will contain updates of the Fed's forecasts,” they wrote. “Forecasts for the unemployment rate may still be high because they will have incorporated only the 0.4 percentage point decline to 9.4% in December. However, we expect that the central tendency for 2011 GDP growth will move up 0.25-0.50pp. 

“Second, the minutes will likely contain detailed discussion of communication options, such as inflation targeting and post-meeting press conferences. We suspect the committee may be moving forward on the latter, but other communication changes will remain under discussion for now.”

No Treasury auctions today, but the Fed is scheduled to buy $1.5-2.5 billion of Treasury bonds dated May 2021 to November 2027 at 11:00 am.