The Daily Tearsheet

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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* According to Inside Mortgage Finance, 6/5/2026.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.