Morning Report: The yield curve inverts

Vital Statistics:

S&P futures3,833-1.55
Oil (WTI)99.580.14
10 year government bond yield 2.76%
30 year fixed rate mortgage 5.61%

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

The yield curve inverted yesterday afternoon and remains so this morning, with the 2s-10s spread at -2 basis points. An inverted yield curve is usually an early warning sign for a recession. Given the Fed’s aggressive path for rates, we are probably headed for one. The big question lies around the labor market. So far we aren’t seeing any major uptick in initial jobless claims. If that holds, then we might manage to avoid one.

As I discussed yesterday, the unofficial definition of a recession – two consecutive quarters of negative GDP growth – is not used by the government. The NBER basically has discretion to declare one is occurring. Since the labor market is so strong, they probably will avoid declaring one.

Note that the German Bund yielded 1.52% at the end of June and is now trading at 1.1%. This is a big decline in just a week as investors are fearing a recession in Europe. The Euro – dollar spot rate is almost back to parity, something we haven’t seen in over 20 years. Not all sovereign yields are down – the Japanese government bond yield is up to 25 basis points, however British Gilts are down about 30 bps over the past week. While the economies of Europe, the US and Japan are in different phases, sovereign debt markets do generally correlate. This is part of what is pushing down yields in the US.

The Fed Funds futures are becoming a touch less hawkish. Compared to a week ago, the central tendency for the end of the year has decreased by 25 basis points to a range of 3.25% – 3.5%. This is still much higher than a month ago, when the central tendency was 2.75% – 3.0%.

The current handicapping is another 75 basis points at the end of July meeting, 50 basis points in September, then 25 in November and December. That is still a lot of tightening to go, and since the Fed Funds rate tends to impact the economy with a 9 month lag or so we haven’t even begun to feel the impact of the rate hikes we have already seen.

Mortgage applications fell by 5.4% last week as purchases fell 4% and refis fell 8%. There was an adjustment for the early close on July 1, so that is probably affecting the numbers somewhat. The refi index is down 78% from a year ago, and the share of refis has fallen below 30%.

“Mortgage rates decreased for the second week in a row, as growing concerns over an economic slowdown and increased recessionary risks kept Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Mortgage rates have increased sharply thus far in 2022 but have fallen 24 basis points over the past two weeks, with the 30-year fixed rate at 5.74 percent. Rates are still significantly higher than they were a year ago, which is why applications for home purchases and refinances remain depressed. Purchase activity is hamstrung by ongoing affordability challenges and low inventory, and homeowners still have reduced incentive to apply for a refinance.”

The service economy rose in June, according to the ISM Services Index. This reading was above expectations, but lower than May’s numbers. It looks like the prices index fell for the second straight month, which is welcome news on inflation. Here is what one retailer had to say: “Consumers are shifting purchases away from our discretionary products to essentials. Inflation is definitely taking a bite from our sales, and mall traffic is far below the norm, potentially due to inflation, a need for more disposable income on essentials and less willingness to drive to malls. E-commerce sales will be going up again.” [Retail Trade]

Another indication the economy is slowing: job openings are decreasing. Job opening fell by 427k to 11.3 million. The quits rate inched down to 2.8% from 2.9%. The quits rate tends to be a leading indicator for wage gains.

Morning Report: Atlanta Fed GDP Now Index sees negative growth in Q2

Vital Statistics:

S&P futures3,777-49.55
Oil (WTI)106.44-1.94
10 year government bond yield 2.82%
30 year fixed rate mortgage 5.66%

Stocks are lower this morning as investors fret about growth going forward. Bonds and MBS are up again.

The big event this week will be the jobs report on Friday. The Street is looking for 270,000 jobs and for unemployment to remain at 3.6%. We will also get the ISM Services Report which will be a bellwether for the state of the economy.

The data last week has pushed the Atlanta Fed’s GDP Now forecast to -2.1%. This would mean negative GDP growth for the first half of 2022.

This would typically mean we are in a recession. That said, the government and the chattering classes are pushing back against that definition. The government changed the definition of a recession from 2 consecutive quarters of negative GDP growth to something more subjective: “In general usage, the word recession connotes a marked slippage in economic activity. While gross domestic product (GDP) is the broadest measure of economic activity, the often-cited identification of a recession with two consecutive quarters of negative GDP growth is not an official designation. The designation of a recession is the province of a committee of experts at the National Bureau of Economic Research (NBER), a private non-profit research organization that focuses on understanding the U.S. economy.” 

What this means is that even if we get a negative GDP print in the second quarter, the government and the business press will insist we are not in a recession. They will use the low unemployment rate as the reason. That said, the National Bureau of Economic Research generally gets around to calling something a recession after it is over.

Regardless of whether the government determines we are in a recession or not, the yield curve is definitely giving clues that we are headed towards one. The slope of the yield curve (i.e. the difference between short term rates and long term rates) is often a pretty solid indicator of an impending recession. Here is a chart of 2s-10s going back to the 1970s:

The shaded lines indicate an official NBER recession. You could make the argument that this indicator has lost value in a QE world, and you would be 100% correct. That said, the indicator is flashing a warning sign for growth.

The problem for the Fed is that interest rates are still highly negative on an inflation-adjusted basis. The Consumer Price index is running over 8% and the PCE Index is running at a 4.7% rate ex-food and energy. So, even though the Fed is being aggressive in hiking rates, overall monetary policy remains highly accommodative.

Morning Report: The manufacturing economy is weakening

Vital Statistics:

S&P futures3,780-9.75
Oil (WTI)108.64-0.94
10 year government bond yield 2.88%
30 year fixed rate mortgage 5.79%

Stocks are lower this morning as we kick off the third quarter. Bonds and MBS are up. The first half of the year was the worst for the S&P 500 since 1970.

The bond market closes early today at 2:00 pm. Liquidity should be lousy as most of the street will be on the LIE by noon.

The Fed Funds futures are beginning to handicap some chance of a 50 basis point hike at the Fed meeting this month. The current futures contracts imply a 28% chance of 50 bps and a 72% chance of 75.

The manufacturing economy decelerated in June according to the ISM Manufacturing Index. This is the lowest ISM reading since June 2020. New Orders and Employment contracted, which indicates that the economy is slowing down.

“The U.S. manufacturing sector continues to be powered — though less so in June — by demand while held back by supply chain constraints. Despite the Employment Index contracting in May and June, companies improved their progress on addressing moderate-term labor shortages at all tiers of the supply chain, according to Business Survey Committee respondents’ comments. Panelists reported lower rates of quits compared to May. Prices expansion slightly eased for a third straight month in June, but instability in global energy markets continues. Sentiment remained optimistic regarding demand, with three positive growth comments for every cautious comment. Panelists continue to note supply chain and pricing issues as their biggest concerns.”

Construction spending fell 0.1% MOM in May but is still up 9.7% on a YOY basis. Residential construction rose 0.2% MOM and is up 18.7% on a YOY basis.

Overall, it looks like the economy is beginning to slow down and we should start seeing more confirmation in indicators like the jobs report next week. The big question for the stock market will be earnings season which kicks off in a couple of weeks with the big banks. If Q2 earnings are better than expected maybe we could start to put in a base under the stock market.

Morning Report: Spending falls in May

Vital Statistics:

S&P futures3,775-45.75
Oil (WTI)109.21-0.94
10 year government bond yield 3.03%
30 year fixed rate mortgage 5.90%

Stocks are lower as we end a hideous quarter for the markets. Bonds and MBS are up.

FGMC has filed for bankruptcy. It won’t affect closed loans and the company obtained DIP financing. “While we have made considerable efforts to address our ongoing financial challenges related to the state of the mortgage market, we ultimately must do what is best for our borrowers and consumers,” said Aaron Samples, chief executive officer of FGMC. “After careful review and consideration, the Company determined that pursuing the protections of chapter 11 is the right and responsible path at this time. As part of this process, the Company retained a portion of its workforce to manage the day-to-day business. We are requesting that the court approve a variety of motions that will promote a smooth transition for all pertinent parties while also preserving value for the benefit of the Company’s stakeholders.”

Personal incomes rose 0.5% MOM, according to the Bureau of Economic Analysis. This number was in line with expectations. Personal consumption expenditures came in light, rising only 0.2%, when the Street was looking for a 0.5% increase. If you adjust for inflation, spending fell 0.4%.

The inflation indices were at least somewhat encouraging. PCE Inflation rose 0.6% MOM, which was an increase however the YOY change was flat at 6.3%. Ex-food and energy PCE inflation rose 0.3% MOM and fell to 4.7% YOY.

Overall, the spending number is discouraging, and indicates that second quarter GDP might be weaker than people are thinking.

Jerome Powell said yesterday that he was more concerned about the risk of inflation than the risk of recession. Is there a risk we would go too far? Certainly there’s a risk,” Mr. Powell said Wednesday. “The bigger mistake to make—let’s put it that way—would be to fail to restore price stability.” He was speaking at the European Central Bank’s annual economic conference.

The risk is that the economy transitions into a higher-inflationary regime where higher inflationary expectations get baked into the economy. This happened in the 1970s, and the Fed found itself with a economy where growth stagnated and inflation kept ratcheting higher. The state of affairs was eventually described via the misery index, which was the sum of inflation, unemployment and interest rates.

Inflationary expectations tend to have reinforcing effects. People tend to accelerate purchases in order to buy before prices rise. This exacerbates shortages. Workers expect annual cost-of-living increases which further increases the prices of finished goods. This psychological phenomenon is what the Fed is trying to ward off.

Morning Report: Q1 GDP revised downward

Vital Statistics:

S&P futures3,8324.75
Oil (WTI)113.211.14
10 year government bond yield 3.17%
30 year fixed rate mortgage 5.93%

Stocks are flattish this morning after yesterday’s tech rout. Bonds and MBS are flat.

The final revision of first quarter GDP came in at -1.6%, a downward revision from the previous -1.5%. The PCE Price Index (basically inflation) was revised upward to 7.1%. Ex-food and energy it rose 5.2%. Consumption was revised downward to 1.8% from 3.1%.

The latest GDP Now estimate from the Atlanta Fed has growth increasing at 0.3% in the second quarter. If that is how it plays out, we will have managed to avoid a technical recession, however growth is anemic and the recent increases in the Fed Funds rate won’t begin to impact the economy until later this year.

Mortgage applications rose 0.7% last week as purchases rose 0.1% and refis increased 2%. The numbers were affected by the Juneteenth holiday.

“Mortgage rates continue to experience large swings,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. He noted the 30-year fixed rate declined 14 basis points last week to 5.84 percent after increasing 65 basis points during the past three weeks. Rates are still significantly higher than they were a year ago, when the 30-year fixed rate was at 3.2 percent.

“The decline in mortgage rates led to a slight increase in refinancing, driven by an uptick in conventional loans,” Kan said. “However, refinances are still 80 percent lower than a year ago and more than 60 percent below the historical average. Overall purchase activity has weakened in recent months due to the quick jump in mortgage rates, high home prices, and growing economic uncertainty.”

The abrupt shutdown of First Guaranty has left a lot of lenders with uncertain pipelines. The company laid off almost 80% of its staff on Friday, and basically left a skeleton crew to wind things down. “FGMC has experienced significant operating losses and cash flow challenges due to unforeseen historical adverse market conditions for the mortgage lending industry, including unanticipated market volatility,” Cassie Vacante, senior vice-president of Human Resources, wrote in a WARN notice.

I have heard rumors that liquidity is beginning to dry up in the non-QM space. I have to imagine the fallout from FGMC is related to it. Last week there were rumors that FGMC was hit by margin calls, which might be indicative of weakening buy-side demand for private label securities. While these are rumors only, it seems to fit.

Home Prices rose 21% in May, according to the Clear Capital Home Data Index. In the Southern region, prices rose 23%, led by a slew of Florida locations. The Northeast is beginning to experience home price appreciation at long last. Note this index is a month ahead of the FHFA and Case Shiller indices so it reflects more recent data. The rise in mortgage rates has yet to affect home price appreciation.

Morning Report: Home prices up; confidence down

Vital Statistics:

S&P futures3,92824.75
Oil (WTI)110.61-0.14
10 year government bond yield 3.22%
30 year fixed rate mortgage 5.90%

Stocks are higher this morning as China eases lockdown restrictions. Bonds and MBS are down.

House prices rose 1.6% MOM and 18.8% YOY according to the FHFA House Price Index. “House price appreciation continues to remain elevated in April,” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “The inventory of homes on the market remains low, which has continued to keep upward pressure on sales prices. Increasing mortgage rates have yet to offset demand enough to deter the strong price gains happening across the country.”

Separately the Case-Shiller Home Price Index rose 1.8% MOM and 21.2% YOY. These appreciation numbers go back to April, so this is before the Fed really started pushing up rates. That said, I think the supply and demand situation is not really conducive to any sort of meaningful / widespread home price depreciation.

Consumer confidence fell again in June, according to the Conference Board. “Consumer confidence fell for a second consecutive month in June,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “While the Present Situation Index was relatively unchanged, the Expectations Index continued its recent downward trajectory—falling to its lowest point in nearly a decade. Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by yearend.”

The one bright spot is that the present situation (which is how things actually are) is holding up. The other bright spot is that consumers are more pessimistic about the overall economy than they are about their personal financial situations.

Times are still good for landlords as the CoreLogic Single Family Rent Index rose 14% YOY in April. Some numbers are absolutely staggering: Miami was up 41% on a YOY basis. Orlando was up 26%. The downside is that these numbers will almost certainly add to inflationary pressures going forward.

Morning Report: FGMC shuts down

Vital Statistics:

S&P futures3,92711.82
Oil (WTI)107.51-0.14
10 year government bond yield 3.18%
30 year fixed rate mortgage 5.85%

Stocks are higher as markets continue to rebound. Bonds and MBS are down.

We are heading into a pretty big week for data, although the jobs report will slip into next week. We will get home prices and consumer confidence tomorrow, the final revision to Q1 GDP on Wednesday, personal incomes and outlays on Thursday, and ISM data on Friday. Markets will have an early close on Friday ahead of the 4th of July weekend.

First Guaranty mortgage laid off almost all of their staff on Friday. It sounds like they were short on cash and unable to strike a deal to raise more. Instead of ponying up more cash, main backer PIMCO decided to pull the plug instead.

Durable Goods orders increased in May, according to the Census Bureau. Orders were up 0.7% while shipments increased 1.3%. The report shows that demand remains strong, and some of the supply side numbers show that supply chain issues may be easing a touch, which is good news for the inflation numbers and the economy overall.

Pending Home Sales rose 0.7% in May, according to NAR. The Northeast saw the biggest gain, with home sales rising 15.4%. “Despite the small gain in pending sales from the prior month, the housing market is clearly undergoing a transition,” said NAR Chief Economist Lawrence Yun. “Contract signings are down sizably from a year ago because of much higher mortgage rates. Trying to balance the housing market by choking off demand via higher mortgage rates is damaging to consumers and the economy,” Yun added. “The better way to balance the market is through increased supply, which also helps the broader economy.”

His point about housing construction being the answer to soaring home prices is spot-on. Historically housing has led the economy out of a recession. It wasn’t unusual to see housing starts spike above a 2 million annualized pace coming out of recessions in the past. This was almost par for the course in the 1970s and 1980s.

The 2008 financial crisis never witnessed a rebound in home construction as we did have an overhang of foreclosures and excess new construction. That overhang was probably balanced out by the mid teens, and now we have an abject shortage of housing. The government would love to see new home construction, however the constraints are on the supply side – materials and especially labor.

I suspect the recovery from the current / imminent recession will finally be the one that ushers in a wave of new home construction. The big question will be whether we have the workers to do it.

Morning Report: New home sales rebound

Vital Statistics:

S&P futures3,83131.82
Oil (WTI)106.381.84
10 year government bond yield 3.09%
30 year fixed rate mortgage 5.82%

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

The S&P Flash Composite Purchasing Managers Index showed the economy slowed pretty dramatically in June. PMI Indices are based on questionnaires given to business executives, so they are a little more timely than some of the government statistics.

Service industries fared a little better than manufacturers, which is starting to see evidence of demand destruction. New orders contracted for the first time since July of 2020. Pricing pressures show no sign of abating however. Business confidence numbers fell to the lowest in over a decade.

It is possible that we are on the cusp of “bad news is good news” as far as market sentiment – where economic weakness is interpreted as good news for stocks and bonds because it means the Fed may ease up on the brakes. We aren’t there quite yet, but it feels like we are close.

Regardless of the PMI data, the Fed Funds futures are still a lock for 75 basis points in hikes at the next meeting.

New Home Sales rose 10.7% MOM to a seasonally adjusted annual pace of 696,000 units. This is still down over 5% on a YOY basis. The Street was looking for 587k, so this is an upside surprise. Note that April’s number was exceptionally low, so perhaps some sales got pushed to May. Regardless, housing still remains a bit of a drag on the economy.

The University of Michigan Consumer Sentiment index slipped in June to 50. This is a big decline from May, and it confirms the lousy initial reading. This is the lowest reading on record for the index. It is down an astounding 41% on a YOY basis.

Morning Report: Jerome Powell returns to the Hill

Vital Statistics:

S&P futures3,77817.82
Oil (WTI)106.380.24
10 year government bond yield 3.07%
30 year fixed rate mortgage 5.90%

Stocks are higher this morning as Jerome Powell heads to the Hill to testify in front of the House. Bonds and MBS are up.

Jerome Powell reiterated his commitment to reducing inflation and said a recession is a possibility. “At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so,” the Fed chief said in remarks for the Senate Banking Committee. “We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2%,” Powell said. “We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy.”

Despite the increase in interest rates, the employment market remains resilient. Initial Jobless Claims ticked down slightly to 229,000 last week, which is still historically very low.

The CFPB is reviewing the Non-QM rule. The CFPB’s Qualified Mortgage Rules to explore ways to spur streamlined modification and refinancing in the mortgage market, as well as assessing aspects of the “seasoning” provisions. The other thing probably worth exploring is the APOR / HPML issue and how it is applied in a period of rapidly rising interest rates.

The number of mortgages in forbearance fell last week to 0.85% from 0.94%. So far we are seeing scant evidence that the increase in interest rates and the weakening economy is having an effect on loan performance. “Servicers are whittling away at the remaining loans in forbearance, even as the pace of monthly forbearance exits slowed in May to a new survey low,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “Most borrowers exiting forbearance are moving into either a loan modification, payment deferral or a combination of the two workout options.”

Morning Report: Citi sees a 50% chance of a global recession this year

Vital Statistics:

S&P futures3,717-50.85
Oil (WTI)102.20-7.24
10 year government bond yield 3.17%
30 year fixed rate mortgage 6.07%

Stocks are lower this morning as investors get more bearish about the economy. Bonds and MBS are up.

Jerome Powell heads to the Hill for his Humphrey Hawkins testimony. The meat of the message is this quote from the prepared remarks:

Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy. We will make our decisions meeting by meeting, and we will continue to communicate our thinking as clearly as possible. Our overarching focus is using our tools to bring inflation back down to our 2 percent goal and to keep longer-term inflation expectations well anchored.

The Fed Funds futures still anticipate a 89% chance of a 75 basis point hike in July and a 11% chance of a 50 basis point hike. The central tendency for December is a Fed Funds futures rate of 3.5%, which means another 200 basis points are anticipated.

Citigroup sees a 50% chance of a global recession this year. Chief Global Economist Nathan Sheets said: “The global economy continues to be afflicted by severe supply shocks, which are pushing up inflation and driving down growth. But more recently, two further factors have burst onto the scene: Central banks are hiking policy rates with increasing vigor in their fight against inflation, and the global consumer’s demand for goods looks to be softening. We conclude that central banks face a daunting challenge as they seek to wrestle inflation down,” Sheets added. “The experience of history indicates that disinflation often carries meaningful costs for growth, and we see the aggregate probability of recession as now approaching 50%. Central banks may yet engineer the soft—or ‘softish’—landings embedded in their forecasts (and in ours), but this will require supply shocks to ebb and demand to remain resilient.”

Mortgage applications rose 4.2% last week as purchases rose 8% and refis fell 3%. “Mortgage rates continued to surge last week, with the 30-year fixed mortgage rate jumping 33 basis points to 5.98 percent – the highest since November 2008 and the largest single-week increase since 2009,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “All other loan types also increased by at least 20 basis points, influenced by the Federal Reserve’s 75-basis-point rate hike and commentary that more are coming to slow inflation. Mortgage rates are now almost double what they were a year ago, leading to a 77 percent drop in refinance volume over the past 12 months.”

Existing Home Sales fell 3.4% MOM and 8.6% YOY in May, while the median home price reached $400,000. “Home sales have essentially returned to the levels seen in 2019 – prior to the pandemic – after two years of gangbuster performance,” said NAR Chief Economist Lawrence Yun. “Also, the market movements of single-family and condominium sales are nearly equal, possibly implying that the preference towards suburban living over city life that had been present over the past two years is fading with a return to pre-pandemic conditions.”

Inventory remains an issue, although it is improving. Unsold homes sat at a 2.6 month supply at the end of May. A balanced market is more like 6%. Lawrence Yun is bearish on sales going forward: “Further sales declines should be expected in the upcoming months given housing affordability challenges from the sharp rise in mortgage rates this year,” Yun added. “Nonetheless, homes priced appropriately are selling quickly and inventory levels still need to rise substantially – almost doubling – to cool home price appreciation and provide more options for home buyers.”