Housing starts fell 6.5% in May to a seasonally adjusted annual pace of 1.001 million, the Commerce Department said Tuesday. That marked the first decline in four months and was bigger than the 3.7% drop forecast by economists; building permits, an indicator of future construction, fell 6.4% in May to 991,000 on a sharp decline the volatile multifamily segment. Single-family permits jumped 3.7% to 619,000, their fastest rate of increase since September 2012. Single-family construction represents the bulk of the housing market and is considered a better gauge of underlying demand. The housing sector is still not where it should be for added economic growth, but it is slowly showing a little life still in the sector. The National Association of Home Builders' confidence index yesterday, rose in June for the first time this year. But it reflected builders' continued concern with a lack of demand for new housing. The index rose to 49, just below the 50 level which indicates more builders generally see conditions as good rather than not so good.
In yesterday’s afternoon report I noted two data points at 8:30 the housing starts and permits and May CPI. My comment then was that the CPI was not much concern; based on the report this morning I could not have been more wrong. The CPI index was expected to be up 0.2% to +0.3%, as reported it jumped to +0.4%; the core (excluding food and energy) was thought to be up 0.2%, it increased 0.3%. That was the fastest increase since February 2013 and came after prices rose 0.3% in April and 0.2% in March. Yr/yr CPI +2.1%, and yr/yr core CPI +2.0%. The reaction ahead of tomorrow’s FOMC policy statement took the 10 yr note yield up 3 bps points to 2.64% and MBS prices down 14 bps. The Fed’s favorite measure of inflation is the PCE price index that usually mirrors the CPI in the long run but does deviate a lot of times. Markets’ concerns that the Fed may be closer to increasing rates if inflation holds at or slightly above the Fed’s 2.5% target. The report today surprised traders and investors. The IMF yesterday forecast that inflation will run below the Fed's 2% target through 2017 and urged the central bank to keep its policy rate pinned near zero for longer than investors expect.
The situation in Iraq is escalating rapidly. Radical Sunni fighters are being aided by local tribes who reject the Islamists' extreme ideology but sympathize with their goal of ousting the Shiite-led government in Baghdad. The Sunni faction now controls about a third of Iraq. The US is said to be sending troops to Baghdad to defend the US embassy, and talks are continuing with Iran to repel the Sunnis. Iran has deployed forces to aid its Shiite ally. The UN encouraging the Iraq prime minister to start political negotiations with rival ethnic and religious groups with the aim of creating a national governing alliance. The main issue is Sunnis and Kurds say they have been isolated by the Shiite government. A lot of concern that oil prices could increase and choke of consumer spending as energy costs would sap consumer’s ability to increase discretionary spending. Last Thursday when this situation boiled up crude oil increased about $2.00/barrel; since then though crude has not increased, this morning the price is actually lower than yesterday.
The DJIA opened -42 at 9:30, NASDAQ -8, S&P -4; 10 yr note 2.63% +3 bp and 30 yr MBS price -11 bps frm yesterday’s close and -5 bps frm 9:30 yesterday.
Nothing left on the plate for today; the FOMC meeting is now underway but until tomorrow at 2:00 we won’t know anything about the decisions. The recent increase in inflation readings are having an impact today in the early trade in stocks and bonds. The debate now is how will the Fed phrase its comments regarding increasing interest rates; will the Fed signal a quicker target for increasing the FF rate? The Fed will continue to taper another $10B as it removes its support for the long end of the curve and mortgage rates. As we noted yesterday, we don’t believe the tapering is having much impact on treasuries and MBSs these days.
The 10 is testing a couple of key technicals; the down trend line and the 100 day average are in the spot light for us today. 2.65% is a level that has to be held a breach above it would alter the near term outlook. As previously noted; the 10 is in a neutral condition presently. Most of our models are turning more negative. The recent data indicating an increase in inflation may change the Fed’s plans to increase rates sooner than is currently thought (2015).