The Daily Tearsheet

Stocks are flattish this morning after a strong ADP report and an inflation reading that wasn’t as bad as feared. Bonds and MBS are still down regardless as the sentiment in the bond market remains putrid. Note that today is the end of the quarter so we might see some weirdness towards the close on window dressing.

Personal incomes rose 0.2% MOM while personal consumption expenditures (i.e. spending) rose 0.9%. The all-important PCE Price Index (the Fed’s preferred inflation measure) rose 0.3% MOM and 3.4% YOY. The core rate, which excludes food and energy, increased 0.2% MOM and 3.0% YOY. This numbers were below Street expectations, but still well above the Fed’s target rate. Still, it looks like inflation is at least flat, and the rate hikes haven’t even begun to take effect yet.

The private sector added 90,000 jobs in September according to the ADP Employment Report. “It’s a strong report. After a three-month slowdown, job creation rebounded and pay growth remained solid.” Education / Health Services accounted for 55k, followed by leisure / hospitality at 22k. Financial activities declined as did professional / business services. The 90k increase is higher than the Street estimate for 75k private payrolls in Friday’s report.

Job openings fell by 258k last month to come in just above 7 million. We saw big declines in professional / business services and healthcare / social assistance. Trade / Transportation / Utilities saw an increase.

Home prices rose 1.9% YOY in July according to the Case-Shiller Home Price Index. Again we saw a wide divergence between MSAs with Chicago leading the pack (up 6.9% YOY) and Seattle (down 1.6%) bringing up the rear. New York and Cleveland also were top gainers.

“While home prices continued to decline in real terms in July 2026, marking the 14th consecutive month of real declines, slightly lower inflation and stronger nominal home price appreciation helped narrow the gap,” said Rebecca Kaufman, Associate Director of Commodities at S&P Dow Jones Indices. “In July 2026, the S&P CoreLogic Case-Shiller National Home Price Index posted a 1.9% annual gain, up from 1.6% in June. During the same period, consumer prices posted a 3.4% annual gain, down slightly from 3.5% in June.

“Although inflation remained elevated at 3.4%, much of the increase was concentrated in energy, with energy and gasoline prices rising 14.7% and 24.6%, respectively,” Kaufman concluded. “By contrast, core inflation, which excludes food and energy, rose only 2.5% year over year. This distinction is important because persistent inflation in shelter and other core categories tends to have a more direct impact on housing affordability than energy-driven price fluctuations.”

It is interesting that home price appreciation is lagging inflation but shelter inflation remains a big driver of overall inflation.

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Consumer confidence declined in September according to the Conference Board Consumer Confidence Index. “The Consumer Confidence Index deteriorated notably in September, following two prior months of softening,” said Dana M Peterson, Chief Economist, The Conference Board. “The Present Situation Index fell sharply, while the Expectations Index slipped further into negative territory. Consumer appraisals of current business conditions became negative for the first time since September 2024. Perceptions of the current labor market also worsened, though remained within positive territory. Over the next six months, consumers expected both business conditions and the labor market to weaken. Consumers still anticipated their household incomes to rise, but less so compared to previous months.”

As usual, higher gasoline prices are driving the decline. “Consumers’ write-in responses regarding factors affecting the economy were mostly pessimistic in September. References to prices, the high cost of goods and services, and oil and gas prices in particular, rose to new heights, reflecting September’s surge in fuel costs. Comments about war/conflict eased this month but remained elevated. Consumers also frequently cited politics, trade, and employment in their write-in responses, though to a lesser extent.”

Year-ahead inflation expectations increased to 6.1%. This is definitely out of step with UMich expectations and market-based indicators like Treasury Inflation Protected Securities (TIPS). The 5-year breakeven inflation rate for TIPS has been in a narrow range of 2.2% to 2.6% for the past several years. Unfortunately, 5-year is the shortest maturity for TIPs.

Mortgage applications fell 6% last week as purchases fell 4% and refis fell 9%. Rising rates drove the decrease. “Mortgage rates jumped to their highest level in almost three years, pushing borrowers to the sidelines. The 30-year fixed rate increased for the sixth consecutive week to 7.3%, the highest rate since November 2023,” said Joel Kan, CMB, MBA’s Vice President and Deputy Chief Economist. “Mortgage applications fell by 6% due to the recent surge in rates, with purchase and refinance applications both declining to their slowest weekly pace since 2025. Government refinances declined 13%, with both FHA and VA applications experiencing double digit decreases over the week.

Stocks are higher this morning as oil prices stabilize and bonds find a level. Bonds and MBS are up small.

We are coming up on the end of the quarter, where asset allocators begin to make adjustments for the upcoming quarter. We could see some swings in the bond market over the next couple of days which will be exacerbated by the PCE report tomorrow.

Mideast oil exports are picking up as shippers become better at avoiding Iranian drones and other pipelines pick up the slack. Current Middle Eastern oil shipments are running around 80% of pre-war levels. Daily volume was 13MM barrels per day, which is much higher than the roughly 7.5MM / day we saw during the summer. So things are improving despite a stalemate on the hostilities side.

Delinquencies ticked up 14 basis points last month to 3.53% according to the ICE First Look. This is up 10 basis points on a YOY basis, but is still well below pre-pandemic levels. The seriously delinquent rate remained at 1.04% or about 574,000 homes.

Foreclosure starts ticked down 6%, but are up 29% YOY. Foreclosure inventory build was only 2,000 units to 89,000 units which is still up 41% YOY. Foreclosure volumes were depressed due to COVID-era restrictions, but are returning to more normal levels. The current foreclosure percent (0.54%) is more or less where we were in February 2020.

__________________________

The MBA Annual conference in Chicago is rapidly approaching. Are you looking to hedge a pipeline of non-QM loans or your servicing portfolio? CME Group lists SOFR futures including Eris SOFR Swap futures and are an excellent way to manage this risk. Plus, with the rollout of Eris Options this past summer, you have even more tools to tailor your strategy. Talk to John Douglas at john.douglas@erisfutures.com to book a meeting.

In addition, Eris Innovations will also have a cocktail hour on Monday afternoon. Space is limited. Please reach out to john.douglas@erisfutures be placed on the guest list.

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MBA CEO Bob Broeksmit laid out three ways the government could improve housing affordability. First, he says that FHFA could direct Fan and Fred to lower their LLPAs overall or do something for first time homebuyers. Note I wrote an article advocating just that earlier this year. He argued that the GSEs are charging too much in g-fees for the amount of risk they are taking.

“Housing is too big a part of the economy for it to flounder, and there are things we can do immediately to rejuvenate it,” Broeksmit stated.

He started with the guarantee fees and the loan-level price adjustments from the GSEs, both of which he categorized as “too high.”

“If you look at their quarterly profits and you look at the credit quality of the loans they close, there’s a big mismatch between the price they’re exacting and the risk they’re taking,” Broeksmit said.

“You could do that with an across-the-board change to LLPAs,” Broeksmit noted. “You could do it targeted to first-time home buyers, you could do it to certain loan amounts. You could turn it into a closing cost credit. There are myriad ways to do this.”

I like the idea of a LLPA adjustment targeted to first time homebuyers because it won’t just push up prices across the board which defeats the purpose.

He also said that FHA could lower its insurance premium as well and there could be something done on credit scores.

Stocks are lower as we head into the final week of the third quarter. Bonds and MBS are down. Again, this is not a US-centric phenomenon – global sovereign yields are up across the board.

The week ahead will contain a couple big reports, with the personal incomes and outlays report on the 30th which will contain the all-important PCE Price Index. The jobs report will come out on Friday. We will also get ISM data and home prices, the final estimate for Q2 GDP and consumer confidence.

The street is looking for a 0.2% MOM increase in the headline PCE Price Index and the core. The headline YOY PCE Price Index is expected to rise 3.7% while the core is expected to increase 3.3%.

For the jobs report, the street expects 162k jobs with the unemployment rate to remain unchanged at 4.1%.

Consumer sentiment fell in September according to the University of Michigan Consumer Sentiment Survey. This is the lowest reading in 4 months and is 15% lower than January. Deteriorating expectations for the future drove the decrease. Year-ahead inflation expectations increased from 4.0% to 4.6% while longer-term expectations rose from 3.3% to 3.4%.

Given that unemployment is sitting at 4.1% (a level that would have been unheard of in the 70s, 80s and most of the 1990s) consumers shouldn’t be so dour. What is the driver? Gasoline prices. Below I charted UMich sentiment versus gas prices. The blue line is sentiment while the green line (right axis) is gasoline. This is a very strong negative correlation. In other words, gas prices rise and consumers get surly.

Cleveland Fed President Beth Hammack said that inflation risks are tilted to the upside at an event on Friday. “Current ​conditions in the United States ​indicate that output is growing at a solid pace and the ​labor market remains close ​to my definition of maximum employment, but ‌inflation ⁠remains elevated,” Hammack said in comments opening a conference at her bank. “The inflation outlook ​continues ​to be ⁠highly uncertain, with risks tilted to the ​upside” and “the longer that ​high ⁠inflation persists, the more challenging and costly it can ⁠be ​to bring it ​back down,” she said.

“The longer that high inflation persists, the more challenging and costly it can be to bring it back down,” said the Federal Open Market Committee voting member. “Because monetary policy affects the economy with long and variable lags, we need a reliable way to separate temporary moves in inflation from changes that are more persistent.”

She also said that the recent sell-off in the bond market does not reflect a loss of confidence in the Fed.

China and the US agreed to cut tariffs on some $30 billion of goods. China gets relief on toys and Christmas decorations (good timing) while the US gets relief on agricultural goods.

Stocks are higher this morning as the bond vigilantes take a day off. Bonds and MBS are up.

Bonds got slammed again yesterday, with the 10 year yield pushing above 5.2%. Mortgage rates rose 11 basis points according to the Optimal Blue Mortgage Market Index. Generally speaking mortgage rates will lag the move in Treasuries, however that will become less tenable as bond market volatility increases. And yes, bond market volatility is increasing:

We are approaching the levels seen when the Iran War began. Again, this is a global phenomenon, not something that is US-centric. All of the major central banks are in tightening mode although the US has a higher inflation problem than most. But it also has higher growth. It feels like a lot of the action is oil-driven and if that is the case things will adjust. There are a lot of wells out there that were drilled when oil prices were in the 120-150 range that can be re-opened. That supply will come back on line the longer prices stay elevated. As they say in the commodities market: the cure for high prices is high prices.

That said, bond market cycles are long. The last cycle in the bond market began in the early 1980s when Paul Volcker was tightening to defeat 1970s inflation. It ended around 2021 when ultra-low interest rates began causing inflation. It feels like we are in a secular bear market in bonds that might last decades. That said even in secular bear markets, there will be opportunities.

What can borrowers / loan officers do? If you think this is temporary, then adjustable rate mortgages offer a way to lower the rate initially. I am not making investment advice, but Trump will be gone in just over two years. A new administration will almost certainly get rid of the tariffs, mend fences with our trading partners and find an off-ramp in the war with Iran. Things could look a lot different in a few years. The Fed might cause a recession, which will push rates lower. That said, the structural issues of deficit spending will not. So it isn’t a slam-dunk but it is something to consider.

New Home Sales rose 6.4% MOM to a seasonally-adjusted annual rate of 684,000 units. This is down 2.8% compared to a year ago. We have seen all of the homebuilders report a tough market out there, with resellers competing against new construction and tightening margins as builders throw in more amenities to entice buyers.

The median new home price rose 0.4% MOM and fell 5.8% YOY to $393,700. New home prices remain well below existing home prices as builders focus on smaller homes. There were 483,000 unsold units at the end of August, representing a 8.5 month supply.

This is the tough phase of the cycle for the builders. We are in late stages of a boom where the Fed is raising rates to quell inflation. Builders are early-stage cyclicals which perform best coming out of a recession. In this phase of the cycle, it is the time to make a shopping list of the defensives you want to buy when the music stops.

Stocks are lower this morning after bonds got crushed yesterday. Bonds and MBS are down.

There wasn’t any real catalyst that I saw for the bond market sell-off yesterday. The business press will attribute it to hawkish Fed comments from Barr or oil prices or economic strength because they have to cite something. It really wasn’t anything in particular. The global bond vigilantes who have been dormant since the mid-90s are back and they are running the show.

Fed Governor Mike Barr said: “In my base case, further policy adjustments are likely to be needed to ensure inflation comes down to target in a timely fashion,” he said. “We want to support sustainable, durable growth in support of maximum employment, and price stability is crucial to that.”

Note again it was global, with UK Gilts, German Bunds and Japanese Government Bonds all getting slammed. The JGB now yields 3.08%, which is up 101 basis points from the beginning of the year. The US 10 year and the JGB have taken the brunt of the abuse but it has been a bloodbath for sovereign yields this year.

The Fed Funds futures now see a rate hike in October and December as the base case scenario for the rest of the year. The June 2027 FF futures see a base case of 4.5% – 5% for the Fed funds rate.

At some point the US stock market will start paying attention – there is an old market saw that says “don’t fight the Fed.” The more time rates spend up at these levels the more the stock market is vulnerable to a sell-off. The stock market and the economy were able to take the 2022 tightening cycle in stride, but that isn’t necessarily a given this time around. The yield curve was much flatter then, and long-term bond yields were lower than today. Just something to keep in mind.

Business growth surged to its fastest pace in 5 years according to the S&P flash PMI. This is the fastest pace since 2021 during the COVID rebound.

The report suggests that growth is around 5%, which is consistent with the Atlanta Fed’s GDP Now Model. So we have a slew of estimates for Q3 ranging from the mid 2s to the high 5s.

The increase in growth is putting pressure on supply chains and prices however:

“However, this growth is being accompanied by some of the most severe supply chain bottlenecks seen in the near-two-decade survey history if the pandemic is excluded, with companies also reporting increasing problems finding suitable staff. Backlogs of work are consequently rising sharply. While this accumulation of uncompleted orders bodes well for the further expansion of output and capacity in the coming months, it also indicates that companies are developing more pricing power, and hence is a worry for the inflation outlook.

“Firms’ input costs have meanwhile jumped in September at the steepest rate for four years, with fuel and transport costs spiking higher thanks to the rise in oil prices seen during the month, which will add further to the upward pressure on selling prices and inflation in the coming months.”

Stocks are flattish this morning despite a drop in oil prices. Bonds and MBS are down.

Boston Fed President Susan Collins sees more rate hikes ahead: “Given all the available information, I now see an increased likelihood of future scenarios in which inflation remains notably above 2 percent. While the upside risks to inflation have increased, labor market conditions seem a bit stronger overall, and the unemployment rate remains low – though I recognize that experiences vary considerably by place and sector. With the labor market on a better footing, monetary policy can focus on a timely return to price stability, especially after five and a half years of too high inflation. A somewhat more restrictive federal funds rate will help ensure that inflation durably returns to target.”

Richmond Fed President Tom Barkin said that tariff and oil shocks are not the short-term impacts the Fed initially thought they were and he sees the potential for further hikes: “There was an argument that inflation would return to target on its own, without any additional help from the Fed,” Barkin said in a speech in Baltimore. “One problem with that argument, of course, is that the ‘passing’ shocks aren’t proving to be short-lived, or one-off events.”

“These may pass in time, but I do expect it will take time,” said Barkin. “In the interim, there is a risk that current elevated levels of inflation could affect future inflation… With inflation more than a percentage point above target, that’s a problem.”

Mortgage applications fell 1.5% last week as purchases fell 1% and refis fell 3%. “Mortgage rates vaulted higher last week, with the 30-year fixed rate at 7.12%– the highest level since May 2024. With fixed rates much higher, more borrowers opted for ARMs, with the ARM share reaching 9.8%, as rates for 5/1 ARMs were more than a percentage point lower than those for fixed rate loans,” said Mike Fratantoni, MBA’s SVP and Chief Economist. “Applications for both refinance and purchase loans declined further last week, noting that the comparison is to the week that included the Labor Day holiday. With this week’s decline, the pace of refinancing fell to its slowest pace since February 2025.”

Homebuilder KB Home reported Q3 earnings that missed Street expectations. Revenues fell 20% YOY to $1.3 billion as deliveries decreased 19%. Gross margins fell from 18.2% to 16.5% and earnings per share fell 35% to $1.05.

“We are operating in a housing market that continues to be challenging, with conditions weakening since our June earnings report. Higher mortgage interest rates have further pressured affordability and, together with geopolitical uncertainty and broader economic headwinds, have caused many prospective buyers to be more cautious on purchasing a home,” said Jeffrey Mezger, Executive Chairman.

KB Home is moving towards a more build-to-order model which should help reduce the amount of inventory it needs to carry. The company noted on the conference call that the resale market is competing with newer homes. In other words, customers are taking delivery and selling the home, which can’t help selling prices for the newer homes. This is primarily a Texas and Florida problem. Average selling prices were flat on a YOY basis.

Overall the builders are struggling which is par for the course for this phase in the economic cycle.

Stocks are flattish this morning as oil and bond yields fall. Bonds and MBS are up.

Oil is dropping as investors hope for a diplomatic solution to the Iranian blockade of the Strait of Hormuz. Iranian President Masoud Pezeshkian is set to fly to NY for a meeting at the UN.

Economic growth decreased in August according to the Chicago Fed National Activity Index. Production and sales indicators pulled down the index while consumption and employment indicators were contributors. The CFNAI index showed the economy more or less growing on trend, which is another data point suggesting the Atlanta Fed’s GDP Now model has an issue.

Chicago Fed President Austan Goolsbee spoke in London yesterday, discussing how the Fed’s thinking has changed regarding supply shocks. The conventional wisdom has been to “look through” supply shocks but the Fed considers that inapplicable in the current situation.

Historically supply shocks were thought to cause a temporary spike in inflation as prices rise and then fall back. Aside from the Arab oil embargoes of the 1970s, most supply shocks like strikes or weather proved to be temporary blips and chasing a temporary blip with something with a long lag like monetary policy was usually the wrong move. By the time monetary policy changes began to affect the economy (usually 6-9 months) the shock was in the rear view mirror.

This is why the Fed has resisted raising rates to tariffs and the Iran war for so long. The tariffs were declared unconstitutional and had a limited time span. The Iran War was supposed to be a short-term event, and even if it stuck around longer than expected, oil companies would increase production to take advantage of the higher prices.

So far that isn’t happening, and high diesel prices (which are a refining issue, not a crude oil issue) push up prices all over. Inflation is still stubbornly high and so far there is no indication it is coming back down. While supply-driven inflation is easier to tame than demand-driven inflation it cannot be ignored and that is Goolsbee’s message.

FHFA Director Bill Pulte said that Fannie Mae and Freddie Mac will be buying “large quantities” of MBS. The GSEs are authorized to buy up to $200 billion in order to help address affordability.

The unemployment rate is 4.1%, which is super low on a historical basis. Inflation is higher than the Fed’s 2% target, but it isn’t anywhere near the high single digits rate of 2022 or the normal rates we saw in the 70s and 80s. So why is consumer sentiment so low?

Note that consumer sentiment is worse than it was during the depths of the Great Recession, or the high inflation late 1970s. Empirically economic conditions are much, much better today. So what gives? Gasoline prices are playing a part, but Goldman says that happiness in general is much lower, and that is being driven by collapsing trust in institutions.

The Misery Index (unemployment plus inflation) was coined in the 1970s as a way to measure the economy’s comfort level. Note that the misery index today is much lower than it was back then.

I suspect social media algorithms are playing a part here. People interact with content that makes them angry and social media is flooded with nonsense rage bait like this:

400 grand is the new minimum wage, I guess. The point is that social media is flooded with posts like this which retcon history in order to make you mad (and vote socialist). The point is that consumer sentiment indicators have become less useful as a predictor for spending.

Stocks are higher this morning on no real news. Bonds and MBS are up.

The week ahead won’t have much in the way of market-moving economic data. We will have new home sales and a bunch of second-tier economic news like durable goods and consumer sentiment. We will also have a lot of Fed speakers. Earnings wise, we get homebuilder KB Home on Tuesday.

The Index of Leading Economic Indicators fell in August according to the Conference Board. The index ticked down marginally by 0.1%. Market-based indicators like stock market returns and interest rates were the positive contributors while economic ones pulled it back.

“The US LEI receded slightly in August, the first monthly decline since March of this year,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “Four out of ten components fell compared to the previous month, with consumer expectations remaining a significant strain on the Index. Building permits also declined on a monthly basis, with decreases in both single- and multi-unit categories and across nearly all regions. The West was the only exception, recording a small increase in total permits. Due to the latest decline, the LEI’s six-month growth rate turned back to slightly negative, suggesting a less certain economic environment ahead. The economy is still expanding, but growth is expected to slow. The Conference Board forecasts real GDP to increase at a 1.9% rate in 2026, with our outlook for 2027 downwardly revised from 1.9% to 1.8%.”

It is surprising to see a tepid LEI while the Atlanta Fed GDP Now model is predicting 5.1% growth for Q3.

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Industrial production was unchanged in August according to the Federal Reserve. Manufacturing production fell 0.3%. Capacity Utilization was flat at 76.3%.

Stocks are higher this morning on no real news. Bonds and MBS are flat.

Pending Home Sales fell 0.3% MOM and 4.7% YOY in August according to the National Association of Realtors. All regions declined YOY, while the South and West increased on a MOM basis. Pending sales fell in the Midwest and Northeast due to limited inventory. Prices rose the most in those regions as the hip-to-be-square trade continues.

“Buyers steadily entered into contracts in August even though mortgage rates increased,” said NAR Chief Economist Dr. Lawrence Yun. “However, the housing market is still sluggish, with contract signings below last year. This is due to higher mortgage rates offsetting the increased buying power created by job gains and income growth outpacing home price growth.”

“Nationally, contract signings today are running roughly 30% below where they were in the years leading up to the pandemic,” Yun added. “Transaction activity peaked in 2021 when mortgage rates fell to near 3%, a historic low, and has not approached that level since.”

Homebuilder Lennar held their earnings call yesterday, and CEO Stuart Miller said a lot of what we already know: that interest rates are going the wrong way and inflationary headwinds are probably not ending soon.

While market conditions are certainly not terrible, as can be seen from our rather strong volume, the market becomes more difficult as interest rates test affordability, particularly within our price ranges. During our third quarter, interest rates moved in the wrong direction. At our last call, the 30-year fixed rate was sitting between 6.4% and 6.5%. Today, it is at approximately 7% with the 10-year treasury hovering right around 5%. So the modest relief we saw earlier in the year has reversed and the buyer at median family income is stretching well past 30% of gross income to carry a home.

While this was clearly the hope of some, yesterday’s rate hike clearly demonstrates that the Fed will continue to be data-driven. Rate cuts when they eventually come, will be a meaningful tailwind for our business, but we are not holding our breath. We’re waiting for them, and we are not building our business plan around those rate cuts. Fourth, the resale seller has become a more aggressive competitor for our customer, especially at our price range. Resale supply has continued to rebuild and is now very competitive in price. Active listings nationally are back above historic levels. In Texas and in Florida, they are particularly high. Those are our 2 largest markets and states.

When a resale seller cuts price, they are competing directly for our customer, and we respond, which is a meaningful part of the incentive and pricing dynamic you see in our South Central and Southeast markets. On the cost side of our world, while we continue to perform extremely well, labor availability has started to become more of an issue. Immigration enforcement and enthusiastic data center construction continue to create tightness in certain geographies. While we’ve been able to offset labor cost increases with efficiencies from scale, the pressure on cost is certainly building.

The comments about labor supply are interesting. We have seen a shortage of skilled labor in the construction sector and the big data center building isn’t helping matters. Since Lennar’s biggest markets are Florida and Texas, it makes sense that immigration enforcement would have an impact. Further on in the call, they mentioned immigration enforcement as a local, somewhat sporadic issue. The big issue is data centers.

The comment about active listings is mainly about Texas. Florida is also an issue, but listings are down from a couple years ago. Nationally, listings are rising, but they aren’t really at pre-pandemic levels. And as the pending home sales data shows, just because a home is listed, it doesn’t mean people are buying.

Overnight the Bank of Japan raised interest rates 25 basis points to 1.25%. Ever since the 1990s, the “yen carry trade” has been a constant in the background of global finance, and it will have an impact on the US.

After the Japanese real estate bubble burst, most of the banks in Japan were insolvent if you marked their portfolios to market. Given Japan’s culture, forcing bankruptcies of zombie companies was not an option, so banks were forced to support their borrowers even if they couldn’t pay. Naturally, a banking system cannot do that for long, so the government came up with an idea. It let the Japanese banks borrow from the Bank of Japan at 0% interest rates and invest that money in overseas assets that paid a decent return. Historically that was US Treasuries. The government would control the currency and the banks would build their capital back slowly over time and hopefully would become solvent without having to put any of their borrowers through bankruptcy.

It succeeded. While there were a few banks that didn’t make it (Yamaichi Securities) most of Japan Inc was able to muddle through. Fast forward to today, that trade is unwinding. The Japanese economy is no longer in a deflationary environment after spending a lot of time in one.

Remember how painful 2009-2010 was in the US? Japan spent decades in that environment.

As Japanese banks unwind the yen carry trade, they will sell US Treasuries, buy Japanese government bonds and sell dollars to buy yen. This will be another force pushing up long term Treasury yields and push down the dollar, making Japanese goods more expensive in the US. So the net effect at the margin will be higher yields and higher inflation.

Granted Japan doesn’t move fast and this will probably play out over a decade or so, but a tailwind for the US economy: a stronger dollar and demand for US Treasuries is losing steam and will reverse.

Stocks are higher this morning after the Fed raised rates. Bonds and MBS are up small.

As expected, the Fed raised the Fed Funds rate by a quarter point and telegraphed more hikes ahead. The vote was unanimous. The bond market had been battered in the leadup to the meeting, so there wasn’t any reaction to the actual rate hike, though stocks sold off. They are clawing back their losses this morning though.

The Fed’s estimate for 2026 GDP growth was bumped up 10 bp from 2.2% to 2.3%, while the unemployment rate estimate was taken down from 4.3% to 4.1%. Headline PCE estimates were taken up from 3.6% to 3.7% and the core estimate rose to 3.4% from 3.3%.

The dot plot shows the Fed sees another rate hike this year, and possibly one more in early 2027. The June plot is on the left, and September is on the right. Note that only two voters saw this as a one-and-done event. So plan on a December hike as well as the base case.

I would also point out the last column, which represents r-star. We still see the same range of estimates (generally 3%-4%) however more people are seeing the possibility that r-star is higher. This will be something to watch, as it implies home base for the Fed Funds rate might be closer to 3.5% than 3.25%. Kevin Warsh voted to raise rates, but also symbolically did not contribute to the dot plot. It is clear that Warsh would like less guidance out of the Fed and the dot plot’s days are probably numbered. The dot plot was a Janet Yellen idea when the country was fighting deflation and wanted to tell the Street that the Fed would keep rates low for a long time in order to encourage growth. Those days are over, and the dot plot will probably be discontinued at some point.

The October Fed Funds futures see a 55% chance of another rate hike to 4% while the December futures are pricing in a 40% chance of another hike to 4.25%.

Mortgage rates inched up on the Fed decision, but again the rate hike was kind of priced in over the past several weeks. The Optimal Blue Mortgage Market Index shows the 30 year above 7%, and while that might seem high, rates have been much higher before. This isn’t going to kill the housing industry the way the doomers think it will. A little historical perspective on mortgage rates:

Predictably, Trump blasted the decision, saying Warsh is in a tough place and the FOMC is a bunch of politicians. He said that the Fed Funds rate should be closer to 1%.

Separately, the Bank of England did not participate in the rate hike party with the ECB and the Fed and maintained rates at current levels. Global sovereign debt yields are down a touch in response.

Yesterday’s retail sales number prompted the Atlanta Fed to take up its estimate for Q3 GDP growth in its GDP Now Model. It sees a whopping 5.1% growth rate for the quarter, driven by higher consumption numbers. Despite the overall bad vibes about the economy, consumers are still opening their wallets.

Homebuilder sentiment fell last month as rising rates keep buyers on the sideline. The index fell to 32 from 35, hitting the worst level in a year. “Buyer traffic has weakened across much of the country, largely because of rising mortgage rates,” said NAHB Chairman Bill Owens, a home builder and remodeler from Worthington, Ohio. “Builders also continue to face higher material costs, rising gas and diesel prices and persistent labor shortages. In some markets, builders report that increased immigration enforcement is discouraging legal workers from reporting to job sites.”

The part about immigration enforcement is interesting. I guess a lot of construction workers might have outstanding warrants or maybe child support obligations and want to minimize contact with the government.

Homebuilder Lennar reported earnings yesterday, which missed Street estimates. Homebuilding revenues fell 6%, while gross margins fell to 15.8%. Average selling prices fell to $372,000 from $383,000 a year ago. Lennar attributed the decrease to weakness in the market, not product mix. This is consistent with the lower gross margins – Customers are balking so Lennar is increasing incentives to make sales. The stock is down a buck or so pre-open.

The homebuilding sector is the classic early cyclical. It struggles in environments like the current one, where the Fed is raising rates to cool down an overheating economy. It performs best coming out of a recession – the builders are usually the first green shoots in Spring – because rates are being cut.