Morning Report: Parsing the Beige Book

Vital Statistics:

S&P futures4,519-9.2
Oil (WTI)83.11-0.39
10 year government bond yield 1.67%
30 year fixed rate mortgage 3.27%

Stocks are lower this morning on no real news. Bonds and MBS are down again.

Initial Jobless Claims fell to 290k last week, which was lower than expected. We are still well above pre-COVID levels however.

The economy grew at a “modest to moderate” rate in September, according to the Federal Reserve Beige Book, which is a report by all of the regional Fed banks on the economy. The overall punch line is that growth is slowing and supply chain issues and a lack of labor are pushing up prices.

On the overall economy, they said: “Economic activity grew at a modest to moderate rate, according to the majority of Federal Reserve Districts. Several Districts noted, however, that the pace of growth slowed this period, constrained by supply chain disruptions, labor shortages, and uncertainty around the Delta variant of COVID-19.”

On the labor market, they observed: “Employment increased at a modest to moderate rate in recent weeks, as demand for workers was high, but labor growth was dampened by a low supply of workers….Firms reported high turnover, as workers left for other jobs or retired….The majority of Districts reported robust wage growth. Firms reported increasing starting wages to attract talent and increasing wages for existing workers to retain them. Many also offered signing and retention bonuses, flexible work schedules, or increased vacation time to incentivize workers to remain in their positions.”

And on inflation: “Most Districts reported significantly elevated prices, fueled by rising demand for goods and raw materials. Reports of input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Price pressures also arose from increased transportation and labor constraints as well as commodity shortages. Prices of steel, electronic components, and freight costs rose markedly this period. Many firms raised selling prices indicating a greater ability to pass along cost increases to customers amid strong demand. Expectations for future price growth varied with some expecting price to remain high or increase further while others expected prices to moderate over the next 12 months.”

What does all of this mean? For the Fed, the issue of inflationary expectations is critical. Once the population expects higher prices in the future, it tends to create a self-reinforcing cycle. Consumers accelerate purchases in order to avoid paying more in the future. This exacerbates supply shortages. Workers demand bigger cost-of-living wage increases which bumps up labor costs. Economists call this the wage-price spiral and this was a big component to the 1970s inflationary period.

There are many similarities between the 1970s and today: commodity price increases, shortages, profligate government spending and extremely easy monetary policy. As long as the economy is strong, people grudgingly accept it. The problems begin when the economy slows, because fiscal / monetary policy have reached the point of diminishing returns. Economists call this “pushing on a string” which means that further stimulus doesn’t create growth – it just creates inflation.

Jimmy Carter referred to it as “malaise.” Economists called it stagflation. Regardless of what you call it, I suspect it will be the template going forward. The government spent a crap-ton of money stimulating the economy over the past year and a half, the Fed has cut interest rates to 0% and has been buying MBS and Treasuries to support the economy. In return, economic growth is “modest to moderate,” which is Fed-speak for “meh.”

The Fed and the government have been conducting a stealth experiment in modern monetary theory over the past year and a half. Investors should ignore any gaslighting out of the media that offers MMT as a potential solution, as if we aren’t already there. We are. And we should get the verdict on that experiment soon.

Morning Report: Housing starts disappoint

Vital Statistics:

S&P futures4,52110.2
Oil (WTI)82.13-0.89
10 year government bond yield 1.64%
30 year fixed rate mortgage 3.22%

Stocks are higher this morning as the numbers out of the banks continue to be strong. Bonds and MBS are down.

Housing starts rose 7.4% YOY to 1.55 million, according to Census. Building Permits were flat YOY at 1.59 million. To put the housing starts number into perspective, we are at the same level we were in 1959, when the government first started keeping track. Mind you, the US population has increased by something like 85% since then.

The NAHB Housing Market index improved in September. Homebuilder sentiment has been strong for the past several years as tight inventory conditions give them pricing power.

Separately, mortgage applications for a new home fell 16.2% in September, according to the MBA. “New home sales purchase activity was weaker in September, and the average loan size rose to another record high, as homebuilders continue to grapple with rising building materials costs and labor shortages. The survey-high average loan size of $408,522 is evidence of higher sales prices from these higher costs, as well as the shift in new construction to larger, more expensive homes,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “The estimated pace of new home sales decreased 3.5 percent last month after a strong August reading, but the two-month sales pace is at its strongest since January 2021.”

Mortgage applications fell 6.3% last week as refinances fell 7% and purchases fell 5%. “Refinance applications declined for the fourth week as rates increased, bringing the refinance index to its lowest level since July 2021. The 30-year fixed rate has increased 20 basis points over the past month and reached 3.23 percent last week – the highest since April 2021. The 15-year fixed rate increased to 2.54 percent, which is the highest since July,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity declined and was 12 percent lower than a year ago, within the annual comparison range that it has been over the past six weeks. Insufficient housing supply and elevated home-price growth continue to limit options for would-be buyers.”  

Demand for second homes jumped during the pandemic, according to Redfin. This was probably due to rapidly falling rates and a desire for people to leave crowded urban areas. The decline after March 2021 corresponds with the temporary limits on second homes and investor loans from the GSEs and it looks like demand is back on the upswing.

Morning Report: Retail sales rise, while consumer sentiment slips

Vital Statistics:

S&P futures4,44819.2
Oil (WTI)82.130.39
10 year government bond yield 1.57%
30 year fixed rate mortgage 3.22%

Stocks are higher this morning as good numbers are being reported by the banks. Bonds and MBS are down.

Retail Sales rose 0.7% MOM, which was well above the consensus. Ex-vehicles and gas, they rose 0.7% as well. This report covers the back-to-school shopping season, which is a good indicator of what the holiday season will look like. That said, we have no problem with demand right now, the problem is supply. Higher gas prices were a big factor in the increase, as they are up 38% YOY.

“Services spending may see some renewed strength over the next couple of months, as virus cases continue to drop back,” Capital Economics senior U.S. economist Andrew Hunter wrote. “But with goods shortages likely to persist, and the resulting surge in prices eating into real incomes, we expect consumption growth to remain subdued.”

The supply issues are also evident in import and export prices. Import prices rose 9.2% on a YOY basis, while export prices rose 16%.

Jerome Powell is still expected to be re-nominated to run the Fed, however he is getting some pushback from the hard left, particularly Elizabeth Warren. If he isn’t the nominee, Lael Brainard, who was nominated by Barack Obama, seems to be the next best bet. Brainard is considered more dovish than Powell, however that probably doesn’t matter all that much – after all the FOMC is a committee and decisions are usually arrived by consensus and voting.

“You could see a different path of monetary policy with a Brainard-led Fed” that pushes back initial interest rate hikes and follows with a shorter tightening cycle, said Paul Herbert, Managing Director at Harbor Capital Advisors, who expects Powell to be renominated but is preparing to hold shorter duration bonds for longer in the case of a Brainard-led Fed.

Consumer sentiment slipped in October, according to the University of Michigan Consumer Sentiment Survey. The numbers are well below September’s numbers and October 2020’s. The survey blames the debate in DC over the stimulus bill and the debt ceiling, but IMO that stuff probably doesn’t resonate with the typical US citizen.

If you look at consumer sentiment surveys historically, they have historically correlated (negatively) with gasoline prices, and I suspect that is what is driving the numbers. If gas prices rise, people’s mood sours. That said, the Delta variant of COVID is probably playing a part too.

Morning Report: The Fed plans to taper soon

Vital Statistics:

S&P futures4,39439.2
Oil (WTI)80.820.39
10 year government bond yield 1.54%
30 year fixed rate mortgage 3.20%

Stocks are higher this morning as earnings season begins in earnest. Bonds and MBS are up.

The FOMC minutes pretty much confirmed what we already knew – that that the Fed will begin its tapering process shortly – either at the November or December meeting.

In the discussion of the economy, the job market and inflation seem to have differing views. The Fed participants thought that employment would continue to accelerate, and that the labor force participation rate would increase. So far, that is not happening. The Fed is not sure why this is happening, but it offered explanations like COVID resurgence, school and childcare.

On the inflation front, there is some concern that the identifiable COVID bottlenecks are translating into higher inflationary expectations, although the consensus seems to be that inflation will moderate back to 2% or so once these bottlenecks have worked out.

Overall, the explanation for the worker shortage seems to be largely boilerplate, and it seems unsatisfying. The Great Resignation seems to be something different, and so far no one seems to have a good explanation for it. Much of it is falling down ideological lines.

Initial Jobless Claims fell to 293,000 last week. We are still elevated, however we are well above pre-COVID levels.

Inflation at the wholesale level came in below expectations, however the numbers are still pretty high. The producer price index rose 0.5% MOM and 8.6% YOY. Ex-food and energy, it rose 0.2% MOM and 6.8% YOY.

Morning Report: Inflation comes in hotter than expected.

Vital Statistics:

S&P futures4,3432.2
Oil (WTI)80.02-0.39
10 year government bond yield 1.57%
30 year fixed rate mortgage 3.20%

Stocks are flattish this morning after the consumer price index came in higher than expectations. Bonds and MBS are up.

Prices at the consumer level rose 0.4% MOM and 5.4% YOY. Both numbers were a touch above expectations. Ex-food and energy, they rose 0.2% MOM and 4.0% YOY. FWIW, the Fed will dismiss the current numbers as “transitory” however that term is living on borrowed time. If we don’t see the numbers come down by next summer, then the Fed will probably have to act.

Mortgage applications were up marginally last week as purchases rose 2% and refis fell by 1%. “Mortgage rates reached their highest level since June 2021, but application activity changed little this week. An increase in home purchase applications offset a slight decline in refinances,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The increase in purchase applications was welcome news, but was primarily driven by a 2 percent gain in conventional purchase applications, which kept the average loan size elevated.”

JP Morgan reported earnings this morning. QOQ, numbers were flat, however they rose 28% on a YOY basis. It looks like a big part of the increase in earnings was driven by credit reserve releases. Net income was $11.7 billion, and credit release reserves were $2.1 billion.

Mortgage banking volume rose smartly to $41.6 billion compared to $29 billion a year ago. The increase was driven primarily by a 116% uptick in correspondent volume. Servicing was marked up to 3.85x. The stock is down a couple of percent so far today.

New Rez purchased Genesis Capital, a fix-and-flip / business purpose originator from Goldman Sachs. “The acquisition of Genesis adds a new complementary business line to our Company and advances our ability to create and retain additional strong housing assets for our balance sheet,” said Michael Nierenberg, Chairman, Chief Executive Officer and President of New Residential. “We are excited to work with the seasoned Genesis team and add business purpose lending to our suite of products, furthering our connectivity with a new subset of borrowers. We see the acquisition of Genesis as a great opportunity that supports our growing single-family rental strategy and one that allows us to capture additional unmet demand from our Retail and Wholesale origination channels.”

Mortgage credit availability increased 1.5% last month, according to the MBA. “Last month’s expansion was driven by a 4.5 percent increase in the conventional index, while the government index slightly decreased,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Even with increases in seven out of nine months thus far in 2021, total credit availability is still around 30 percent less than it was in February 2020 before the pandemic.”

Post-COVID, we are back to real estate bust levels of mortgage availability.

Morning Report: Quits rate increases.

Vital Statistics:

S&P futures4,3587.2
Oil (WTI)80.820.29
10 year government bond yield 1.60%
30 year fixed rate mortgage 3.20%

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

The number of job openings slipped in August to 10.4 million from a record in July. Trade / Transportation and Leisure / Hospitality are the big leaders in job openings. The quits rate, which tends to lead wage increases, rose 20 basis points to 2.9%. Check out the quits rate in some other industries: 4.7% in retail, 6.4% in leisure / hospitality, 6.8% in accommodation and food services.

I mentioned yesterday that Goldman Sachs sees US GDP coming in around 2% in the second half of 2021. This is a gutsy call given the consensus is for strong growth next year. Their call is for the supply chain issues to work themselves out and for inflation to return to its 2% level. They see no rate hikes in 2022 as inflation will be on the way down and growth will be too anemic to justify it.

As it stands right now, the December 22 Fed Funds futures see an 85% chance of a rate hike next year.

Note that we are seeing European confidence indices fall and we are on the cusp of third quarter earnings season. The banks will begin announcing numbers tomorrow, and investors are relatively sanguine about the financials. It is tech and industrial stocks that are the concern as rising input costs will reduce profits.

Small business optimism slipped in in September, according to the NFIB. “Small business owners are doing their best to meet the needs of customers, but are unable to hire workers or receive the needed supplies and inventories,” said NFIB Chief Economist Bill Dunkelberg. “The outlook for economic policy is not encouraging to owners, as lawmakers shift to talks about tax increases and additional regulations.”

A net 30% of companies intend to raise compensation in the next 6 months, which is a record for the survey, which goes back to almost 50 years. Interestingly capital expenditures remain low, as uncertainty regarding everything inhibits risk-taking. I think at some point businesses will start investing in labor-saving technology as it will help reduce costs and make it easier to fill orders.

The share of loans in forbearance fell to 2.68% last week, according to the MBA. This was a drop of 27 basis points, which is the fastest so far. “Many borrowers reached the expiration of their forbearance term as we entered October,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “Payment performance has remained steady for those who have exited forbearance and into a workout since 2020, with more than 85% of those borrowers current as of October. It also continues to be striking that so many homeowners in forbearance have continued to make their payments. Almost 16 percent of borrowers in forbearance as of October 3rd were current.”

Morning Report: Goldman cuts growth forecasts.

Vital Statistics:

S&P futures4,373-7.2
Oil (WTI)80.821.49
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.20%

Stocks are lower this morning as energy prices continue to rise. The bond market is closed for the Columbus Day holiday.

The upcoming week is relatively data-light, which is typical for the week after the jobs report. We will get inflation data as well as retail sales. The minutes from the September FOMC meeting will be released on Wednesday.

Goldman Sachs cut its US growth forecasts as consumer spending slips. They took down 2021 estimates rom 5.7% to 5.6% and 2022 estimates from 4.4% to 4%. “After updating our estimates of the key growth impulses that drive our consumption forecast—reopening, fiscal stimulus, pent-up savings, and wealth effects—and incorporating a longer-lasting virus drag on virus-sensitive consumer services spending, we now expect a more delayed recovery in consumer spending,” the economists said.  

Semiconductor shortages are forecasted to last until the second half of next year. Ultimately they believe that slowing of fiscal support will be a drag. Again, the Federal Government has spent an extraordinary amount of money over the past year and a half, and even if it falls government spending is still highly stimulative. Again I think we are at the “pushing on a string” point of fiscal stimulus.

The wheels are coming off the Chinese real estate bubble. Evergrande is the face of the bust, but we are seeing additional companies miss debt payments. The canary in the coal mine – the corporate bond market – however is flashing warning signs. The ICE / Bank of America index of Chinese developer corporate bonds shows 24 of 59 companies trading with yields over 20%, which are distressed levels. If 40% of the industry is trading at distressed levels then it looks like the bust is here and it will be almost impossible to reverse.

Japanese bank Nomura estimates that there is $5 trillion in debt that has been raised by developers over the past 5 years. To put that number in perspective, it is about the size of Japan’s GDP, the third largest economy in the world. China has a tight grip on the financial system and it will be a fascinating to watch how they manage it. As I said before I expect them to follow the Japanese model and to prevent any major defaults. The weaker companies will be bought by the stronger companies, and the economy will enter a long recession as the bad debt accumulated during the bubble years gets worked off.

The bust will send another global deflationary wave which will pull interest rates lower and commodity prices lower. The US will probably be able to get away with profligate spending and super-low interest rates for a while longer. The problem is what happens during the next recession. Interest rates are already at the floor, and fiscal stimulus has reached the point of diminishing returns. So during the next recession, the 10 year yield probably hits zero.

Morning Report: Mediocre jobs report

Vital Statistics:

S&P futures4,39913.2
Oil (WTI)79.321.09
10 year government bond yield 1.57%
30 year fixed rate mortgage 3.20%

Stocks are higher this morning despite a sizeable miss in the employment report. Bonds and MBS are down small.

The economy added 194,000 jobs in September, which was a sizeable miss compared to the 475,000 street estimate. It was also well below the ADP number of 568,000. Most of the jobs growth occurred in retail, fulfillment and transportation. Leisure and hospitality also rose. Health care employment fell.

The unemployment rate fell to 4.8% which was a positive, however it was driven more by people exiting the labor force than it was by jobs growth. The number of people not in the labor force increased by 338,000. The labor force participation rate slipped 10 basis points to 61.6%, which is still about 1.7 percentage points below pre-COVID levels.

Average hourly earnings increased 0.6% MOM and 4.6% YOY and average weekly hours ticked up.

Overall, this report is a mixed bag. Economic bulls will point to the wage increases and falling unemployment rate, while economic bears will point to the anemic job growth and falling labor participation rate.

Ultimately this report probably won’t have an impact on the Fed’s tapering decision this year. The Fed is banking on supply chain disruptions working themselves out which means they won’t have aggressively tighten. While the economy was more or less picture-perfect heading into COVID, that was almost two years ago, so those conditions are becoming less and less relevant.

Shortages are more and more evident whether one goes to a Kroger or Home Depot. Anyone who has gone to a restaurant and waited 10 minutes for someone to notice sees the staffing shortage. These shortages are going to impact GDP growth at some point. This is going to present a conundrum for the Fed. A weakening economy should be flashing warning signs to go slow. That said, the dual mandate gives them two navigation stars: unemployment and inflation. And if you look at this mediocre jobs report, both indicators are flashing “tighten.” It will be interesting to see how they thread the needle going forward.

Jerome Powell’s term is up in 4 months, and since Trump nominated him in the first place, he is probably gone. Given the Administrations capitulation to its party’s backbenchers, I expect to see someone more dovish (and more hostile to the banks) to take the reins. I would imagine the Fed of 2022 will be a lot more dovish than the Fed of 2021. This would set up a repeat of That 70s Show, as supply bottlenecks and dovish monetary policy conspire to create the mood and economy of malaise.

The parallels are there: the huge expansion of government over the past 2 years is similar to LBJ’s Great Society expansion, especially if Democrats manage to pass their $3.5 trillion spending bill. The economic shock of COVID, with its concomitant supply shocks resemble the Arab Oil Embargoes of the early 70s. Finally, the lack of productivity increases are similar as well. We seem to be getting to the “pushing on a string” point of fiscal and monetary stimulus as well.

Morning Report: Debt ceiling reprieve.

Vital Statistics:

S&P futures4,39135.2
Oil (WTI)77.02-0.49
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.20%

Stocks are higher this morning after yesterday’s rebound rally. Bonds and MBS are down.

It looks like we have a deal on the debt ceiling to move the deadline to December. “Two months seems like plenty of time and (we) think the debt ceiling would be raised through reconciliation by then and do not expect to experience the past week come December,” NatWest analysts wrote in a research note on Wednesday.

I don’t think the markets ever really thought the US would default on its debt – this is something more like theater for the DC crowd. I think the issue here is that the reconciliation process can only be used a limited number of times, and if Democrats punch their reconciliation ticket on the debt ceiling, they won’t have one for their $3.5 trillion spending plan. Mitch McConnell also knows that the closer we get to the 2022 elections the harder it will be to pass major legislation.

There were 17,895 job cuts in September, according to outplacement firm Challenger, Gray and Christmas. For the third quarter, there were 52.560 cuts, which was the lowest number since 1997.

“Companies are in hiring and retention mode, and job seekers have a lot of power to make demands at the moment,” said Andrew Challenger, Senior Vice President of Challenger, Gray & Christmas, Inc. “We know there are millions of open positions, but many employers are having trouble keeping up with their applicants, taking too long to reach out, not making offers fast enough, or losing out to more attractive offers,” he added.

Health care is experiencing an acute shortage as employees are burned out from the never-ending workload. Hiring is increasing as the big retailers staff up for seasonal demand.

Separately, initial jobless claims fell to 326,000 last week. Below is a chart of the last year’s initial claims. While we have made some big improvements, initial claims are still 50% higher than they were pre-COVID

High home prices are weighing on homebuyer sentiment, according to the Fannie Mae Homebuyer Sentiment Index. The most notable statistic was the percentage of people who thought it was a good time to buy, which fell from 32% to 28%. The percentage of those who thought it was a bad time to buy increased from 63% to 66%. Respondents are also getting less bullish on housing prices going forward, however they are quite sanguine about their job prospects, with 82% saying they are not concerned about losing their job.

Morning Report: The economy added 558k jobs in September

Vital Statistics:

S&P futures4,298-35.2
Oil (WTI)77.99-0.99
10 year government bond yield 1.52%
30 year fixed rate mortgage 3.21%

Stocks are lower this morning on overseas weakness. Bonds and MBS are down small.

The private sector added 568,000 jobs in September, according to the ADP Jobs Report. This was well above the Street estimate of 428k. The Street is looking for 475k jobs in Friday’s jobs report.

“The labor market recovery continues to make progress despite a marked slowdown from the 748,000 job pace in the second quarter,” said Nela Richardson, chief economist, ADP. “Leisure and hospitality remains one of the biggest beneficiaries to the recovery, yet hiring is still heavily impacted by the
trajectory of the pandemic, especially for small firms. Current bottlenecks in hiring should fade as the health conditions tied to the COVID-19 variant continue to improve, setting the stage for solid job gains in the coming months.”

Mortgage Applications decreased 6.9% last week, according to the MBA. Purchases decreased 2% and refis fell 10%. “Mortgage applications to refinance dropped almost 10 percent last week to the lowest level in three months, as the 30-year fixed rate increased to 3.14 percent – the highest since July. Higher rates are reducing borrowers’ incentive to refinance, as declines were seen across all loan types,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity also fell, driven by a drop in conventional loan applications. Government purchase applications were up over 1 percent, but that was still not enough to bring down the average loan balance of $410,000. With home-price appreciation and sales prices remaining very elevated, applications for higher balance, conventional loans still dominate the mix of activity.”  

Chicago Fed President Charles Evans sees the current level of inflation as transitory that will abate as supply chain bottlenecks get worked out. “I’m comfortable in thinking that these are elevated prices, that they will be coming down as supply bottlenecks are addressed,” he told CNBC’s Steve Liesman during a “Squawk Box” interview. “I think it could be longer than we were expecting, absolutely, there’s no doubt about it. But I think the continuing increase in these prices is unlikely.” His point is that the current level of inflation is not a monetary policy issue – it is a supply infrastructure problem.

Fed Chief Jerome Powell has about 4 months left in his term, and Biden has yet to publicly support him for another term. The left is lining up against him however: Powell “poses a danger to our economy and that’s why I oppose him for renomination,” Senator Elizabeth Warren told CNBC on Tuesday, citing what she sees as his overly lax approach to bank oversight as well as his handling of possible investment trading improprieties by fellow Fed policymakers.