Category: economics

Vital Statistics:

	Last	Change
S&P futures	3,972	-60.25
Oil (WTI)	76.52	-0.84
10 year government bond yield		3.47%
30 year fixed rate mortgage		6.31%

Stocks are lower this morning after the Fed poured cold water on a dovish shift in policy. Bonds and MBS are up.

The Fed raised interest rates 50 basis points as expected, however it increased its forecast for the Fed Funds rate in 2023 by 50 basis points. So instead of the markets seeing another 25 basis points of tightening in 2023, it looks like we will get another 75. The dot plot comparison is below:

The Fed revised downward their estimate for 2023 GDP from 1.2% to 0.5%, and increased its unemployment projection from 4.4% to 4.6%. The core PCE inflation forecast was increased as well, from 3.1% to 3.5%. The bottom line is that in spite of a couple good prints on the consumer price index the Fed became more hawkish, not less.

The press conference was basically non-eventful with Powell going back to his 3 components of inflation explanation: goods, housing and services wages. The goods issue was a function of supply chain bottlenecks from the pandemic, and this appears to be more or less over. The housing issue (which is really rental inflation) will probably begin to fade as we head into mid-2023. The wages part is the driver for the Fed’s decision-making.

The Fed is looking at a historically tight labor market, and is trying to avoid the 1970s wage-price spiral. FWIW, I personally don’t think that is as applicable today, mainly because we don’t have as many workers covered under collective bargaining agreements, which is where those wage increases got cemented in the past. Regardless, this is the driver of the Fed’s thinking.

The reaction in the markets was muted. Stocks sold off, while bonds tried to sell off and failed. The yield curve continues to invert, and is now fully negative across the board with the overnight rate at 3.81% and the 30 year rate at 3.49%. This is even more interesting in the context of quantitative tightening. Lower long term rates made sense when the Fed was building its balance sheet, but it is odd when you consider they are letting it run off. The inversion of the yield curve is back towards where it was in the early 1980s during the deep and painful recessions of 1980-1982.

Now check this out: It is still early, but look at the December 2023 Fed Funds futures implied probabilities: They aren’t buying the Fed’s narrative.

The futures may in fact adjust over the coming days, but at least as of this morning, they see the Fed funds rate at 4.25% – 4.5%, exactly where it is today. Really strange.

The press conference was pretty much uneventful, though you are seeing a narrative being formed politically: “The Fed wants you out of work.” Of course that is a simplistic and unfair framing (most narratives are) but watch this germ begin to manifest itself more clearly in the coming weeks. I wouldn’t be surprised to see more and more pointed rhetoric out of Washington over monetary policy as politicians hammer on the idea that workers, who’s wages have not kept up with inflation for decades are finally getting a raise and the Fed is looking to sacrifice them at the altar of 2% inflation. Incidentally one reported asked if the Fed might reconsider its 2% target and Powell basically said it wouldn’t. Personally, I don’t see the magic in 2%, but it they do.

So, bottom line, people who were hoping for the all-clear signal didn’t get it. That said, with MBS spreads still wide and the 10 year kind of solidly stuck where it is, we should see mortgage rates work lower despite all of this.

Vital Statistics:

	Last	Change
S&P futures	4,318	14.2
Oil (WTI)	110.13	6.63
10 year government bond yield		1.79%
30 year fixed rate mortgage		3.98%

Stocks are higher this morning as commodities rise and Western firms continue to impose “self-sanctions” against Russia. Bonds and MBS are down small.

Jerome Powell heads to the Hill today for his semiannual Humphrey-Hawkins testimony. Here are his prepared remarks. On inflation:

Inflation increased sharply last year and is now running well above our longer-run objective of 2 percent. Demand is strong, and bottlenecks and supply constraints are limiting how quickly production can respond. These supply disruptions have been larger and longer lasting than anticipated, exacerbated by waves of the virus, and price increases are now spreading to a broader range of goods and services.

On tapering and reducing the size of the balance sheet:

The process of removing policy accommodation in current circumstances will involve both increases in the target range of the federal funds rate and reduction in the size of the Federal Reserve’s balance sheet. As the FOMC noted in January, the federal funds rate is our primary means of adjusting the stance of monetary policy. Reducing our balance sheet will commence after the process of raising interest rates has begun, and will proceed in a predictable manner primarily through adjustments to reinvestments.

Finally, on Ukraine:

The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain. Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.

Conclusion, inflation is not transitory, we are raising rates in March, and the effects of the Ukraine invasion are impossible to model.

United Wholesale reported fourth quarter and full year numbers. Volumes were up on a YOY basis compared to the fourth quarter of 2020, which is surprising. Margins collapsed from 305 bp to 80, which is par for the course for what we are seeing with the mortgage banks. Like crosstown rival Rocket, they expect margins to hold steady here going into the first quarter.

The economy added 475,000 jobs in February, according to ADP. The January number was revised upward big time, from -300k to +500k. About a third of the job gains were in leisure / hospitality. “Hiring remains robust but capped by reduced labor supply post-pandemic. Last month large companies showed they are well-poised to compete with higher wages and benefit offerings, and posted the strongest reading since the early days of the pandemic recovery,” said Nela Richardson, chief economist, ADP. “Small companies lost ground as they continue to struggle to keep pace with the wages and benefits needed to attract a limited pool of qualified workers.”

Mortgage applications fell marginally last week as purchases fell 2% and refis rose 1%. We are back to 2019 levels in apps. “Mortgage rates last week reached multi-year highs, putting a damper on applications activity,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Although there was an increase in government refinance applications, higher rates continue to push potential refinance borrowers out of the market. Purchase activity remained weak, but the average loan size increased again, which indicates that home-price growth remains strong, and a greater share of the activity is occurring at the higher end of the market.”

Vital Statistics:

	Last	Change
S&P futures	4,123	-92.2
Oil (WTI)	99.91	7.23
10 year government bond yield		1.87%
30 year fixed rate mortgage		4.2%

Stocks are lower this morning after Russia invades Ukraine. Bonds and MBS are up.

The action in the markets is pretty dramatic this morning, with the 10 year yield falling 10 basis points. Actual bond prices are up over a point, but MBS are up about half a point. Stocks are getting clobbered, and anything oil-sensitive like airlines are getting whacked. The NASDAQ 100 has entered bear market territory, falling 20.5% since late December.

We have a lot of Fed-Speak this morning. I doubt anyone will be revising their remarks on what is happening overseas, but this situation for the Fed has become quite fluid.

Oil is up big this morning, with West Texas Intermediate up 8% and North Sea Brent trading up 7.6%. Brent is trading over $100 a barrel. Natural gas futures are up big as well. None of this bodes well for gasoline prices going forward as refineries are about to switch over from producing heating oil to gasoline for the summer driving season.

The action in commodities puts the Fed in a bind since it becomes harder for them (and central banks worldwide) to engineer a soft landing. Rising commodity prices will increase inflation, however it will also depress the economy. The stagflation case is bolstered by what is going on. The Atlanta Fed GDP Now estimate has 1.3% growth in Q1, however rising gas prices translate into lower consumer spending and lower GDP growth.

The Fed Funds futures have dramatically shifted in March, with the futures now predicting a 87% chance of a 25 basis point increase and a 13% chance of 50 basis points. Given the uncertainty, I think the prediction of 150 basis points in hikes this year is probably going to get trimmed back.

The main takeaway is that the bond market will be driven by global risk on / risk off sentiment than economic numbers as long as this crisis lasts. MBS will probably lag any improvement in rates as the Fed’s tapering will be the dominant factor. Fortunately for mortgage bankers, this means we probably won’t have a repeat of the margin calls of 2020, even if rates move lower since the Fed won’t be buying. I suspect mortgage spreads will just widen as the 10 year yield falls and mortgage rates go nowhere.

Fourth quarter GDP was revised upward from 6.9% to 7% however personal consumption expenditures were revised downward. I suspect much of this growth is inventory build as supply chains catch up with demand.

New Home Sales continue to disappoint, as Jan sales came in at a seasonally adjusted annual rate of 801,000. This is 4% lower than December’s rate and 19% lower than a year ago. The median new home price came in at 397k, which is up 18% from a year ago.

Vital Statistics:

	Last	Change
S&P futures	4,332	32.2
Oil (WTI)	91.91	-0.43
10 year government bond yield		1.97%
30 year fixed rate mortgage		4.15%

Stocks are lower this morning despite continued Ukraine / Russia fears. Bonds and MBS are down.

Initial sanctions on Russia seem to be less severe than initially feared. The main piece is a halt on the Nord 2 pipeline. That said, this is apparently a “first tranche” of sanctions, so more might be coming if things don’t change.

Consumer confidence fell in February, according to the Conference Board.

“Concerns about inflation rose again in February, after posting back-to-back declines. Despite this reversal, consumers remain relatively confident about short-term growth prospects. While they do not expect the economy to pick up steam in the near future, they also do not foresee conditions worsening. Nevertheless, confidence and consumer spending will continue to face headwinds from rising prices in the coming months.”

Consumer confidence is still much better than the aftermath of the financial crisis, however it remains below pre-COVID levels. Interestingly, the University of Michigan Consumer Sentiment Index is much worse, having fallen back to 2012 levels. I suspect the Conference Board is more accurate. The labor market is much stronger today than 2012 and that is a big driver of consumer confidence. Well, that and gas prices.

Mortgage Applications fell to December 2019 lows, according to the MBA. Purchases fell by 10% while refis fell by 16%. Refinances now account for about half of all mortgages.

“Higher mortgage rates have quickly shut off refinances, with activity down in six of the first seven weeks of 2022,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Conventional refinances in particular saw a 17 percent decrease last week. Purchase applications, already constrained by elevated sales prices and tight inventory, have also been impacted by these higher rates and declined for the third straight week. While the average loan size did not increase this week, it remained close to the survey’s record high.”

ARMs increased to 5.1% of total applications. I suspect we will be seeing more activity in this space, however the spread between an ARM and a fixed is still pretty tight, which means there isn’t much incentive to go with the ARM versus the 30 year. That said, if you plan on moving in 5 years, why not take out a 5/1 and save some money?

The non-QM space has been having issues lately, and I have been hearing about some lender out West not honoring locks. The rapid move in interest rates is exposing one of the big issues of NQM, and that is the difficulty in hedging the product. NQM loans are not deliverable into TBAs, and the rates seem to move much less frequently than TBAs. But, when they move, they move. We saw a lot of reprices last week as buyers of NQM rates re-adjusted upwards.

The big question is how does one hedge the interest rate risk? TBAs might be the least worst choice, but there hasn’t been a long enough track record of this product that you can use to come up with a correlation between conforming loans and NQM. I think a lot of people are flying blind here, and maybe some risk managers said “Wait a minute. We have no idea what our interest rate risk here is. Let’s hold off buying more paper until figure out what our exposure is.” This is all speculation of course, but I suspect that conversation is happening a lot right now.

Vital Statistics:

	Last	Change
S&P futures	4,440	-29.2
Oil (WTI)	91.35	-2.23
10 year government bond yield		1.97%
30 year fixed rate mortgage		4.17%

Stocks are lower this morning on continued Ukraine fears. Bonds and MBS are flat.

The Fed released the minutes from the January FOMC meeting yesterday. The Fed will be taking it meeting by meeting, and did allow for the possibility that they might have to be more aggressive than the December dot plot indicated, which is a nod to the fact that the Fed Funds futures and the December dot plot have a pretty big difference between forecasts.

In their discussion of the outlook for monetary policy, many participants noted the influence on financial conditions of the Committee’s recent communications and viewed these communications as helpful in shifting private-sector expectations regarding the policy outlook into better alignment with the Committee’s assessment of appropriate policy. Participants continued to stress that maintaining flexibility to implement appropriate policy adjustments on the basis of risk-management considerations should be a guiding principle in conducting policy in the current highly uncertain environment. Most participants noted that, if inflation does not move down as they expect, it would be appropriate for the Committee to remove policy accommodation at a faster pace than they currently anticipate. Some participants commented on the risk that financial conditions might tighten unduly in response to a rapid removal of policy accommodation. A few participants remarked that this risk could be mitigated through clear and effective communication of the Committee’s assessments of the economic outlook, the risks around the outlook, and the appropriate path for monetary policy.

The Fed Funds futures moved ever-so-slightly less hawkish on the news, with the March futures now predicting a roughly 2/3 chance of a 25% hike and a 1/3 chance of a 50 basis point hike compared to roughly a toss-up the day before.

Bottom line, the Fed is looking at the Fed Funds futures and it realizes the market is much more hawkish than they were in December. They are still of the opinion the inflation will moderate as supply chain issues work themselves out, however they are ready to act as necessary if that turns out to not be the case. They are concerned that credit will tighten as they raise rates, but they hope that they can avoid this through clear communication.

Housing starts disappointed yet again, coming in at 1.64 million versus the 1.71 that was expected. Building Permits came in at 1.9 million, which was above expectations, so perhaps this will change in the future. Materials aka “sticks and bricks” remain expensive and that is undoubtedly affecting things. Lumber continues its upward trend:

One of the most precious commodities these days is apparently garage doors. “It used to take us 20 weeks to build a house,” said Adrian Foley, the president and C.E.O. of the Brookfield Properties development group, which develops thousands of single-family homes annually in North America. “And now it takes us 20 weeks to get a set of garage doors.”

Shortages of skilled labor are an issue as well. The US has a glut of humorless BAs, and not enough welders or electricians.

In other economic news, unemployment claim ticked up to 248k last week. This well above pre-pandemic levels, which were averaging around 220k. One data point doesn’t make a trend, but we might be seeing signs the labor market is cooling.