The Daily Tearsheet

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.

Stocks are higher as we await the Fed’s decision. Bonds and MBS are up.

The Fed decision is due at 2:00 pm today. Warsh will be holding a press conference after the decision. We will also get a fresh set of projections and (hopefully) a new dot plot.

Two things to watch for in the Fed forecasts: The first is whether the Fed considers this a “one and done” hike and second whether the long-range Fed Funds rate moves up. The long run Fed Funds rate is thought to be the neutral policy rate, which is r* or called r-star. R-star cannot be derived directly from the data, it can only be estimated.

Historically, r-star has been thought to be in the 3% – 3.5% range. Many Fed speakers have suggested that the current Fed Funds rate of 3.5% – 3.75% is not restrictive, which means r-star might be higher than people originally thought. If r-star estimates move up, it would imply a higher Fed Funds rate than 4% will be needed to slow the economy and bring down inflation.

Retail sales rose 1.2% MOM in August, which was a sharp reversal from July’s negative numbers. Ex-autos and gasoline retail sales rose 1.2%. On a year-over-year basis, sales rose 6%. Census does not adjust these numbers for inflation, so on an inflation-adjusted basis sales rose 2.6%. Still decent.

August is the beginning of the back-to-school shopping season which can be a good tell for holiday sales. Since consumption is such a large part of GDP, we might see the estimates for Q3 and Q4 GDP rise. This also gives the Fed more confidence to raise rates.

Mortgage applications decreased 4.1% last week as purchases fell 1% and refis fell 9%. “Ongoing market concerns over spiking energy prices, persistently high inflation, and future monetary policy pushed bond yields and mortgage rates higher last week. As the 10-year Treasury inched closer to the 5% mark, mortgage rates followed and were almost 7%. The 30-year fixed rate at 6.97% was at its highest level since May 2025,” said Joel Kan, CMB, MBA’s VP and Deputy Chief Economist. “After adjusting for the Labor Day holiday, purchase applications dipped relative to the week prior as higher mortgage rates caused many buyers to pause their purchase decisions. The current level of rates also eliminated much of the benefit to refinance for many borrowers, resulting in declines in conventional, FHA, and VA refinance applications.”

Note there was an adjustment for the Labor Day holiday.

Single family building permits have declined YTD as more building are focusing on multifamily. This has been the story since COVID as construction continues largely in the cities. Multifamily construction has been highest in the Northeast (where the pace of single family construction could be best described as glacial) and the West.

Single family permits were most prevalent in Texas. I guess the difference is if you have the space to build out, you see more single family and if you don’t you build up. Many of the Northeast cities are seeing residential building in formerly industrial and commercial sites. This is particularly evident in places like Stamford and Norwalk Connecticut and is even moving into Bridgeport. Younger renters prefer walkable urban areas and this is where the action is. Places like Baltimore and Philly are also seeing a lot of decrepit properties turned into new modern apartments.

Stocks are lower this morning as the 10 year is sporting a 5 handle. Bonds and MBS are down.

The FOMC meeting begins today and the markets overwhelmingly see a rate hike coming. The 10 year bond yield has moved up so far, so fast that I am tempted to say the markets have priced in the hike and then some.

That said, the increase in the 10 year is not just a US story. Sovereign bond yields are rising across the board, especially in Japan and Australia. Investors worldwide are turning up their noses at Treasuries, Bunds, Gilts and JGBs. That money is not necessarily going into currency substitutes like gold or Bitcoin however. It is generally going into stocks, as if this is one big risk-on trade.

One thing I keep in the back of my mind is that historically rate hikes have caused recessions. This hasn’t happened since the Great Recession however. It could be that tightening when rates are already at rock bottom doesn’t have much of a dampening effect on the economy. Going from a 25 basis point Fed Funds rate to 100 basis points still means money is extremely cheap. Yes rates were higher during 2002-2024, but the yield curve was inverted (the 10 year had a lower rate than the Fed Funds rate) but that isn’t the case now.

With the 10 year back above 5%, I suspect tightening will have more impact on the overall economy as we exit the era of ZIRP (zero interest rate policy). In other words, investors have been sanguine about interest rates which borders on complacency. There is an old saying in the stock market: “Don’t Fight The Fed.” Stock investors might want to start thinking about defensives and looking at companies like Proctor and Gamble instead of the AI darlings.

The Fed Funds futures see only a 20% chance of a one-and-done move by the Fed. The December futures see a 50% chance we get another hike this year and a 30% chance we get another two hikes (in other words, October and December).

If we see 3 hikes this year, it is time to start thinking about a possible recession in 2027. I wouldn’t say it is a baseline scenario, but keep in mind that the US has typically experienced a recession every 5 years or so, and the current expansion is over 6 years. The building blocks of a recession (over-exuberant stock market, inflation) are already in place.

Given the torrid pace of home price appreciation in 2020-2022, homeowners are sitting on a big chunk of equity. That may exacerbate a K-shaped recession, where homeowners fare better than renters.

New home mortgage applications fell 6% YOY according to the MBA. “Increasing mortgage rates continue to put pressure on new home sales activity. Applications to purchase newly constructed homes declined in August for the fifth straight month, with the level of applications down to its lowest in 2026,” said Joel Kan, CMB, MBA’s Vice President and Deputy Chief Economist. “More homebuyers turned to FHA loans in response to higher mortgage rates and those loans accounted for 35% of applications, the highest share in three months. New home sales were estimated to have increased over the month to a seasonally adjusted annual pace of 664,000 units, but remain 9% lower than last year’s pace.”

Note Lennar reports this week. The homebuilders have been struggling for a while, cutting prices to move a bloated inventory.

Stocks are lower this morning as tech leaders talk about “slowing down” AI development. Bonds and MBS are down as oil rises.

The week ahead will be dominated by the FOMC meeting on Tuesday and Wednesday. The current consensus is that the Fed will hike rates by 25 basis points like the ECB did last week.

Aside from the FOMC we will get housing starts, NAHB Homebuilder sentiment and retail sales. We will also get earnings from homebuilder Lennar.

The Fed Funds futures have a 88% chance for a rate hike at the September meeting. Typically with a September meeting we will get a set of projections and a new dot plot, but with Kevin Warsh’s desire to communicate less, we might not get what we have been used to.

Consumer sentiment declined in early September as gas prices rose according to the University of Michigan Consumer Sentiment Survey. “Consumer sentiment receded less than 4 index points for the second consecutive month of decreases. Democrats and Republicans alike posted sizable declines, while independents were little changed from August. Year-ahead expectations for both personal finances and business conditions plunged. With a resurgence in fuel prices and trade tensions, consumers anticipate greater pressures on their pocketbooks to come. Five-year expected business conditions remained stable at readings well below their historical average, suggesting that consumers believe that emerging risks this month may not have further worsened the long-run outlook. Overall, sentiment is now 16% below February, prior to the start of the Iran conflict, and 13% lower than a year ago.”

Inflation expectations rose from 4% to 4.6% for the year ahead and longer-term expectations rose from 3.3% to 3.4%.

The Wall Street Journal is out with a piece talking about prepayment risk in mortgage backed securities. This is something that hasn’t been an issue since 2022 when the Fed started hiking rates. After the big refi boom of 2020 and 2021, most everyone refinanced into ultra – low 3% mortgages which haven’t had any incentive to refinance since. This created the mortgage rate lock-in effect which is part of the reason why home sales have been disappointing.

That said, as 3% mortgage rates fade into the rear view mirror, the entire mortgage space is resetting to higher and higher coupons. The share of mortgages with 5% rates or higher is now over 40%.

Despite higher rates, people still move, people still do cash-out refinancings and life moves on. This is setting the seeds for a refinance boom if rates begin to fall. This should be good news for the mortgage banking industry which has been through tough times for the last few years.

Interestingly, MBS spread should reflect this and they are not. If you look at the difference between the 30 year fixed rate mortgage and the 10 year bond, the spread has narrowed over the past few years. This indicates that either MBS investors are in denial or perhaps they think the move in the 10 year bond is temporary (i.e. driven by the war in Iran and tariffs). Finally it could be the mortgage market betting that we aren’t going to see lower rates for a long time.

If this reverses, the most vulnerable assets will be agency mortgage REITs and mortgage servicing rights. Right now MSRs are priced for perfection and prepayment risk is treated as a benefit, not a risk because models are pricing in some recapture profits on the refi. It will be interesting to see how MSR values reset when we see a refi wave.

The Fed is about to embark on a tightening regime and historically those have caused economic slowdowns which translate into lower down the road. In the near term, that could cause defaults to rise (and repurchase risk to increase) however a refi boom could be the reward at the end.

Stocks are higher this morning after the CPI didn’t turn out worse than expected. Bonds and MBS are still getting slammed as global investors turn their noses up at sovereign debt.

While Treasury yields are up, Japanese yields rose 7 basis points overnight, while Australian yields are up 12 basis points. So far, it doesn’t appear that this increase in long-term yields is slowing down the global economy, which is the only thing that can stop the inexorable run up in yields.

Consumer inflation rose 0.4% MOM and 3.4% YOY according to the Consumer Price Index. Ex-food and energy, the index rose 0.3% MOM and 2.4% YOY. Gasoline accounted for a third of the increase in the index. Shelter inflation rose 0.3% MOM. The monthly core rate increase was a touch above expectations, but the rest of the numbers were in line.

Shelter inflation was up 3% YOY, but that seems overstated given that the home price indices are rising at 2% and average asking rents are flat / falling in most MSAs. I think there has to be something off in the way BLS is calculating shelter inflation. The numbers aren’t making sense any more.

Home price appreciation rose 1.5% quarterly and 1.9% annually last month according to the Clear Capital Home Data Index. The hip-to-be-square trade continues as the Northeast and the Midwest experienced faster growth than the West and the South.

While housing advocates claim there is a supply shortage driving up home prices, if you look at new homes for sale, that doesn’t appear to be the case, like at all. New homes for sale overall are similar to levels we last saw in the 2006 real estate bubble. In the South, there are more homes for sale than there was in 2005-2006.

So why is there this constant drumbeat of supply narratives in the media? The issue isn’t supply per se — it is supply in the places where demand is strongest. The chattering classes are overrepresented in cities like Los Angeles, New York City and Washington, D.C. These areas are already dense, and additional supply has been tilted towards luxury apartments. The point is that housing advocates generally don’t live in places like Akron, OH where real estate is cheap and that colors their opinions.

Existing home sales fell 2% to a seasonally adjusted annual rate of 3.98 million units. The median home price increased 1.6% YOY to $429,100. “Mortgage rates and home sales move in opposite directions, so it’s not surprising to see a mild dip in home buying activity due to high mortgage rates,” said NAR Chief Economist Lawrence Yun. “Still, home prices are rising, and existing home sales are actually up 1.6% year-to-date through the first eight months of the year. Homebuying demand, despite higher interest rates, is no doubt being supported by rising wages, which grew 3.1% in August, along with 643,000 net new jobs added since the start of the year. Job creation and wage growth typically drive housing demand.” 

“The number of months it would take to exhaust the total inventory at the current sales pace has grown to 4.9 months’ supply—its highest level in over ten years. The ample supply of homes for sale on the market is giving homebuyers better opportunities to negotiate,” Yun added.    


Stocks are lower as Iran ups its attacks on US warships. Bonds and MBS are down.

Note that the sell-off in bonds is global. Japanese government bonds, UK Gilts, German Bunds etc. are all seeing increased rates. The European Central Bank raised rates 25 basis points this morning to 2.5%. Needless to say this isn’t helping the case in Treasuries.

The 10-year Treasury has picked up almost 100 basis points in yield since March:

Inflation at the wholesale level rose 0.4% MOM and 5.4% YOY. The index ex-food and energy rose 0.3% MOM and 4.7% YOY. The producer price index is an input into consumer inflation, not final inflation. The increase in the PPI was unsurprisingly driven by higher energy prices, particularly diesel which rose 24%. The index for final demand services rose 0.1%.

In the aftermath of the PPI report, the September Fed Funds futures see a 64% chance of a rate hike next week.

Initial Jobless Claims fell to 206,000 last week. The labor market continues to exhibit strength.

Mortgage credit availability decreased in August according to the MBA. This was driven by a decrease in cash-out refis and bank statement loans. “Credit availability decreased in August, as lenders reduced their offerings of loan programs that require flexible documentation, along with cash-out refinance loans,” said Joel Kan, CMB, MBA’s Vice President and Deputy Chief Economist. “Many of these loan programs had jumbo features, which contributed to the decline in jumbo credit availability. The conforming index was unchanged and remained in a narrow range as conforming lending standards and loan offerings continue to be conservative, even as mortgage rates are at their highest levels in more than a year.”

Stocks are lower as oil continues to climb. Bonds and MBS are down.

Brent crude hit $100 a barrel this morning as fighting continues in the Middle East. The US has destroyed 10 Iranian tankers while Iran is claiming to have struck two US vessels. CENTCOM is denying Iran’s claim:

“No U.S. Navy warship has been struck; all IRGC attempted attacks failed. Meanwhile, U.S. forces have successfully destroyed 10 Iranian tankers in just the last week. These vessels were part of a multibillion-dollar shadow network that funds the IRGC, and Iran cannot defend them.”

No end is in sight here, and oil / bond yields continue to work their way higher.

While the inflation indices are showing inflation ticking up, market views of inflation have not moved up in any meaningful way. The US Treasury issues Treasury Inflation Protected Securities (TIPS) which pay a lower rate but the principal increases with the Consumer Price Index. This is intended to give bondholders a way to hedge inflation risk. The difference in yield between a TIPS and Treasury bond can be used to deduce the inflation assumptions embedded in the TIPS price. This is called the breakeven inflation rate. If inflation ends up being higher, the TIPS bond is a better bet. If inflation comes in lower, the Treasury is the better bet.

The breakeven rate has been trading in a narrow range for the past several years, and you would be hard pressed to conclude that tariffs and the Iranian war have had any meaningful effect on market estimates of future inflation.

Mortgage applications fell 2.7% last week as purchases fell 3% and refis fell 2%. “Mortgage rates moved higher last week, driven by ongoing investor concerns over inflation and the federal budget deficit. The 30-year fixed rate increased to 6.85%, the highest since June 2025 and 36 basis points higher than a year ago,” said Joel Kan, CMB, MBA’s vice president and deputy chief economist. “Refinance applications remain significantly impacted by these higher rates, falling to the slowest weekly pace since May 2025. Purchase applications overall were little changed from last week, but more borrowers have shifted to using ARM loans, with the ARM share of applications at 8.5%, the highest share since June. Higher mortgage rates continue to weigh on prospective homebuyers looking to act, even as housing inventory has increased in many markets.”

The employment market is set to improve based on the Conference Board’s Employment Trend Index, which (like the Leading Economic Indicators) tends to predict future trends in the job market. “The ETI increased for a second consecutive month in August and is now up 2.0% from its level one year ago,” said Conrad Qi, Economic Data Scientist Associate, The Conference Board. “Although they were mixed in August on a month-over-month basis, all eight components of the ETI delivered positive average contributions over the past six months. This suggests support for continued job growth after nonfarm payrolls grew by 162,000 in August.”

Stocks are lower this morning as oil rises on continued fighting in the Middle East. Bonds and MBS are down.

We have a short week coming up which will be dominated by the CPI report on Friday. We will also get existing home sales and the Producer Price Index. We are in the quiet period ahead of the FOMC meeting next week, so we won’t have any Fed speakers.

The Fed is meeting next week, and the CPI report will loom large in their decision. We had a 9-3 split at the previous meeting over raising rates. On Friday, Trump told the Fed to cut rates or else he would suspend trade with any country that has a trade surplus with us.

Great jobs number just announced, breaking all estimates (except mine!) by double and triple – And you haven’t seen anything yet! EMPLOYERS ADDED 162,000 JOB IN AUGUST. Lower the interest rates because the U.S.A. is a much stronger credit than it was just a short time ago! A STRONG COUNTRY MEANS A LOWER INTEREST RATE – IT’S A BETTER CREDIT…Very simple! We should have the LOWEST RATE of any country in the World, like “the old days.” Without the United States agreeing to allow them their big surpluses, and we could stop that immediately, they would no longer be considered financially ELITE! LOWER THE RATE OR I’LL STOP TRADING WITH COUNTRIES WITH WHICH WE HAVE A DEFICIT, which the U.S. Supreme Court, in its ridiculous and very costly Tariff decision, strongly acknowledged “the President” has an absolute right to do. IT’S BETTER THAN TARIFFS! The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change. High interest rates put the U.S.A. at a very unfair disadvantage, and I won’t allow that to happen! President DONALD J. TRUMP

Needless to say, the Fed had no comment on this. I am not sure how moving to autarky (i.e. becoming self-sufficient) would improve the inflation situation, and I am sure this will probably have little consideration at the Fed. Meanwhile the Fed Funds futures see a 58% chance for a hike next week. A lot will ride on the CPI.

Small business optimism fell 1.1 points in August according to the NFIB. Sales and earnings fell but were offset somewhat from a decrease in uncertainty. As an aside, I guess at some point business becomes inured to the chaos and just learns to accept it and move on.

Inflationary indicators were flat, meaning the situation isn’t improving or deteriorating. Labor fell, while credit remains relatively available. The outlook was generally good.

Labor quality / availability was listed as the single most important problem, followed by inflation and taxes. The K-shaped economy is still the biggest driver of the economy right now, with high incomes benefiting from the AI boom while the consumers on lower incomes are getting killed by high energy prices.

Consumer sentiment is low and retail sales show their lack of enthusiasm. Winners in the AI stock market surge are spending on stuff high-income people buy, but most consumers are not included in the party. Meanwhile, spending on AI is booming, creating new fixed assets including power generation, data centers, office buildings, new equipment, etc. These investments have powered the stock market and have released substantial purchasing power as investors “cash in” their success.

But back on Main Street, uncertainty remains high among owners. The Iran War lingers on with many promises that the war was about to end, but it didn’t and hasn’t. This has escalated the cost of energy which raises the price of almost everything. A third (31%) of the owners reported raising their average selling prices and as about as many plan to do so in the coming months. This will not help the Fed get inflation to its goal of 2%. Capital spending weakened, as there’s no AI boom on Main Street, yet. Uncertainty suppresses investment activity. Reducing sources of uncertainty will help bring spending back to higher levels.

Job growth is muted on Main Street and more broadly. The resumption of school will add many teachers, and the healthcare industry will continue to produce more employment. But overall, employment growth will remain modest. Construction jobs will benefit from the AI boom but overall, there will not be a surge in employment. Resolving the Iran conflict will provide a major boost to the economy, reducing uncertainty significantly and possibly reducing government spending. If the stock market realizes it is overvalued, domestic spending will slow but remain solid. Otherwise, the economy will behave much as it has for the past year.

Stocks are flattish this morning after a good jobs report. Bonds and MBS are down.

The economy added 162,000 jobs in August, which was well above the Street estimate of 55,000. The unemployment rate was steady at 4.1%. June and July payroll estimates were revised upward by 55,000 in total, turning July’s job losses back positive.

Food and drinking establishments added the most jobs while employment in IT fell. Average hourly earnings rose 0.3% MOM and 3.1% YOY. The labor force participation rate rose .2% to 61.6% and the employment-population ratio increased 0.2% to 59.1%.

In the establishment survey, it looks like the number of people employed rose by 569,000. The labor force itself increased by 683,000, which was driven by 551,000 people leaving the “not in labor force” category. This implies many long-term unemployed people found jobs last month. If so, this is an encouraging sign for the economy.

I don’t know that this changes anything for the September FOMC meeting, but the rebound in payrolls and the revision should quell any fears about the labor market weakening.

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As anyone who hedges their pipeline knows, volatility is the enemy of margin. Big moves in the markets can depress loan bids and make hedges underperform. Swaptions provide a way to buy some insurance against that risk. If you are hedging your MSR portfolio or Non-QM loans for sale, SOFR swaptions may be a good fit. 

Exchange traded swaptions also have the benefit of no upfront premium, no counterparty risk, and better execution than a over-the-counter (OTC) option. In an OTC transaction, you contact a bank who will “take the other side” of your trade. So they can sell you an expensive option and then buy it back cheaply when you want to exit since they know your position (or “which way you are”). On an exchange, you will get better pricing because the counterparties are anonymous and have no knowledge about your position.

Contact John Douglas at www.erisfutures.com to learn more. 

The CME has an article discussing exchange-traded SOFR swaptions, which are options on Eris SOFR Swap Futures. It is a good backgrounder on how they work, what the advantages of them are, and talks about how you don’t need to be a huge bulge bracket bank anymore to take advantage of them. Lower margin requirements are also helpful for mortgage banks who need to maintain maximum liquidity.

The article is an excellent backgrounder for those who want to learn more about how these instruments are traded. Anyone thinking about hedging non-QM and MSR positions should take a deep dive and understand the possibilities.

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Nonfarm productivity rose 1.4% last month as output increased 1.7% and hours worked rose 0.3%. Unit labor costs rose 1.2%, driven by a 2.6% increase in compensation and a 1.4% increase in productivity.

If AI is helping make us more productive, it has yet to really show up in the data:

Fed Governor Chris Waller said that he is seeing signs that inflation is beginning to move back towards the Fed’s target and if next week’s CPI report confirms it he will be inclined to hold rates steady.

“The short version is that, while inflation remains meaningfully above the Federal Open Market Committee’s (FOMC) 2 percent goal, recent data suggest we are finally seeing some signs of disinflation. If this continues in the data due over the next two weeks, I would be inclined to support holding the target for the federal funds rate at its current setting.”

Note these things on non-market services:

“Inflation is elevated significantly above the FOMC’s 2 percent goal and has exceeded that target for five and a half years. In July, prices based on personal consumption expenditures (PCE) rose 0.2 percent, and core prices excluding food and energy increased 0.2 percent. While I was happy to see this monthly number for core inflation because it continued the pattern of lower monthly readings that we saw earlier in the year, what caught my eye in the last PCE report is that nonmarket services prices accounted for approximately half of the increase in core prices. As you are probably aware, I don’t like throwing out specific categories going into the estimate of PCE inflation, but nonmarket services prices have always been an issue for me, since they are imputed and not actual price changes.³ So, ignoring this one factor, my take is that underlying inflation is doing better than the core numbers suggest.”

“One factor that I expect will lower reported inflation a bit is a pending change in the way the Commerce Department estimates the fees paid to stock market traders and related professionals. That change in this “nonmarket” price estimate, which I expect to be made shortly, could lower 12-month PCE inflation by a few tenths of a percentage point. Given my issues with nonmarket services prices, this is a welcome measurement correction.”

FWIW, I am surprised that stock trading commissions are influencing inflation that much. Stock trading commissions have fallen to almost nothing (Robinhood is free) and algorithms are fighting for a tenth of a penny front-running these orders. The idea that something essentially free is driving inflation by a few tenths of a percentage point is baffling to me.

Waller’s comments in reference to “nonmarket services” also includes shelter inflation, which I believe has been overestimated for a while. Shelter inflation includes something called owner’s equivalent rent, which is a rental estimate for your home. Shelter inflation has been running at 3% plus for the past year:

The Case-Shiller Home Price Index has been increasing by about 1.5% annually for the past year:

Average asking rents are up about 0.5% YOY depending on the source you use. Regardless, 0.5% rental inflation and 1.5% home price appreciation are somehow translating into 3.1% shelter inflation, which implies something is off in the way BLS is calculating it.

Stocks are flattish this morning as oil continues to climb. Bonds and MBS are flat.

The economy grew modestly over the past 6 weeks according to the Fed’s Beige Book. Consumer spending grew moderately despite higher gasoline prices. The labor market continued its low hire / low fire state, while price inflation was more or less steady. Residential construction declined, however data center building offset it. As an aside, I wonder how much data center construction is drawing away skilled labor from resi construction.

Given that backdrop, it is surprising to see the Atlanta Fed’s GDP Now model predicting Q3 GDP growth at a torrid 4.8%. Note particularly the chasm between the Atlanta Fed model and the Street consensus, which sees something like 2.4%. The ISM reports are doing a lot of heavy lifting in the model.

Private residential construction spending continues to be under pressure according to the NAHB and the latest construction spending report. It fell 1.3% MOM and 7.3% YOY. Single family construction accounted for all of the decline. Blame high mortgage rates and a glut of inventory with the builders. All of the publicly-traded homebuilders reported lower gross margins, which indicates price cuts. Most builders are allocating spare capital to buying back stock instead of expanding and lot purchases.

Despite the claims of the housing advocates, there is not a shortage of homes. The builders are sitting on inventory levels that rival the glut before the 2008 housing crash:

They aren’t building more until that inventory gets worked off. Multifamily tells a similar story. Construction of 5+ unit structures during the low-interest rate post COVID years soared, especially in places like Phoenix and Austin. Average asking rents have been declining for 4 years as the new inventory gets absorbed.

___________________________________________

As anyone who hedges their pipeline knows, volatility is the enemy of margin. Big moves in the markets can depress loan bids and make hedges underperform. Swaptions provide a way to buy some insurance against that risk. If you are hedging your MSR portfolio or Non-QM loans for sale, SOFR swaptions may be a good fit. 

Exchange traded swaptions also have the benefit of no upfront premium, no counterparty risk, and better execution than a over-the-counter (OTC) option. In an OTC transaction, you contact a bank who will “take the other side” of your trade. So they can sell you an expensive option and then buy it back cheaply when you want to exit since they know your position (or “which way you are”). On an exchange, you will get better pricing because the counterparties are anonymous and have no knowledge about your position.

Contact John Douglas at www.erisfutures.com to learn more. 

The CME has an article discussing exchange-traded SOFR swaptions, which are options on Eris SOFR Swap Futures. It is a good backgrounder on how they work, what the advantages of them are, and talks about how you don’t need to be a huge bulge bracket bank anymore to take advantage of them. Lower margin requirements are also helpful for mortgage banks who need to maintain maximum liquidity.

The article is an excellent backgrounder for those who want to learn more about how these instruments are traded. Anyone thinking about hedging non-QM and MSR positions should take a deep dive and understand the possibilities.

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New York Fed President John Williams said that rising bond yields are being driven by strong economic growth, not market dysfunction. “What’s driving it, in large part, is … really a strong U.S. economy and a strong economic outlook fueled by big investments in AI and data centers and technology in general,” he said. “So, I think it’s not really about financial conditions affecting the economy. It’s more about the economy affecting financial conditions.”

I would add that the increase in bond yields is global and not limited to the US. Japan has seen nearly a 100 basis point rise in yields year-to-date, with Europe seeing similar increases to the US.

We wouldn’t say whether he supported a hike at the September meeting. “I think that we have to wait and see. There’s no clear signs right now whether monetary policy currently is sufficient to make sure we bring inflation back to target in the next year or two, or whether you need to see further action to do that.”

“The [inflation] data recently have been encouraging towards that, but again we can’t just look a month or two. We’ve got to get a full picture and and look at all the … different pieces of information we have,” he added.

The September Fed Funds futures are still leaning towards a hike, with a 62% probability.

Announced job cuts rose 38% MOM but fell 38% YOY, according to the Challenger Gray and Christmas Job Cut report. This is the lowest August since 2022, and is consistent with the low hire / low fire labor market.

“This is the quietest August since 2022, but is generally on average for the month since the mid-2010s. What we’d like to see with low layoffs is an increase in hiring activity. While companies are making plans to hire more workers than last year, according to our numbers, it doesn’t appear those positions are being filled quickly,” said Andy Challenger, workplace expert and chief revenue officer for Challenger, Gray & Christmas.

Year-to-date, technology leads with the most announced job cuts, followed by transportation. While it is tempting to name AI as the reason for the cuts, AI is the fourth-most cited reason. Restructuring is the top one, followed by economic conditions and closings. Note that even if AI is the reason, companies will be reluctant to say that.

Surprisingly, the tech sector led in hiring, so there appears to be some churn going on as software is struggling while AI is growing.