- Partial US/Mexico NAFTA deal may be close
- FOMC minutes are slightly dovish
- US new home sales expected to recover from 8-month low
- U.S. home prices expected to march higher
- 5-year TIPS auction to yield near 0.72%
Partial US/Mexico NAFTA deal may be close — The stock market saw some temporary strength late Tuesday when Politico reported that the Trump administration as early as Thursday could announce a handshake deal on a bilateral trade agreement between the U.S. and Mexico. Commerce Secretary Wilbur Ross on Wednesday then said “We’re making progress. We don’t have a deal just yet, but I think a deal is very likely within reach in the very, very near future.” A U.S. Trade Representative Office spokesperson on Wednesday said that there was no deal yet and that major issues remain.
The U.S. stock market will obviously be pleased if the U.S. and Mexico can reach a NAFTA deal since that would reduce the threat of a complete blow-up of NAFTA, which would create major export and supply chain disruptions for U.S. companies. However, the U.S. has excluded Canada from the NAFTA negotiations in recent weeks with the apparent goal of getting the more pliant Mexico to agree to a deal first and then trying to strong-arm Canada into agreeing to the same concessions as Mexico. Progress by the U.S. and Mexico towards a NAFTA deal would be a big step forward, but the NAFTA renegotiation won’t be over until Canada agrees or until the Trump administration formally ends NAFTA and seeks separate trade deals with Mexico and Canada.
Elsewhere on the trade front, the U.S. and China today will wrap up two days of mid-level trade talks. Unless the talks produce a breakthrough, the U.S. today will implement a 25% tariff on $16 billion of Chinese goods and China will retaliate in kind. The U.S. this week is also holding hearings on the Trump administration’s plan to implement 10-25% tariffs on another $200 billion of Chinese products after the public comment period is over on Sep 6.
FOMC minutes are slightly dovish — The federal funds futures curve on Wednesday showed a slightly dovish shift by 1-2 bp for the 2019-2021 contracts on the release of the July 31-Aug 1 FOMC minutes. The minutes were mostly in line with market expectations but a dovish factor was that the FOMC said it plans to remove its reference to an “accommodative” policy “fairly soon.” That suggested that the FOMC believes the funds rate is getting closer to the neutral rate.
On the monetary policy front, the markets will be closely watching developments at the Fed’s Jackson Hole conference that begins today. The headline event will be Fed Chair Powell’s speech on Friday titled “Monetary policy in a Changing Economy.” The markets will be watching the Jackson Hole conference for issues such as (1) the Fed’s neutral rate and how far the Fed will raise interest rates in this cycle, (2) the risks to the economy from trade tensions and the emerging markets, (3) the Fed’s ultimate balance sheet reduction goals, and (4) the outlook for wages and inflation, among many other issues.
The market is currently discounting a 100% chance of another 25 bp rate hike at the next FOMC meeting on Sep 25-26. The market is then expecting an unchanged policy at the following meeting on Nov 7-8 and then a 77% chance of the fourth rate hike of the year at the Dec 18-19 meeting.
US new home sales expected to recover from 8-month low — The market consensus is for today’s July new home sales report to show a +2.2% increase to 645,000, recovering somewhat after June’s -5.3% drop in an 8-month low of 631,000. New home sales in June were down by a total of -11% from last November’s 10-3/4 year high of 712,000. Yesterday’s July existing sales report of -0.7% to a 2-1/2 year low of 5.34 million units was weaker than expectations of +0.4% and did not bode well for today’s new home sales report.
U.S. home sales have recently fallen due to the limited supply of homes available for sale and some resistance to high home prices. In addition, the current 30-year mortgage rate of 4.53% is up by +60 bp since late-2017, thus making homes much less affordable. Indeed, the NAR Housing Affordability index in June fell to a 10-year low of 134.8, illustrating that homes are the least affordable in a decade.
U.S. home prices expected to march higher — The market consensus for today’s June FHFA house price index is for an increase of +0.3% m/m, a little stronger than May’s increase of +0.2% m/m. The FHFA home price index is sharply higher by +6.5% y/y and has risen by a total of +47% from the housing-bust trough. U.S. home prices have risen on strong demand and tight supplies. However, home prices may start to moderate through summer and autumn due to the recent fall-off in home sales. Potential homebuyers are apparently becoming more cautious due to rising mortgage rates, high home prices, and the decline in home affordability to a 10-year low.
5-year TIPS auction to yield near 0.72% — The Treasury today will sell $14 billion of 5-year TIPS in the first reopening of April’s 5/8% 5-year TIPS of April 2023. The 5-year TIPS yield in the past three weeks has eased by -15 bp to the current level of 0.72% from the 8-3/4 year high of 0.87% posted on Aug 1. However, the 5-year TIPS is still about 70 bp higher than the near-zero levels seen in late 2017 before the passage of the massive tax cut bill sparked expectations for stronger economic growth, higher inflation, and an accelerated Fed rate-hike regime.
The 12-auction averages for the 5-year TIPS are as follows: 2.48 bid cover ratio, $44 million in non-competitive bids to mostly retail investors, 5.6 bp tail to the median yield, 16.1 bp tail to the low yield, and 36% taken at the high yield. The 5-year TIPS is very popular among foreign investors and central banks with indirect bidders taking an average of 66.4% of the last twelve 5-year TIPS auctions, well above the median of 62.9% for all recent Treasury coupon auctions.
