The Day Ahead: "Down in Coupon" Shift in Progress
Loan pricing is set to improve by 12 to 25bps this morning after disappointing ADP Private Payrolls survey results.
The ADP Employment Report showed U.S. private payrolls increased by 38,000 private sector jobs in May. This was well below economists' expectations for a gain of 175,000 jobs and is the lowest print since September 2010. While this report is not the "be all, end all" in terms of jobs data, it does provide a preview of things to come this Friday when the BLS releases the official Employment Situation Report.
From the release: A deceleration in employment, while disappointing, is not entirely surprising. In the first quarter, GDP grew at only a 1.8% rate and only about 2¼% over the last four quarters. This is below most economists’ estimates of the economy’s potential growth rate and normally would be associated with very weak growth of employment. While employment in the service-providing sector rose by 48,000, marking 17 consecutive months of employment gains, employment in the goods-producing sector fell 10,000 following six months of increases. Manufacturing employment fell 9,000 in May following seven consecutive monthly gains. Employment in the construction industry dropped 8,000 in May, completely reversing April’s increase. The total decrease in construction employment since its peak in January 2007 is 2,124,000. Employment in the financial services sector decreased 6,000 in May.
Rate sheet influential" MBS coupon prices are up 5 to 8/32 and the benchmark 10yr note is testing psychological resistance at 3.00% as stock futures fall. S&Ps are -5.50 (0.41%) at 1338.50. Dow futures are down 48 points (0.38%) at 12,511.
A "down in coupon" shift is in progress after this report, but it will need to be confirmed by a poor Employment Situation Report on Friday before we start seeing lock desks hedge with 4.0 MBS coupons in size.
What does "Down in Coupon" mean?
Trading lower on the MBS coupon stack, i.e. going from a holding of 6.0s to 4.0s, or 4.5%s to 4.0%. The purpose of the trade in most instances is to buy a longer duration security to prosper as rates rally. That also infers a flatter yield curve, where longer maturities are gaining at a faster pace than shorter ones (10yrs outperforming 2yr notes for example). This trade reduces prepay risk as declining mortgage rates insinuate higher MBS coupons will be called out (prepaid) at par price. If you paid 102-00 and the coupon gets paid back at 100-00...you lose the premium you paid and the trade is upside down. Not good for your P&L!
This matters to loan originators because a "Down in Coupon" shift means increased investor demand for 4.0 MBS coupons, which makes it easier for lock desks to hedge loan pipelines with 4.0 coupons which in turn allows secondary to offer better pricing on mortgage rates below 4.625%. We could go as low as 4.25% before another shift "Down in Coupon" is needed to rally loan pricing further....
Key Events Today:
10:00 - The ISM Manufacturing Index slowed
for a second month in April to 60.4, its lowest since December. But
overall the reading was quite robust, marking the 21st month of
expansion in the sector with 17 of the 18 industries surveyed posting
gains. The May report is forecast to be considerably less optimistic -
the median estimate is 57 - but many point out any score above 55 is no
indication of weakness.
"The ISM manufacturing index should
falter in May as the manufacturing sector loses momentum," wrote
analysts at IHS Global Insight. "The expected May reading of 55.3 is
still healthy, just less ebullient than the boom-like readings of over
60 recorded for the first four months of 2011."
"It is difficult
to estimate the direct and knock-on impacts of the earthquake in Japan
and its drag on motor vehicle output, but that is at least a part of the
story," they added. "Vehicles and parts are about 6% of the
manufacturing sector (not even including the steel, glass, and plastics
used in their manufacture) so they can never be ignored."
Citigroup had a similar outlook.
"We
figure that the May ISM measure of manufacturing activity slipped
somewhat from readings that were among the highest in the past quarter
century," they wrote. "We figure the national index cannot sustain such
elevated levels. However, even with the expected retreat in May, the ISM
index probably remained at a buoyant level consistent with solid growth
of factory output."
10:00 - Predictions for Construction Spending could
hardly be more diffuse. While the so-called consensus expects a 0.4%
increase in April, estimates range from a 1.5% drop-off to a healthy 1%
gain. Some of the uncertainty relates to the previous report, where a
higher-than-expected 1.4% jump may have been "payback from
weather-related dips in prior months," as IHS Global Insight put it. The
public sector/private sector dynamic offers further uncertainty.
"Construction
spending will drop in April, mostly on a decline in residential
construction," said economists at IHS Global Insight, predicting a 0.5%
decrease overall. "Nonresidential construction, up two straight months,
may show a further small increase. With infrastructure spending
declining, a small decline in public construction is likely.
10:20 - John Williams, president of the San Francisco Fed, speaks on economics instruction to a conference on teaching economics and research.
12:25 - Sandra Pianalto, president of the Cleveland Fed, speaks on labor markets and monetary policy to the Columbus Metropolitan Club Forum.
12:30 - Fed Governor Daniel Tarullo speaks on U.S. and international financial regulatory reform to the Peterson Institute in Washington.
Treasury Auctions:
11:30 - 4-Week Bills
11:30 - 52-Week Bills