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Fed plans to reduce balance sheet this year



Volatility in the bond and mortgage markets is increasing recently. Yesterday the 10 yr note and across the entire yield curve interest rates declined 7 bps, and the 10 dropped to 2.18% -7 bps and MBS prices increased 33 bps. This morning with no additional news, the 10 yield, in very early trading, back to 2.21% +3 bps, MBS prices at 8:30 AM EST-17 bps from yesterday. This weekend the French elections are weighing on markets; the first of two with the run-off happening on May 7th. Two of the candidates are the focus, both saying they would change the relationship of France with the EU. The far right Le Pen and far left communist Jean-Luc Mélenchon; current betting in markets is that neither will win the second round, but we know how badly the UK Brexit vote turned out for those betting on a no vote. The track record for forecasting elections is not good. In recent head-to-head polls, Ms. Le Pen trailed conservative candidate and former Prime Minister François Fillon and Emmanuel Macron, a pro-EU centrist who was a French economy minister. Centrist Emmanuel Macron holds a narrow lead in the polls at 23%. Anti-euro candidate Marine Le Pen is close behind with 22.5%, and conservative candidate Francois Fillon polled at 19.5%. Communist-backed Jean-Luc Melenchon trailed at 19%.

Somewhat of a relaxing on the North Korean issue; this morning the WSJ reported that the US “armada” that was on its way toward North Korea hasn’t. The aircraft carrier USS Carl Vinson was thousands of miles away on exercises off the northwest coast of Australia. It isn’t expected to get to Korean Peninsula until sometime next week. The Trump administration was misleading with its tough talk and apparently hid the whereabouts of the carrier. Takes a little of the fear factor off the table for today.

The Fed, the ECB and the Bank of Japan’s balance sheets have grown to $13 trillion dollars since the 2008 financial crisis. Recently Fed officials have begun talking about when the Fed will start selling its portfolio, although so far it’s more to prepare markets for the eventuality and not imminent. When it begins, it will likely be small and will take years to get the Fed balance sheet back to $800B that it held before all of the QEs. It is inevitable that when the three banks begin unwinding it will pressure interest rates higher. The Fed accumulated almost one-quarter of the mortgage bonds sold by government-linked agencies over the last year. The first moves from the Fed will be to phase out the re-investments of pay-downs according to the Fed officials, namely Vice Chair Stanley Fischer a couple of days ago.

Weekly MBA mortgage applications declined; -1.8% for the composite, down 3.0% on purchases and refinances up 0.2%. Unadjusted, the purchase index also fell 3% from the prior week and was down 1% from the level in the same period last year. The refinance share of mortgage activity rose 0.8 percentage points from the previous week to 42.4%.

There are no economic data points today, but at 2:00 this afternoon the Fed will release its Beige Book, details from the 12 Fed districts.

Q1 GDP will be very weak, the third year when Q1 growth has been soft. The Fed and markets won’t pay it too much attention as it has become a pattern. That said, it is one-quarter of the year and will serve as a drag on the annual growth. Yesterday Christine Lagarde, IMF, said she expects the US economic growth this year at 2.5%; much lower than those lofty forecasts last year.

Source: TBWS

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