Morning Report: More anecdotal evidence of declining inflation

Vital Statistics:

 LastChange
S&P futures3,733-33.25
Oil (WTI)79.82-3.76
10 year government bond yield 3.71%
30 year fixed rate mortgage 6.40%

Stocks are lower as people adjust to the new reality of higher rates. Bonds and MBS are down.

Goldman has cut their target for the year-end S&P 500 from 4,300 to 3,600. Commodity prices are beginning to reflect the lower-growth forecast, with oil dropping below $80 a barrel. A stronger dollar is part of the explanation too, but this is a global growth story.

S&P Global’s flash PMI registered an improvement in September, however we are still in a weak environment. New orders improved and while pricing pressures were still present, the increase in prices was the lowest since January 2021. This gives us at least some evidence that the Fed’s rate hikes are gaining some traction.

“US businesses are reporting a third consecutive monthly fall in output during September, rounding off the weakest quarter for the economy since the global financial crisis if the pandemic lockdowns of early-2020 are excluded. However, while output declined in both manufacturing and services during September, in both cases the rate of contraction moderated compared to August, notably in services, with orders books returning to modest growth,
allaying some concerns about the depth of the current downturn.


There was also better news on inflation, with supplier shortages easing to the lowest since October 2020, helping take some of the pressure off raw material prices. These improved supply chains, accompanied by the marked softening of demand since earlier in the year, helped cool overall the rate of inflation of both firms’ costs and average selling prices for goods and services to the lowest since early-2021. Inflation pressures nevertheless remain elevated by historical standards and, with business activity in decline, the surveys continue to paint a broad picture of an economy struggling in a stagflationary environment.”

Home flipping volume decreased in the second quarter, according to ATTOM. A total of 115k homes were flip transactions, or about 8.2%. This is a decline from the first quarter, but is still an increase from the second quarter of 2021.

“The second quarter was another strong showing for fix-and-flip investors. The total number of properties flipped was the second-highest total we’ve recorded in the past 22 years, and the median sales price of a flipped property – $328,000 – was the highest ever,” said Rick Sharga, executive vice president of market intelligence for ATTOM. “The big question is whether the fix-and-flip market will begin to lose steam as overall home sales have declined dramatically over the past few months, and the cost of financing has virtually doubled over the past year.”

You can look at the iBuying experience of Zillow and Opendoor to see it can be hard to make money in this business even in the best of markets, let alone when rates are higher and the number of transactions are falling.

Despite recessionary fears, mortgage delinquencies remain near record lows, according to Black Knight. The national delinquency rate fell to 2.79%, which was just a touch above the May 2022 record low. Foreclosure starts did tick up 15% in August, but we are well below pre-pandemic levels.

Morning Report: The Fed hikes again

Vital Statistics:

 LastChange
S&P futures3,8033.25
Oil (WTI)85.622.76
10 year government bond yield 3.64%
30 year fixed rate mortgage 6.28%

Stocks are flat after the Fed hiked rates yesterday. Bonds and MBS are down.

As expected, the Fed hiked interest rates by 75 basis points. The decision was not the focus however; the dot plot was the main attraction. The September versus June plots are below:

The median consensus in June was for the Fed Funds rate to end the year in a range of 3.25% – 3.5% and to end 2023 in a range of 3.5% – 3.75%. This was bumped up considerably yesterday. The voting members now see an end-of-year Fed Funds rate of 4.25%- 4.5% and a 2023 ending range of 4.75% – 5%.

The economic projections were tweaked as well – with 2022 GDP revised materially lower from 1.7% to 0.2%. Since GDP was negative in Q1 and Q2 that forecast seems optimistic. The unemployment forecast was revised upward as well, to 3.8% for 2022 and 4.4% for 2022 and 2023. They see inflation coming in at 5.4% this year and gradually getting back to their 2% target by 2025.

During the press conference, Jerome Powell stressed the Fed’s commitment to taming inflation and its willingness to support a period of below-trend growth. The Blue Check Marks squawked on Twitter about the Fed decision, and we can expect more of that as the economy slows and they fret about the political ramifications.

I don’t see how we get to positive 0.2% GDP growth this year given that Q1 and Q2 were negative, the Atlanta Fed’s GDP Now index is predicting only 0.3% growth for Q3 and we have about 225 basis points in Fed hikes that will begin to impact the economy in Q4. The NBER will probably still find a way to bird box its way into not calling a recession though.

The Fed Funds futures see another 125 basis points in hikes between November and December. The December 2023 Fed Funds futures see rates at the same level, so perhaps we are close to the end of this process.

The yield curve inverted even more after the announcement, with 2s / 10s dropping to negative 55 basis points at one point. This morning, 2s / 10s are at negative 47 basis points.

The economy is looking to weaken, according to the Conference Board’s Index of Leading Economic Indicators. The index fell 0.3% in August after falling 0.5% in July. It has been falling for the last six months.

“The US LEI declined for a sixth consecutive month potentially signaling a recession,” Ataman Ozyildirim, Senior Director, Economics, at The Conference Board. “Among the index’s components, only initial unemployment claims and the yield spread contributed positively over the last six months—and the contribution of the yield spread has narrowed recently.”

“Furthermore, labor market strength is expected to continue moderating in the months ahead. Indeed, the average workweek in manufacturing contracted in four of the last six months—a notable sign, as firms reduce hours before reducing their workforce. Economic activity will continue slowing more broadly throughout the US economy and is likely to contract. A major driver of this slowdown has been the Federal Reserve’s rapid tightening of monetary policy to counter inflationary pressures. The Conference Board projects a recession in the coming quarters.”

The red lines indicate a recessionary signal, and it is flashing red right now.

Morning Report: Awaiting the Fed

Vital Statistics:

 LastChange
S&P futures3,89320.25
Oil (WTI)85.801.34
10 year government bond yield 3.55%
30 year fixed rate mortgage 6.34%

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

The Fed decision is slated to come out at 2:00 pm EST. The market consensus is that they will hike the Fed Funds rate by 75 basis points. Since this is a September meeting, we will also get a new dot plot and a fresh set of economic projections. The decision probably won’t be the driver of the market’s reaction – the dot plot will. The focus will be on how long the Fed keeps rates elevated before cutting them. As of now, the Fed Funds futures see the Fed begin to cut rates in mid-2023. If the dot plot shows them keeping rates elevated all through 2023 and into 2024, the market will probably take that negatively.

Mortgage applications rose 3.8% last week as purchases increased 1% and refis rose 10%. This is surprising given the move up in rates, but comparisons versus the holiday-shortened Labor Day week could be the reason. Mortgage rates continue to march higher.

“Treasury yields continued to climb higher last week in anticipation of the Federal Reserve’s September meeting, where it is expected that they will announce – in their efforts to slow inflation – another sizable short-term rate hike,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Mortgage rates followed suit last week, increasing across the board, with the 30-year fixed rate jumping 24 basis points to 6.25 percent – the highest since October 2008. As with the swings in rates and other uncertainties around the housing market and broader economy, mortgage applications increased for the first time in six weeks but remained well below last year’s levels, with purchase applications 30 percent lower and refinance activity down 83 percent. The weekly gain in applications, despite higher rates, underscores the overall volatility right now as well as Labor Day-adjusted results the prior week.”

Another sign that the housing market is cooling: we are seeing rent growth begin to slow. “July marked the third month of slower annual gains in single-family rents,” said Molly Boesel, principal economist at CoreLogic. “However, higher interest rates this year increased monthly mortgage payments for new loans, and potential homebuyers may choose to continue renting rather than buy, helping keep price increases in check.” While rental inflation is slowing, vacancy rates remain extremely low.

Existing home sales slipped 0.4% in August and are down 20% compared to a year ago. The median home price rose 7% to $389,500. “The housing sector is the most sensitive to and experiences the most immediate impacts from the Federal Reserve’s interest rate policy changes,” said NAR Chief Economist Lawrence Yun. “The softness in home sales reflects this year’s escalating mortgage rates. Nonetheless, homeowners are doing well with near nonexistent distressed property sales and home prices still higher than a year ago.”

Housing inventory remains low, with 1.28 million units. This is a 3.2 month supply, which indicates a tight market. “Inventory will remain tight in the coming months and even for the next couple of years,” Yun added. “Some homeowners are unwilling to trade up or trade down after locking in historically-low mortgage rates in recent years, increasing the need for more new-home construction to boost supply.”

Days on market came in at 17, an uptick from July, but down from a year ago. 81% of homes sold within a month. All-cash sales, which are an indicator of investor activity, increased. Price increases were prevalent in Miami, and Memphis, while erstwhile stalwarts like Phoenix, Las Vegas and Austin saw price decreases.

Morning Report: Rates hit fresh highs

Vital Statistics:

 LastChange
S&P futures3,885-32.25
Oil (WTI)84.85-0.88
10 year government bond yield 3.58%
30 year fixed rate mortgage 6.25%

Stocks are lower as we begin the FOMC meeting. Bonds and MBS are down.

The 10 year bond yield has risen to an 11 year high. The rise over the past two years has been dramatic:

Housing starts unexpectedly increased in August to a seasonally-adjusted annual rate of 1.575 million. This was up 12.2% MOM and flat YOY. Building Permits declined 10% MOM and 14% YOY to 1.517 million. Housing completions fell 5.4% MOM to 1.342 million.

Overall, the decline in building permits supports the view that we are in a housing recession. Note that we are starting to get speculation that the Fed might start reducing rate hikes because housing has historically been a big part of of the economy. “Markets currently price-in an 80% chance of another 75 basis points hike in November, but we think 50bp is much more likely, and the parlous state of the housing market is a key factor in our forecast,” wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics. “The longer and deeper the housing recession becomes, though, the greater the pressure it will exert on the Fed to dial back the pace of tightening.”

That said, housing (owners equivalent rent) is a big input into the inflation numbers, so the Fed would love to see home price appreciation slow. Median asking rents rose 14% YOY in July, according to Redfin. This is a deceleration from June and May. In fact, the monthly increase of 0.6% was the slowest since February.

The problem for renters is that there is still a shortage of housing units and rising rates are pushing would-be buyers into the rental market, which is pushing up rents.

The iBuying business hasn’t worked out as well as hoped. First Zillow got out of the business, and now Opendoor lost money on 42% of its transactions in August. In Los Angeles, it lost money on 55% of its sales and in Phoenix it lost money on 76%

“We provided third quarter guidance in our last earnings to reflect lower-than-normal transaction volume and home-price appreciation, as well as longer than normal hold times for our inventory associated with the most rapid change in residential real estate fundamentals in 40 years,” an Opendoor representative said in a statement. “We have moved quickly and decisively to prioritize inventory health and risk management.”

Given that Phoenix home price appreciation has been around 30%, it boggles the mind how it could lose money on these properties.

Morning Report: Fed Week

Vital Statistics:

 LastChange
S&P futures3,861-27.50
Oil (WTI)82.35-2.70
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.19%

Stocks are lower this morning as we head into Fed week. Bonds and MBS are down.

The FOMC will meet on Monday and Tuesday. The Fed funds futures have a 80% chance for a 75 basis point increase and a 20% chance of 100. The yield curve continues to invert, with 2s / 10s trading at 46 basis points. Note that the Bank of England and the Bank of Japan also meet this week.

The September meeting will also bring a fresh set of economic projections and a new dot plot. Investors will be looking keenly at the rate predictions for 2023 and 2024. Earlier this summer, investors were looking for a Fed “pivot” from hawkishness to dovishness in 2023. At Jackson Hole, Jerome Powell threw cold water on that idea, stressing that the policy mistake of easing too early was a driver of inflation in the 1970s. The forecasts and dot plot will interesting to see if the Fed truly believes it.

Below is a chart of the Fed Funds rate and the CPI during the 1970s. FWIW, it seems like the Fed Funds rate and inflation correlate pretty closely. I can’t see where the policy mistake lies. Maybe the rate cuts in early 1975, but inflation was decreasing at the time, and didn’t really start picking up until 2 years later.

Rising rates and home prices have conspired to depress homebuilding. You can see this effect in lumber prices, which are down considerably over the past few months. It seems like everyone expects home prices to fall over the near term, although recent prints are still in the high teens YOY. Speaking of homebuilding, we will get housing starts tomorrow.

Homebuilder confidence fell for the ninth straight month, according to the NAHB Housing Market Index.

“Buyer traffic is weak in many markets as more consumers remain on the sidelines due to high mortgage rates and home prices that are putting a new home purchase out of financial reach for many households,” said NAHB Chairman Jerry Konter, a home builder and developer from Savannah, Ga. “In another indicator of a weakening market, 24% of builders reported reducing home prices, up from 19% last month.”

“Builder sentiment has declined every month in 2022, and the housing recession shows no signs of abating as builders continue to grapple with elevated construction costs and an aggressive monetary policy from the Federal Reserve that helped pushed mortgage rates above 6% last week, the highest level since 2008,” said NAHB Chief Economist Robert Dietz. “In this soft market, more than half of the builders in our survey reported using incentives to bolster sales, including mortgage rate buydowns, free amenities and price reductions.”

.

Morning Report: FedEx profit warning spooks the markets

Vital Statistics:

 LastChange
S&P futures3,870-40.50
Oil (WTI)86.201.16
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.17%

Stocks are lower this morning after economic bellwether FedEx withdrew its guidance based on a deteriorating economy. Bonds and MBS are down.

FedEx stock is down some 23% this morning after it issued a profit warning. Note that Fed Ex is on a May fiscal year. “Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S. We are swiftly addressing these headwinds, but given the speed at which conditions shifted, first quarter results are below our expectations,” said Raj Subramaniam, FedEx Corporation president and chief executive officer. “While this performance is disappointing, we are aggressively accelerating cost reduction efforts and evaluating additional measures to enhance productivity, reduce variable costs, and implement structural cost-reduction initiatives. These efforts are aligned with the strategy we outlined in June, and I remain confident in achieving our fiscal year 2025 financial targets.”

It looks like the rate increases are beginning to be felt, and we will be seeing more of this. FedEx is kind of an economic canary in the coal mine. It looks like the Fed’s rate hikes are gaining some traction.

Consumer sentiment improved in September, according to the University of Michigan Consumer Sentiment Survey. Most notably, the median expected inflation rate declined to 4.6%, the lowest reading in a year. The Fed pays close attention to this number because inflationary expectations are a critical input into inflation. Inflation uncertainty is the highest it has been since 1982 however, which is a concern.

The rise in interest rates this year has caused MBS spreads to widen considerably. MBS spreads describe the difference between the mortgage rate and a Treasury of similar maturity. When MBS spreads are large (aka “wide” in trader parlance) it means that mortgage rates are high relative to underlying interest rates. This describes the current state of affairs, as MBS spreads have widened considerably this year. We are at 10 year highs (setting aside the short spike in the initial days of COVID).

Morning Report: Retail sales rise

Vital Statistics:

 LastChange
S&P futures3,950-16.50
Oil (WTI)86.85-1.56
10 year government bond yield 3.44%
30 year fixed rate mortgage 6.12%

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

Retail sales rose 0.3% MOM in August, which was above expectations. Ex-vehicles they fell 0.3%. Ex-vehicles and gas, they increased 0.3%. Miscellaneous store retailers rose 1.6% MOM and 15.3% YOY. Departments stores rose 0.9%. Food and drinking places rose 1.1% MOM and 10.9% YOY.

The miscellaneous and department store numbers bode well for the back-to-school shopping season which is a good harbinger for the holiday shopping season.

We received a couple Fed reports this morning – the Empire State and Philly Fed regional reports. These reports discuss business conditions generally for the Northeast and Mid-Atlantic. These reports are generally not market moving however the Fed does pay attention to them. Business conditions are slowing overall, but more importantly we are seeing declines in the prices paid and prices received indices. These are more anecdotal measures of inflation, but are encouraging data points for the Fed.

Industrial production fell 0.2% in August, according to the Fed. Manufacturing production rose 0.1%. Capacity Utilization fell to 80%. So far, it doesn’t look like the Fed’s tightening has affected the manufacturing sector yet.

The labor market remains tight as well, with initial jobless claims falling to 213k. Historically, this is an extremely low number. The Fed wants to see the unemployment number tick up in order to slow down wage growth. I know that seems counter-intuitive but it will keep pressure on the Fed to keep hiking rates.

The yield curve continues to invert as the 2 year yield has been rocketing upward. 2s 10s are out to 40 basis points, and 2s 30s are out to 36 basis points. This is a recessionary indicator, and it shows the long end of the curve hanging in there while the short end rises. Note mortgage rates are still rising as mortgage backed security spreads widen. This means the difference between the market mortgage rate and a Treasury of comparable maturity is increasing.

It appears the government has averted a rail strike, which should help prevent even more supply chain issues. That would have been disastrous for the economy if it lasted for any length of time.

Morning Report: Wholesale inflation falls

Vital Statistics:

 LastChange
S&P futures3,9599.50
Oil (WTI)88.431.16
10 year government bond yield 3.43%
30 year fixed rate mortgage 5.97%

Stocks are higher this morning after yesterday’s bloodbath. Bonds and MBS are down small.

Inflation at the wholesale level fell 0.1% MOM and rose 8.7% YOY. The decline was driven primarily by a big decrease in energy prices. Ex-food and energy, the monthly index rose 0.2% MOM and 8.1% YOY. The report was more or less in line with Street expectations, so we aren’t seeing any sort of major reaction in the markets.

The encouraging thing is that the monthly core numbers (ex food, energy and trade services) is on a general downtrend over the past year. Will this have an effect on the Fed’s plans next week? Nope.

The Fed Funds futures now see a 70% chance of a 75 basis point hike and a 30% chance of a 100 basis point hike.

The effect on the yield curve is much more pronounced at the short end. The 2 year bond yield has picked up 23 basis points in yield over the past two days, while the 10 year is up about 8 basis points. The yield curve continues to invert, and the spread between the 2 year and the 10 year is now negative 36 basis points. The amount of tightening that has yet to hit the market is piling up. IMO, this is going to increase the chance for a hard landing.

Luckily since mortgage rates are more influenced by longer-term rates we aren’t seeing much of an impact on mortgages, at least not yet.

Mortgage applications fell 1.2% last week as purchases increased 0.2% and refis fell by 4%. Last week was short with the Labor Day holiday. “The 30-year fixed mortgage rate hit the six percent mark for the first time since 2008 – rising to 6.01 percent – which is essentially double what it was a year ago,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Higher mortgage rates have pushed refinance activity down more than 80 percent from last year and have contributed to more homebuyers staying on the sidelines. Government loans, which tend to be favored by first-time buyers, bucked this trend and increased over the week, driven mainly by VA and USDA lending activity.”

Median incomes fell about 2.9% to $67,251 in 2020, according to the Census Bureau. I’m sure the pandemic wreaked havoc on the numbers, so I would put an asterisk next to this one.

Morning Report: No relief on the inflation front

Vital Statistics:

 LastChange
S&P futures4,046-80.5
Oil (WTI)87.08-0.66
10 year government bond yield 3.43%
30 year fixed rate mortgage 5.97%

Stocks are lower this morning after the consumer price index (a measure of inflation) came in higher than expected. Bonds and MBS are down.

The consumer price index rose 0.1% in August, which was higher than expected. The Street was looking for 0.1% decrease as energy prices have been falling. On a year-over-year basis, prices rose 8.3%.

If you strip out food and energy, prices rose 0.6% MOM and 6.3% YOY. These were both higher than expected. Energy prices fell 5% MOM while food increased 0.8%. Higher prices for motor vehicles put upward pressure on the index.

The reaction in the markets was swift and severe. The S&P 500 futures went from a 0.75% increase for the day to a 2% decrease. In the bond market, the reaction was even more dramatic with the 10 year yield rising from 3.29% to 3.45%. The two-year spiked from 3.51% to 3.75%.

The Fed Funds futures were already predicting a 75 basis point increase at next week’s Fed meeting, and are now pricing in a 18% chance of a 100 basis point hike. The November futures are now pricing in a 75 basis point hike as well. The December futures now see a better-than-70% chance for a 4 handle on the Fed funds rate at the end of the year.

Needless to say, this report is highly bearish and raises the chance of a hard landing in the US economy. We are conceivably talking about 400 basis points in hikes over the course of 9 months, which is comparable to the rate hikes in the early 1980s in terms of magnitude.

Given that we started the year with negative GDP growth, and we haven’t begun to feel the effects of the summer rate hikes, I think a recession is inevitable, though the NBER will pull out all the stops trying to prevent itself from declaring one.

Notwithstanding the CPI print, the National Federation of Independent Businesses sees inflation beginning to moderate. The NFIB Small Business Optimism index improved in August as the outlook brightened. That said, we are coming from pretty depressed levels.

Mortgage credit availability declined for the sixth straight month in August, according to the MBA. “Mortgage credit availability declined slightly in August, as investors reduced their offerings of ARM and non-QM loan programs,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “As overall origination volume is expected to shrink in 2022, some lenders continue to streamline their operations by dropping certain loan programs to simplify their offerings. Additionally, with a worsening economic outlook and signs of cooling in home-price growth, the appetite for riskier loan programs has been reduced.”

As you can see from the chart below, mortgage credit is almost back to the bad old days in the aftermath of the bubble.

Morning Report: Inflation data looms large this week.

Vital Statistics:

 LastChange
S&P futures4,10821.5
Oil (WTI)88.481.72
10 year government bond yield 3.29%
30 year fixed rate mortgage 5.96%

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

The upcoming week will be dominated by the consumer price index report tomorrow and the producer price index on Wednesday. On Friday, we will get the University of Michigan consumer sentiment survey which should include inflation expectations. There will be no Fed-speak this week as we are in the quiet period ahead of the FOMC meeting next week.

The Fed Funds futures see a 88% chance of a 75 basis point hike next week. The impact of 225 basis points in rate hikes (75 in June, July and September) hasn’t even begun to be felt. We could be looking at a major slowdown at the end of the year.

The Atlanta Fed GDP Now index now sees 1.3% growth in the third quarter.

Note that we will get retail sales this week, which should contain the back-to-school spending numbers. BTS is generally a good predictor of the holiday shopping season.