Morning Report: Banking fears spread

Vital Statistics:

S&P futures3,956-32.25
Oil (WTI)67.93-1.99
10 year government bond yield 3.33%
30 year fixed rate mortgage 6.34%

Stocks are lower this morning as banking fears spread to Deutsche Bank. Bonds and MBS are up on the flight to safety trade.

Deutsche Bank was down 12% this morning in Frankfurt trading and its credit default swaps surged. We also saw some pressure on regional banks in the US yesterday, which indicates this banking crisis is not over yet. The net result of this will almost certainly be a restriction of credit as banks become more cautious on risk, which will be recessionary.

The Fed Funds futures have reacted sharply to the news, with the May futures seeing no move and the June futures pricing in a 60% chance for a rate cut.

St. Louis Fed President James Bullard spoke this morning. The presentation is here. He refers to the current situation with the banks as similar to events in the past where rising rates caused financial stress, but didn’t tank the economy. He mentioned the Mexican Peso / Orange County crisis of the mid-90s, Continental Illinois in the mid 80s, and Long Term Capital Management in the late 90s as examples. The labor market remains exceptionally strong, however financial stress is increasing.

Durable Goods orders fell 1% in February. Ex-transportation they were flat. Both numbers were below consensus. Core Capital Goods orders (a proxy for business capital expenditures) were flat.

Homebuilder KB Home reported first quarter numbers. Revenues were flat while gross margins contracted due to seller concessions and rising construction costs. Average selling prices rose 2% to $494,500. “As we entered the Spring selling season during the quarter, we began to see an increase in demand. This reflected in part the targeted sales strategies we deployed, together with a stabilizing mortgage interest rate environment. As a result, we achieved a sequential improvement in our net orders in both January and February, and net orders have remained strong in the early weeks of March. Although there are still considerable interest rate and economic uncertainties, we are encouraged by this progression.”


Morning Report: The Fed hikes rates and pours cold water on rate hikes this year

Vital Statistics:

S&P futures3,99020.25
Oil (WTI)70.970.09
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.48%

Stocks are rebounding this morning after yesterday’s Fed-induced sell-off. Bonds and MBS are up.

As expected, the FOMC hiked the Fed Funds target by 25 basis points yesterday. The Fed did discuss the recent turmoil in the banking sector, and they felt that this will restrict credit going forward. At the same time, the labor market has remained unusually tight and inflationary pressures have been stronger than expected. These two things more or less offset each other. The dot plot showed a minimal change in the forecast for the Fed Funds rate:

They also inched down their forecast for GDP growth and unemployment while taking up their forecast for inflation. So far, the Fed is not seeing any decrease in credit from the banking crisis, and therefore they didn’t feel the need to pause or cut rates. They did tweak the language about future rate hikes from “ongoing increases in the target range will be appropriate” to “some additional policy firming may be appropriate” to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

On the banking system, the statement said: “The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity,
hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks”

Lots of market observers are calling for the Fed to pause due to the banking crisis, but the situation is so new that the Fed doesn’t have a read yet on the fallout. Any general restriction of credit will take some time to play out. Global central banks are more or less on the same page, with the ECB hiking 50 bp this week, and the Swiss National Bank hiking 50 this morning, despite the Credit Suisse situation.

The Fed Funds futures now don’t see rate cuts starting until September.

Janet Yellen, while testifying in front of the Senate was asked if the FDIC was considering doing a blanket guarantee of all deposits without Congressional authorization. The response was: “This is not something that we have looked at. It’s not something that we’re considering,” she said. “I have not considered or discussed anything having to do with blanket insurance or guarantees of all deposits.” It is an odd response given the question was specifically about Congressional authorization.

The punch line is that Treasury considers this an isolated case, and not indicative of future policy. Of course that is the only thing they could say. That said, I suspect this opens the door for full coverage of deposits, and FDIC insurance premiums will have to increase to cover the added risk. This will almost certainly exacerbate the situation with the small banks – the big ones can probably absorb the added cost more than the smaller ones who will have to pass on those costs via lower deposit rates. This will create a bank run in slow motion which resembles the disintermediation problem of the 1970s. It will almost certainly drive more consolidation in the banking sector and I wouldn’t be surprised to see a wave of bank mergers similar to the late 90s.

New home sales rose 1.1% MOM to a seasonally adjusted annual rate of 640,000 units. This is still down about 19% from last year. The median price rose slightly to $438k while the average price fell a touch to $499k. As Powell has emphasized, the housing market has been weak, which will start pulling down inflation by summer, but wages remain the driver.

Morning Report: Awaiting the Fed decision

Vital Statistics:

S&P futures4,0361.5
Oil (WTI)69.760.09
10 year government bond yield 3.60%
30 year fixed rate mortgage 6.54%

Stocks are flattish as we await the FOMC decision at 2:00 pm EST. Bonds and MBS are flat as well.

The markets still see a 25 basis point hike at the meeting today. We will get a fresh set of economic forecasts as well as the dot plot. Jerome Powell will hold a press conference at 2:00 pm. We could see a lot of volatility this afternoon.

Existing Home Sales rose 14.5% in February, according to the National Association of Realtors. This ended a 12 month streak of declines. Most notably, the median home price fell by 0.2% to $363,000. Prices rose in the Midwest and the South, while falling in the Northeast and the West. The number of homes for sale came in at 980,000 which represents about a 2.6 month supply at the current sales pace. This is indicative of a tight market; a balanced market is about 6 months’ worth of sales.

“Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines,” said NAR Chief Economist Lawrence Yun. “Moreover, we’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs.”

The first time homebuyer accounted for 27% of sales which is a pretty low percentage. First time homebuyers accounted for 26% in 2022, which was a record low.

Mortgage applications rose 3% last week as purchases rose 2% and refis rose 5%. “Treasury yields declined last week, driven by uncertainty over the health of the banking sector and worries about the broader impact on the economy. Mortgage rates declined for the second week in a row, with the 30-year fixed rate dropping to 6.48 percent, the lowest level in a month,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “However, mortgage rates have not dropped as much as Treasury rates due to increased MBS market volatility. The spread between the 30-year fixed and 10-year Treasury remained wide at around 300 basis points, compared to a more typical spread of 180 basis points.”

MBS spreads are a function of interest rate volatility – when interest rate volatility rises, mortgage backed securities will underperform Treasuries. While the VIX (a measure of stock market volatility) has been relatively muted, the MOVE Index (which is sort of the VIX for bonds) has been spiking:

The spike has been largely due to a massive head fake in the bond market. 2022 ended with a couple of benign CPI prints which convinced the bond market that the Fed was accomplishing its mission and inflation was about dead. The January and February CPI prints (along with a robust January jobs report) caused investors to re-think that forecast and rates spiked. The latest banking crisis has massively increased uncertainty over future Fed moves. The fact that First Republic has been part of the walking wounded is an ominous sign as well that the crisis is still with us.

The punch line is that this uncertainty has caused mortgage backed securities to hold relatively steady while Treasury yields fall. The other problem is that mortgage backed securities have a dark cloud over them given that banks might need to sell them to raise capital.

Morning Report: Janet Yellen soothes the banking system

Vital Statistics:

S&P futures4,018 35.5
Oil (WTI)68.60 0.90
10 year government bond yield 3.58%
30 year fixed rate mortgage 6.46%

Stocks are higher this morning on speculation that First Republic will get a capital injection. Bonds and MBS are down.

First Republic might get a capital injection. The Wall Street Journal reported that the consortium of banks that deposited $30 billion at the troubled bank are looking at converting those deposits into a capital infusion. The news (along with the Credit Suisse merger) has improved sentiment in all of the regional banks, including Western Alliance, PacWest and US Bank.

Janet Yellen is speaking at a banking conference today and is expected to reassure bankers that the Treasury is ready to protect depositors in the event of a system-wide bank run. The punch line is she will tell the American Bankers Association that the US banking system is “sound” and the situation is “stabilizing.” Additional measures to protect depositors “could be warranted.” “The Fed facility and discount window lending are working as intended to provide liquidity to the banking system. Aggregate deposit outflows from regional banks have stabilized.”

That is good news, but ultimately deposit rates are low and people have better options with their money. Banks can either stand pat and watch deposits run away of raise rates and watch net interest margins collapse. Pick your poison.

The FOMC starts its two day meeting today. The Fed Funds futures are forecasting a 80% chance of a 25 basis point hike. Overall, the Fed Funds futures are getting more hawkish as the market bets the banking crisis is over. That might be wishful thinking, but so far the markets are in a risk-on move.

Borrowings at the Federal Home Loan Bank increased by $304 billion last week, while borrowings at the Fed’s discount window increased to $150 billion. It is amazing how close to the bad old days of the 2008 crisis we are. That said, the 2008 crisis was a sea change in how accessing the discount window was perceived. Prior to 2008, accessing the discount window was considered to be an act of desperation, and a bank’s Board of Directors would think long and hard about accessing those funds. It was a signal to the markets that things were unraveling and most bank executives would avoid doing that like the plague. In 2008, we had a slew of investment banks convert to commercial banks in order to gain access and the stigma is now gone. History will judge whether that was a good thing or not.

The dot plot will probably matter way more than whether the Fed hikes 25 basis points or not. The markets see the Fed cutting rates this year, and if the dot plot doesn’t confirm that I think we could see a major sell-off in stocks and bonds.

Morning Report: First Republic is rescued, sort of…

Vital Statistics:

S&P futures3,972-22.5
Oil (WTI)68.25-0.12
10 year government bond yield 3.46%
30 year fixed rate mortgage 6.50%

Stocks are lower this morning as Credit Suisse is declining again. Bonds and MBS are up.

Treasury has cooked up a quasi-rescue of First Republic. A consortium of 11 banks have agreed to deposit $30 billion at the bank. “We would like to share our deep appreciation for Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, PNC Bank, State Street, Truist, and U.S. Bank. Their collective support strengthens our liquidity position, reflects the ongoing quality of our business, and is a vote of confidence for First Republic and the entire U.S. banking system. In addition, we want to share our sincerest thanks to our colleagues, clients, and communities for their continued and overwhelming support during this period.”

The company also suspended its dividend. That said, investors are cool to the measure and the stock is down 22% pre-market. Ultimately the banks are going through something similar to the the 1970s – disintermediation. People are pulling their money out of the banks because you can get better returns elsewhere. The short term Treasury market is a much better place to put your money than a bank right now, and money market funds saw $108 billion in inflows this week. There really isn’t a policy lever that can change that. We are re-experiencing the 1970s, when rising short term rates caused people to pull out their deposits for higher returns elsewhere, while the banks balance sheets were full of 3% mortgage loans that kept falling in value.

Meanwhile, Janet Yellen said that the banking system is safe.

The Conference Board’s Index of Leading Economic Indicators declined in February. “The LEI for the US fell again in February, marking its eleventh consecutive monthly decline,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “Negative or flat contributions from eight of the index’s ten components more than offset improving stock prices and a better-than-expected reading for residential building permits. While the rate of month-over-month declines in the LEI have moderated in recent months, the leading economic index still points to risk of recession in the US economy. The most recent financial turmoil in the US banking sector is not reflected in the LEI data but could have a negative impact on the outlook if it persists. Overall, The Conference Board forecasts rising interest rates paired with declining consumer spending will most likely push the US economy into recession in the near term.”

Industrial Production was flat in February, while manufacturing production rose 0.1%. Capacity Utilization fell to 78%.

Consumer sentiment fell in February, according to the University of Michigan Survey. Most of the survey was conducted prior to the recent banking failures, so the data doesn’t really reflect it yet. Importantly, inflationary expectations fell, which is good news for the Fed.

Morning Report: Larry Summers telegraphs 25 basis points next week

Vital Statistics:

S&P futures3,919-5.75
Oil (WTI)67.56-0.05
10 year government bond yield 3.44%
30 year fixed rate mortgage 6.48%

Stocks are lower after the European Central Bank hiked rates by 50 basis points. Bonds and MBS are up. MBS spreads are widening again as volatility spikes in the bond market. Credit Suisse gets a $54 billion loan from the Swiss National Bank.

Despite the stress in the banking sector, the Atlanta Fed increased its GDP Now estimate for Q1 from 2.8% to 3.2%. Granted, Q1 is largely in the books, but you would think a banking crisis would have a negative effect.

Ex-Treasury Secretary Larry Summers was interviewed by Bloomberg yesterday and said that 50 basis points next week was probably off the table. The stress in the banking system will restrict credit and that will have a tightening effect on its own. That said, he also though that not hiking would send a “very ominous” kind of signal. Since the Fed is in the quiet period, I suspect this was the “official” telegraphing of the Fed’s intentions next week. The Fed Funds futures see a 72% chance of a 25 basis point hike and a 28% chance of no hike.

Building Permits rose 13.8% MOM to a seasonally adjusted annual rate of 1.52 million. This is still down about 18% from a year ago. Housing starts rose 9.8% MOM to 1.45 million, but are still down about 18% from a year ago. Single family construction is still the dominant housing category, but not by much as multi-fam (5+ units) construction continues to surge. Single family came in at 777k last month, and it was 1.2 million a year ago. Multi-fam (5+ units) rose to 700k and it was 599k a year ago. Multi-fam rose 17% YOY while one-unit fell 35%.

Homebuilder confidence improved in March, according to the NAHB / Wells Fargo Homebuilder Sentiment Index. “While financial system stress has recently reduced long-term interest rates, which will help housing demand in the coming weeks, the cost and availability of housing inventory remains a critical constraint for prospective home buyers,” said NAHB Chief Economist Robert Dietz. “For example, 40% of builders in our March HMI survey currently cite lot availability as poor. And a follow-on effect of the pressure on regional banks, as well as continued Fed tightening, will be further constraints for acquisition, development and construction (AD&C) loans for builders across the nation. When AD&C loan conditions are tight, lot inventory constricts and adds an additional hurdle to housing affordability.”

Homebuilder Lennar reported results yesterday. Revenues and earnings increased but average selling prices declined YOY and gross margins fell by 570 bps as sales prices were flat and costs increased. Backlog fell 29% in units and 33% in dollar value.

Stuart Miller, Executive Chairman of Lennar, said, “During the quarter, we saw a generally strong economy at the intersection of high inflation and strong employment numbers, while the housing market continued down a winding road of trying to find its footing. In December, interest rates and sticker shock continued to constrain sales activity, while in January and early February, lower interest rates energized sales. In late February, a spike in interest rates impacted website and community traffic and had a slight impact on sales. The Federal Reserve stayed its course of raising interest rates to cool inflation, though has yet to reach desired results. Homebuyers are considering the possibility that today’s interest rate environment may be the new normal. Accordingly, the housing market continues shifting as growing household and family formation continued to drive demand against a chronic supply shortage.”

Agile Technologies was named one of HousingWire’s Tech100 Mortgage winner.Agile launched in 2021, and this second consecutive Tech100 award further validates the company’s mission and approach. Now digitally connecting over 300 mortgage lenders of every size and sophistication with an established and growing roster of leading broker-dealers, all users on Agile’s platform benefit from increased transparency and functionality. Agile’s three-step process for digital TBA trading communication helps lenders improve efficiency and profitability. Users experienced an average improvement of 1.6 basis points on their TBA trades after implementation. Agile’s cloud-native platform also supports MBS pooling and can be accessed via desktop or mobile.

Both JP Morgan and Bank of America passed on acquiring failed Silicon Valley Bank over the weekend. Sounds like Goldman, PNC, and Royal Bank of Canada also passed. Certainly for Jamie Dimon the memories of 2008 were probably too fresh. Separately, troubled bank First Republic is exploring a sale.

The FHFA is delaying its new DTI adjustments until August 1 2023. “Since the January 2023 announcement, FHFA has received feedback from mortgage industry stakeholders about the operational challenges of implementing the DTI ratio-based fee. FHFA has decided to delay the effective date of the DTI ratio-based fee by three months to August 1, 2023, to ensure a level playing field for all lenders to have sufficient time to deploy the fee. In addition, lenders will not be subject to post-purchase price adjustments related to this DTI ratio-based fee for loans acquired by the Enterprises between August 1, 2023, and December 31, 2023. This temporary price adjustment exception will not alter any other quality control review decisions by the Enterprises. During this time, FHFA and the Enterprises will continue to engage with industry stakeholders to address operational concerns.”

Morning Report: Stocks down as Credit Suisse gets slammed

Vital Statistics:

S&P futures3,895-57.75
Oil (WTI)70.35-0.91
10 year government bond yield 3.49%
30 year fixed rate mortgage 6.62%

Stocks are lower this morning as investors fret over problems at Credit Suisse. Bonds and MBS are up.

Some encouraging news on inflation: The Producer Price Index fell 0.1% MOM and 4.6% YOY. Interestingly, 80% of the drop was due to a 36% decline in the price of eggs. The index for final demand after stripping out food and energy rose 0.2% MOM and 4% YOY. The Consumer Price Index is more important than the PPI, but it demonstrates that commodity prices are falling.

Yesterday, Credit Suisse announced in its financial filings that it has identified “material weaknesses” in its reporting and financial controls. Credit default swaps on the company are approaching 1200 basis points on one-year senior debt.

Top Credit Suisse shareholder and Saudi National Bank Chairman Ammar Al Khudairy was asked by Bloomberg if he was willing to put in additional cash into the company, he said: “The answer is absolutely not, for many reasons outside the simplest reason which is regulatory and statutory.” 

The stock is down 29% in Swiss trading and is trading at a record low.

Chris Whalen had a great piece on the issues in the banking sector. His argument is that the issues in the banking system stem directly from quantitative easing. The problem is that these extremely low coupon mortgage backed securities become illiquid and hard to hedge when interest rates start to rise. Who wants a 2.5% Ginnie? I found this part good:

“It seems that SVB management anticipated a recession on the heels of last year’s tech meltdown,” notes a veteran fund manager and long-time reader of The IRA. “Not only was new biz going into hibernation but the credit quality of the SIVB loan book was going to be in jeopardy as were the potentially juicy returns of their warrant book and other holdco assets.”

He continues: “So, in anticipation of recession and the consequently assumed Fed pivot, they decided to proactively make a very large, long duration Treasury/MBS bet, figuring they’d hit the ball out of the park on that play which would more than offset the ensuing pain in the loan book, warrants, etc.”

This was nothing more than an outsized interest rate bet. The bank was doubling down on its MBS position as it went more and more underwater in hopes of making back the losses. It was entirely human (albeit bad) trading instincts.

Ken Griffin’s hedge fund Citadel has taken a 5.4% stake in Western Alliance, and UBS has initiated the stock with a buy this morning with a price target of $85. The company has proactively taken steps to improve its liquidity position and UBS thinks fears of contagion are overdone.

Retail sales fell 0.4% in February, driven by decreases in autos and gasoline prices. Excluding these items, retail sales were flat.

Mortgage applications increased 6.5% last week as purchases rose 7% and refis increased 5%. “Treasury yields declined late last week, as market concerns over bank closures and the potential for broader ripple effects triggered a flight to safety in Treasury bonds. This decline pushed mortgage rates for all loan types lower, with the 30-year fixed rate decreasing to 6.71 percent,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Home-purchase applications increased for the second straight week but remained almost 40 percent below last year’s pace. While lower rates should buoy housing demand, the financial market volatility may cause buyers to pause their decisions.”

The Mortgage Credit Availability Index fell in February. “Mortgage credit availability decreased to its lowest level since January 2013 with all loan types seeing declines in availability over the month,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The conforming subindex decreased 4.3 percent to its lowest level in the survey, which goes back to 2011. This decline was driven by the ongoing trend of shrinking industry capacity as mortgage rates stayed significantly higher than a year ago. Additionally, in this volatile rate environment and potentially weakening economy, there was also a reduction in refinance programs offered for low credit score and high-LTV borrowers.” 

Morning Report: Inflation remains high in February

Vital Statistics:

S&P futures3,933 44.75
Oil (WTI)73.50-1.24
10 year government bond yield 3.61%
30 year fixed rate mortgage 6.54%

Stocks are higher this morning as the regional banks rally. Bonds and MBS are down.

The regional banks are all rallying today despite news that Moody’s has placed a slew of them on review for a downgrade. Western Alliance is up big this morning after it increased its liquidity. First Republic is up 50%, as is PacWest.

The 10 year bond yield is up a touch this morning, but the 2 year yield is up 28 basis points to 4.26%.

Inflation at the consumer level rose 0.4% month-over-month and 6% year-over-year. Housing was the big driver of the increase, while lower energy prices helped pull the number down.

If you strip out food and energy, inflation rose 0.5% MOM and 5.5% YOY. The month-over-month number was a 0.1% uptick from January.

If it weren’t for SVB these numbers would justify a 50 basis point hike in the Fed Funds rate next week, but with cracks showing in the financial sector they probably can’t do that. The Fed Funds futures are predicting another 25 basis points with a small probability that the Fed stands pat.

Small business optimism improved in February, but remains well below its historical average. Inflation remains the biggest problem, although it looks like it has peaked, at least if you are looking at the number of firms planning price hikes. Labor is still a problem, as many small businesses have unfilled positions and cannot find the workers.

The report doesn’t mention the issue with the regional banks, although the vast majority of small businesses weren’t interested in borrowing anyway. Overall, small businesses expect a recession, but it is taking some time getting here. Spending remains robust, probably because people have job security.

Rate lock volumes rose 2% in February, according to Black Knight. “Mortgage rates ticked up again in February after a brief respite, showing once again just how rate sensitive the market continues to be,” said Kevin McMahon, president of Optimal Blue, a division of Black Knight. “Conforming rates dipped below 6% early in the month but finished it up 52 basis points from January. Even though the number of rate locks was down month over month, dollar volume increased due to a rate environment that favored jumbo and ARM loans over GSE products. Essentially, though, the story remains the same – one of a market facing significant interest rate-driven headwinds. As Black Knight reported last week in our latest Mortgage Monitor, there were clear signs of buyside demand when rates neared 6% – it just quickly pulled back when rates began to climb again.”

Guild has acquired Cherry Creek Mortgage, a Colorado-based lender.

Morning Report: Bank Runs complicate the Fed’s plans

Vital Statistics:

S&P futures3,840 -20.75
Oil (WTI)74.44-2.24
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.69%

Stocks are lower this morning as the markets digest the failures of Silicon Valley Bank and Signature Bank. Bonds and MBS are up big.

I talked a bit about the Silicon Valley Banking situation and the implications in a Substack article over the weekend. It goes into the theme I have been talking about where the US is re-living the 1970s. But here is the recap. Silicon Valley Bank failed on Friday, and the New York Fed took over Signature Bank on Sunday. Depositors at these banks will be made whole (even uninsured depositors). The Fed created a liquidity facility for banks over the weekend, with 1-year term loans that can be collateralized at par against Treasuries and MBS that are trading below par.

First Republic is down big pre-market and looks like the next domino to fall. Western Alliance is down big as well, despite assuring investors that its tech exposure was limited and it had ample liquidity. PacWest is another. Investors are shooting first and asking questions later

The Fed Funds futures are now handicapping a 48% chance of no move in March and a 52% chance of only a 25 basis point hike.

FWIW, I think the Fed anticipates that these bank failure will restrict credit in the banking sector, which will have a similar effect to rate hikes. In other words, they won’t need to hike the Fed Funds rate as much going forward because the bank failures are doing the work for them. We are seeing the flight-to-safety trade this morning as investors pile into sovereigns and MBS.

Silicon Valley Bank’s sin was to buy Treasuries and MBS without hedging the interest rate risk. Beset with withdrawal requests, it sold its available-for-sale securities at a loss to cover withdrawals. Every bank on the planet has been dealing with rapidly rising interest rates, and I wouldn’t be surprised to see some European banks in the same situation.

The Fed’s new credit facility is meant to prevent that from happening. Instead of selling securities at a loss into the market, banks can now pledge these securities as collateral at 100% of face for a loan to pay off deposit requests. It is a way for them to “sell” their securities for a year without taking losses. The Fed hopes that this will prevent a bank run.

The current environment is lousy for the banks because inverted yield curves make it hard to generate net interest income (i.e. the difference between what they receive on their investments minus their borrowing costs). This is why deposit rates remain stubbornly low – banks aren’t earning enough on their assets to cover the cost of market deposit rates. So people are pulling their deposits to buy Treasuries direct from the government. This is a bank run in slow motion, similar to the problems we had in the 1970s. Since this phenomenon has nothing to do with a bank panic – it is just people making rational financial decisions – the temporary bank facility isn’t going to do much to stem that problem. If deposit rates are lower than other options people are going to continue to pull money out of the banks. Other banks might have better risk management, but if deposits are falling, so will lending which will slow the economy.

While the 10 year bond has gotten the most attention, the action has been in the two year. The two year bond yield is now trading at 4.09%. It was at 5.06% on Wednesday. This is another signal the market thinks the Fed is done. Don’t forget that 2023 was the most aggressive tightening cycle in 40 years.

The upcoming week will have the Consumer Price Index on Tuesday, which creates a real conundrum if inflation is running hot again. We well also get a lot of housing data with housing starts and homebuilder sentiment.

Morning Report: Troubles in the banking sector

Vital Statistics:

S&P futures3,909-9.75
Oil (WTI)74.98-0.74
10 year government bond yield 3.78%
30 year fixed rate mortgage 6.80%

Stocks are lower this morning on fallout from the Silicon Valley Bancorp situation. Bonds and MBS are up.

Bank stocks got slammed yesterday after SVB Financial announced it would take actions to “strengthen its financial position.” SVB will sell its available for sale securities portfolio and undertake an equity and convertible preferred stock offering to raise capital. This sent the stock down 60% and also hit troubled First Republic. Tech venture capitalist Peter Theil has recommended that people pull their money from the troubled bank. The entire banking sector was sold off, with the KBW Bank Index down 7.7% for the day. The contagion has spread to Europe (the financial sector correlates a lot), and it sounds like SVB’s capital raise found no takers.

Below is a chart of the KBW Bank Index.

An inverted yield curve is a major headache for banks, who borrow short and lend long. If you want to know why your local bank is paying depositors well below the Fed Funds rate, well, there you go. If a bank is only earning 3.8% on Treasuries, it isn’t going to pay 4.25% on a savings account.

If there is one thing that could get the Fed to halt its tightening regime, troubles in the banking sector is it. We have been seeing bankruptcies in the commercial mortgage space (especially office and mall paper), so this is something to watch. Banking crises have a tendency to spread into unanticipated spaces, like when the subprime crisis ended up making the commercial paper market freeze. Sovereign yields are down across the board so the bond market is paying close attention to this.

Of course for mortgage originators this means even tighter credit from warehouse banks and liquidity risk for non-QM products. This will also mean much lower rates and an even more inverted yield curve as investors flock to safe assets. If the playbook runs as usual, we could see a flight to MBS as well since those are more or less guaranteed by the government.

The economy added 311,000 jobs in February, according to the Employment Situation Report. The gains were primarily in leisure / hospitality, government, retail and health care. The unemployment rate ticked up to 3.6% from 3.4%, while the labor force participation rate inched up to 62.5% and the employment-population ratio was flat at 60.2%. Both numbers remain below pre-pandemic levels.

Average hourly earnings rose 0.2% month-over-month and 4.6% year-over-year, which was below the 0.3% / 4.7% Street estimates. The average workweek fell. Since the Fed is mainly concerned with wage growth right now this should be welcome news. That said the CPI report next week will be the big driver and it will come during the quiet period for the Fed ahead of the March FOMC meeting so we won’t get any sort of take from the Fed until the actual meeting.

The jobs report and the SIVB situation have the markets leaning towards a 25 basis point hike again.

The Federal Trade Commission has voted to officially block the merger of Black Knight and ICE. The FTC did mention the proposed remedy of selling Empower to Constellation Software: “Black Knight has proposed to remedy the competitive harm resulting from the proposed deal by selling its Empower LOS and some related services to a technology company, Constellation Web Solutions, Inc. According to the complaint, the proposal does not address the anticompetitive effects in the market for PPE software and would not replace the intense competition between ICE and Black Knight in the LOS market.”

Apparently there was internal documentation from ICE about how it could use price increases for Encompass as a “ever” to drive revenue increases. Bad move. As part of the deal, ICE had committed to litigate with the FTC to get the deal done, but this is a classic “Coke and Pepsi” merger.