Morning Report: Job growth remains robust

Vital Statistics:

S&P futures4,139-32.25
Oil (WTI)117.050.64
10 year government bond yield 2.97%
30 year fixed rate mortgage 5.42%

Stocks are lower this morning as investors fret about a slowing economy. Bonds and MBS are down.

The economy added 390,000 jobs in May, which was above Street expectations and the 129,000 increase ADP reported yesterday. The unemployment rate was steady at 3.6%. Average hourly earnings rose 5.2% on YOY basis. The usual suspects (leisure / hospitality and health care) increased employment, while retail fell. Retailers have been warning about consumer spending, so the number seems to fit.

Payrolls are close to pre-pandemic levels, but aren’t quite there yet.

The services economy expanded at a slower rate in May, according to the ISM Services Index. This is the lowest reading in the past year. “According to the Services PMI®, 14 industries reported growth. The composite index indicated growth for the 24th consecutive month after a two-month contraction in April and May 2020. Growth continues — albeit slower — for the services sector, which has expanded for all but two of the last 148 months. The sector’s slowdown was due to a decline in business activity and slowing supplier deliveries. The Employment Index (50.2 percent) returned to expansion territory, and the Backlog of Orders Index grew, though at a slower rate. COVID-19 continues to disrupt the services sector, as well as the war in Ukraine. Labor is still a big issue, and prices continue to increase.”

Home Prices accelerated in May, according to the Clear Capital Home Data Index. Overall prices rose 8.9% quarter-over-quarter and almost 22% YOY. The Sun Belt and Florida are the big winners, with prices in Phoenix rising 38% and Tampa rising 40%. Interestingly, the Northeast had the fastest quarterly rise. The Northeast and Midwest have lagged the rest of the market since the 2008 bust, so maybe there are some signs of life there.

Morning Report: Employment costs soar

Vital Statistics:

S&P futures4,086-12.25
Oil (WTI)115.650.64
10 year government bond yield 2.90%
30 year fixed rate mortgage 5.42%

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

The economy added 128,000 jobs in May according to the ADP Employment Survey. This was below expectations and is lower than the Street 325k estimate for tomorrow’s jobs report. “Under a backdrop of a tight labor market and elevated inflation, monthly job gains are closer to prepandemic levels,” said Nela Richardson, chief economist, ADP. “The job growth rate of hiring has
tempered across all industries, while small businesses remain a source of concern as they struggle to keep up with larger firms that have been booming as of late.” You can see the the “tempering” of jobs growth in the chart below.

Productivity declined 7.2% in the first quarter, according to BLS. This is the biggest drop in productivity since 1947. Declining productivity is generally an inflationary indicator, as firms are making less with more resources. Unit Labor Costs rose 12.6%, which is a function of declining productivity and rising wages. The chart below shows inflation (red line) versus unit labor costs (blue line). In a lot of ways, the current environment is reminiscent of the late 1960s, where a tight labor market, profligate government spending, and easy money combined to create the 1970s inflation.

The thing to keep in mind is that inflation is a ratchet – the higher prices often do not decrease – they create a new plateau. So if prices increase 6% and wages increase 4%, it will take a while for wages to catch up, and in the meantime people will be worse off.

Job openings decreased to 11.4 million, but are still at close to record levels. Layoffs hit a record low of 1.2 million, while quits edged down slightly to 4.4 million. Separately, 200,000 people filed for initial unemployment benefits last week. The labor market remains strong, and that should bolster the economy going forward.

JP Morgan CEO Jamie Dimon got the market’s attention yesterday when he warned of an economic hurricane. “You know, I said there’s storm clouds but I’m going to change it … it’s a hurricane,” Dimon said Wednesday at a financial conference in New York. While conditions seem “fine” at the moment, nobody knows if the hurricane is “a minor one or Superstorm Sandy,” he added. “You’d better brace yourself,” Dimon told the roomful of analysts and investors. “JPMorgan is bracing ourselves and we’re going to be very conservative with our balance sheet.”

He is primarily worried about the Fed’s quantitative tightening, or the reversal of its bond buying program. He is right that we are in uncharted territory here. The last time the Fed tried quantitative tightening, it caused major disruptions in the money market. That was during an environment of benign inflation, so the Fed was able to reverse its policy easily. That might not be possible this time around.

Morning Report: Energy constraints are driving inflation

Vital Statistics:

S&P futures4,15422.25
Oil (WTI)116.2551.94
10 year government bond yield 2.85%
30 year fixed rate mortgage 5.34%

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

Manufacturing expanded in May, according to the ISM Manufacturing Report. This is the second-lowest reading since September, 2020. New Orders and production improved, while prices inflation is moderating. Employment is falling. “The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. Despite the Employment Index contracting in May, companies improved their progress on addressing moderate-term labor shortages at all tiers of the supply chain, according to Business Survey Committee respondents’ comments. Panelists reported slightly lower rates of quits compared to April. May was a second straight month of slight easing of prices expansion, but instability in global energy markets continues. Surcharge increase activity appears to be stabilizing across all industry sectors. Sentiment remained strongly optimistic regarding demand, with five positive growth comments for every cautious comment. Panelists continue to note supply chain and pricing issues as their biggest concerns.

Janet Yellen admitted she was wrong about inflation over the past couple of years. “Well, look, I think I was wrong then about the path that inflation would take,” the Treasury secretary said when asked about her previous comments. “As I mentioned, there have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t — at the time didn’t fully understand. But we recognize that now.”

When discussing inflation, it pays to look at how some inputs affect each other. For example, here is a chart of natural gas:

Natural gas is a big component of electricity generation, and energy-intensive industries will have to pass on that increased costs to consumers.

Know what else is reliant on natural gas? Food. This is because natgas is a big input into fertilizer, which makes growing food more expensive. The US is a net exporter of natural gas, so world markets are not driving this. This is a capacity issue in the US, which ironically is the Saudi Arabia of natural gas. ESG (environmental and social justice funds) have declared war on fracking and made difficult for energy companies to raise funds for exploration and production. Of course as prices rise, we might see some members of the Climate Action 100 break ranks, however this is going to be a constraint on new production. It is the elephant in the room with the business press but realistically there is no lever that Washington can push. Additional drilling permits will do nothing if the energy companies can’t get financing.

Refining capacity has fallen over the past several years, and in order to maintain production of gasoline, diesel fuel refining has taken the hit, driving up diesel (and therefore transportation costs). Of course this gets passed onto consumers in the form of higher prices. Regulations could help here, especially suspending the Jones Act which requires American-flagged ships to transport goods from one US port to another. Shortages of diesel, particularly on the East Coast) could be addressed with supply elsewhere in the US.

Mortgage applications fell 2.3% last week as purchases fell 1% and refis fell 5%. Mortgage applications are at the lowest level since 2018. “Concerns of weaker economic growth and the recent stock market sell-off drove Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The purchase market continues to struggle with supply and affordability challenges. With the 30-year fixed rate at 5.33 percent, the refinance market continues to shrink, led by larger decreases last week for FHA and VA refinance applications. The refinance index was 75 percent below last year’s level, when rates were more than 200 basis points lower.”

Morning Report: House prices rose 19% YOY in Q1

Vital Statistics:

S&P futures4,143-10.25
Oil (WTI)119.233.94
10 year government bond yield 2.83%
30 year fixed rate mortgage 5.27%

Stocks are lower this morning as oil continues to climb. Bonds and MBS are down.

The upcoming week is packed with data, with the jobs report on Friday, ISM numbers and productivity. The jobs report will be the most impactful on the markets, however the consensus is that the Fed will hike by 50 basis points at the June meeting and another 50 at the July meeting.

House prices rose 18.7% YOY in the first quarter, according to the FHFA House Price Index. “High appreciation rates continued across housing markets during the first quarter of 2022,” said William Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “Strong demand coupled with tight supply have kept prices climbing.  Through the end of March, higher mortgage rates have not yet translated into slower ​​price gains, but new home sales have dropped during the last few months, with a significant falloff in April.”

The fastest growing states were Florida (up 30%), Arizona (up 28%), Utah (up 27%), Tennessee (up 26%) and Idaho (up 26%). The slowest MSA was Washington DC (up 7%). You can see the rapid rise in home prices in the chart below which looks at Q1 appreciation since 2011 when home prices bottomed after the bubble.

Though there is disagreement amongst economists whether money printing causes asset inflation, the above chart certainly correlates with the increase in the money supply.

Mortgage backed securities have been unpopular this year ahead of the Fed’s plan to increase rates and sell some of its portfolio. The additional yield required by MBS investors has risen to 1.2% compared to 0.70% at the beginning of the year. Annaly Capital, a major mortgage REIT has raised capital to start increasing its portfolio of mortgage backed securities. The mREIT stocks have been sold off hard over the past year, but the feared dividend cuts have not materialized. Annaly currently yields over 13%, and AGNC Investment yields 12%

The increase in MBS spreads has also been driven by extreme volatility in the bond market. Since borrowers have the option to prepay the mortgage early, MBS investors are “short” that option. This means that as volatility increases, the value of that option increases, which increases the difference between the yield on Treasuries and mortgage backed securities. The TBA market is trading at extremely wide bid-ask spreads which demonstrates some of the fear in the market.

Bond market volatility seems to be calming down, which will naturally pull MBS yields closer to Treasury yields. In addition, we are seeing relative value investors like the mortgage REITs begin to put in a floor on MBS. If Treasuries stabilize, I would expect to see mortgage rates work lower. We might have already seen the highs of the year in mortgage rates.

Sun Belt cities are the fastest-growing, with 1/3 of them in Arizona. Florida is also seeing a big increase. Where are they coming from? The biggest cities in the US – New York City (which lost 305k people in 2021), Los Angeles, Chicago, San Francisco. 8 of the 10 largest cities in the US lost population in 2021.

Morning Report: Inflation decelerating?

Vital Statistics:

S&P futures4,08430.25
Oil (WTI)113.74-0.9
10 year government bond yield 2.74%
30 year fixed rate mortgage 5.29%

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

The stock market is open for a full day today, but the bond market closes early at 2:00 pm. Liquidity should be downright lousy in the MBS market as most of the street will be on the LIE by noon.

Personal incomes rose 0.4% MOM in April, according to BEA. Personal consumption expenditures rose 0.9%. Incomes were lower than street expectations, while income were higher.

The PCE price index rose 0.2% MOM and 6.3% YOY. Ex-food and energy it was up 0.3% MOM and 4.9% YOY. The trend in the core rate has been decelerating which is good news as far as the Fed is concerned. The YOY numbers are still bad, but it looks like the worst is over as far as inflation goes.

Regardless of the inflation picture, consumer sentiment remains dour. It is back at the lows of 2008 -2010 and 2012. The drop in sentiment was driven primarily by buying conditions for durable goods and housing. Inflation is the key driver here, although housing inventory has been an issue for over a decade. Still, lower inventory and higher borrowing costs are making things difficult for would-be first time homebuyers. That said, consumers view this situation as temporary, and future expectations are higher.

Morning Report: GDP revised downward

Vital Statistics:

S&P futures3,99113.25
Oil (WTI)112.142.59
10 year government bond yield 2.76%
30 year fixed rate mortgage 5.33%

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

GDP growth in the first quarter was revised downward from -1.4% to -1.5%, according to BEA. The PCE price index, which measures inflation was steady at 7%. Ex-food and energy, the PCE index was revised downward from 5.2% to 5.1%. Inventory and exports were the reason for the decline in GDP growth.

The FOMC minutes didn’t have much effect on the markets yesterday. Inflation remains too strong for the Fed’s liking and the Street is looking for 50 basis point hikes in June and July.

They discussed the negative GDP print in Q1 specifically.

Participants commented that after its rapid growth in the last quarter of 2021, real GDP had declined in the first quarter of this year, with net exports and inventory investment making large negative contributions to growth. They noted, however, that these volatile components tended to contain little signal about subsequent growth and that household spending and business fixed investment had remained strong in the first quarter. These advances and the further tightening of labor market conditions were judged consistent with significant underlying momentum in the domestic economy.

The Fed thinks that GDP growth remains solid, and that fiscal policy will act as a natural drag on the economy while the supply chain issues will get worked out. In addition, a few members thought there were signs that the pandemic-related restrictions on labor supply were easing. I take this to mean that many workers who were staying out of the labor market due to health fears are now re-entering the labor force. Of course inflation could have something to do with that as well.

The characterization of GDP growth as “solid” is somewhat contradicted by the latest GDP Now estimate out of the Atlanta Fed, which just revised its estimate downward from 2.4% to 1.8%. I suspect the putrid new home sales number had something to do with it.

Speaking of new home sales, pending home sales fell 3.9% in April, according to NAR. Year-over-year pending home sales are down 9.1%.”Pending contracts are telling, as they better reflect the timelier impact from higher mortgage rates than do closings,” said Lawrence Yun, NAR’s chief economist. “The latest contract signings mark six consecutive months of declines and are at the slowest pace in nearly a decade. The escalating mortgage rates have bumped up the cost of purchasing a home by more than 25% from a year ago, while steeper home prices are adding another 15% to that figure. The vast majority of homeowners are enjoying huge wealth gains and are not under financial stress with their home as a result of having locked into historically low interest rates, or because they are not carrying a mortgage,” Yun explained. “However – in this present market – potential homebuyers are challenged and thus may attempt to mitigate the rising cost of ownership by opting for a 5-year adjustable-rate mortgage or by widening their geographic search area to more affordable regions.”

Morning Report: MBA refinance index back to lows of 2018

Vital Statistics:

S&P futures3,932-18.25
Oil (WTI)110.400.59
10 year government bond yield 2.73%
30 year fixed rate mortgage 5.32%

Stocks are flattish this morning on no real news. Bonds and MBS are flat as well.

Rates have been falling the past few days, which seems to be a return to the “risk off” mentality where investors sell stocks to buy bonds. Regardless of the reason, mortgage rates are beginning to come down which is good news for borrowers. This might be a good time to wake up some borrowers. The latest economic data has been somewhat subdued, which helps the situation. We are nowhere near recessionary territory for this year, but if growth is slowing that takes some pressure off the Fed.

The FOMC minutes will be released today at 2:00 pm. The minutes are usually not market-moving but with the bond market so skittish they might take on more importance.

Mortgage applications fell 1.2% last week as purchases increased by 0.2% and refis fell by 4%. “The 30-year fixed rate declined for the second straight week to 5.46 percent but remains well above what borrowers were used to over the past two years,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Most refinance borrowers continue to remain on the sidelines as a result, and refinance applications have fallen in nine of the past 10 weeks. Compared to January 2022, refinance activity is down 66 percent.” You can see we are at the lows of early 2018 on the refi index.

Durable Goods orders rose 0.4% in April, which was a deceleration from March. Ex-transportation (which tends to be volatile) they rose 0.3%. This is further evidence that the Fed’s actions to slow the economy have working.

You don’t have to look at the charts of the major mortgage bankers (Mr. Cooper notwithstanding) to know that profits fell in the first quarter. The MBA Mortgage Bankers Performance Report showed that average pretax profit was only 5 basis points, which is well below the 55 basis point average since 2008. Rising costs were the big driver.

“It was a challenging mortgage market environment in the first quarter of 2022, with rising mortgage rates and low housing inventory resulting in lower production volume,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “In addition to cost increases, productivity slipped for both sales and fulfillment staff “Furthermore, pull-through rates of closings to applications declined by 5 percentage points in the first quarter, affecting both revenue and cost. With the record-setting refinance volume of the past two years in the rearview mirror, the mortgage industry is clearly in a period of transition and many companies will need to make tough decisions.”

Average production volume fell 29% compared to the fourth quarter, while production revenue was more or less flat at 350 basis points. Servicing income rose to $242 per loan from $71 in the fourth quarter.

Morning Report: New Home Sales collapse

Vital Statistics:

S&P futures3,933-38.25
Oil (WTI)110.20-0.19
10 year government bond yield 2.80%
30 year fixed rate mortgage 5.43%

Stocks are lower this morning after Snap reported lower-than-expected earnings / guidance. Bonds and MBS are up.

Jerome Powell will be speaking at 12:20 today. I don’t see any prepared remarks, but markets are a on a hair trigger these days, so just be aware.

New Home Sales fell to a seasonally-adjusted annual rate of 591,000 in April, which was way below consensus estimates. This is down 17% MOM and 27% compared to a year ago. The report doesn’t give much color on the reasons for the decline, and these reports often have a pretty large sampling error. This reading is typical for what we saw in the 70s and 80s.

The expansion slowed in May, according to the Markit PMI Composite Flash index. The index hit a 4 month low, with manufacturing and services both declining. New orders increased, albeit at the slowest pace since August 2020. Rising input prices hit a series high going back to 2009. “The early survey data for May indicate that the recent economic growth spurt has lost further momentum. Growth has slowed since peaking in March, most notably in the service sector, as pent up demand following the reopening of the economy after the Omicron wave shows signs of waning. Companies report that demand is
coming under pressure from concerns over the cost of living, higher interest rates and a broader economic slowdown.”

Note this puts the Fed in a bit of a bind, as demand is starting to wane early in the tightening cycle. Inflation remains too high for them to pull back on the increases quite yet.

Americans’ financial well-being improved in 2021, according to a Fed study on the subject.

Despite persistent concerns that people expressed about the national economy, the survey highlights the positive effects of the recovery on the individual financial circumstances of U.S. families. In 2021, perceptions about the national economy declined slightly. Yet self-reported financial well-being increased to the highest rate since the survey began in 2013. The share of prime-age adults not working because they could not find work had returned to pre-pandemic levels. More adults were able to pay all their monthly bills in full than in either 2019 or 2020. Additionally, the share of adults who would cover a $400 emergency expense completely using cash or its equivalent increased, reaching a new high since the survey began in 2013.

The report also looks at the emerging use of buy-now-pay-later credit, which allows people to finance purchases using simple interest and making a small number of equal payments. The people who use this often skew towards lower income and education.

Morning Report: ARMS making a comeback

Vital Statistics:

S&P futures3,94140.25
Oil (WTI)110.280.69
10 year government bond yield 2.83%
30 year fixed rate mortgage 5.40%

Stocks are higher this morning after the Biden Administration floated the idea of eliminating some tariffs on overseas goods. Bonds and MBS are up small.

The upcoming week will be relatively data-light, however we will get new home sales and personal incomes / outlays. The personal incomes / outlays number will be watched closely because it contains the inflation number. Markets will be watching closely to see if we are getting some relief in the month-over-month numbers. The year-over-year inflation numbers will be bad, of course but markets are looking for an indication that inflation is on the decline.

Economic growth is accelerating, according to the Chicago Fed National Activity Index. This is a meta index of 85 individual economic numbers. It indicates whether the economy is growing above or below trend. The Atlanta Fed’s GDP Now index has been moving up during May, and is looking at something like 2.3% growth in the second quarter.

The latest concern in the business press is the possibility of a recession. This is due to the fact that the Fed has often overshot to slow the economy. This was particularly true in the 1970s (a similar environment to today). St. Louis Fed President James Bullard doesn’t see a recession this year or next, unless there is a “really large shock” to the economy. “Recessions would have to come because there’s some really large shock and I can’t rule out that there would be some really big shock. Maybe there would be, but I am not seeing it near-term.” Bullard said during an exclusive interview with FOX Business’ Edward Lawrence on “Cavuto: Coast to Coast” on Friday. 

With rising interest rates, adjustable-rate mortgages aka ARMS are making a comeback. The share of ARMS came in at 10% last week, which was a tripling of the previous rate. ARMs allow borrowers to take a lower initial rate, however the rate can move upwards or downwards after a fixed period of time. Note that in the past most ARM loans had 1 year resets i.e. 5/1, 7/1 etc. Now most are based on SOFR, and they are resetting every 6 months. So you’ll hear 5/6, 7/6 etc. You can see in the chart below that ARMs are increasing but they are nowhere near where they were in the early 2000s.

Morning Report: Recession risks rising

Vital Statistics:

S&P futures3,93840.25
Oil (WTI)112.280.69
10 year government bond yield 2.85%
30 year fixed rate mortgage 5.42%

Stocks are higher this morning after China cut interest rates overnight. Bonds and MBS are flat.

The Chinese economic situation will be something to watch as that will probably stick a fork in a lot of the commodity inflation we have been seeing. China has a real estate bubble comparable to the one the US experienced in the 1920s and Japan experience in the 1980s. I suspect that countries which experience decades of supernormal growth often create real estate bubbles, which cause epic slowdowns – the Great Depression in the US, the lost decade in Japan.

Risks for a US recession in late 2022 and early 2023 are building, and we are starting to see some strategists become more pessimistic on the economy. “Recession risks are high — uncomfortably high — and rising,” said Mark Zandi, chief economist at Moody’s Analytics. “For the economy to navigate through without suffering a downturn, we need some very deft policymaking from the Fed and a bit of luck.” Senior executives from Wells Fargo and Goldman Sachs have echoed this sentiment.

Further evidence is coming from retailer earnings. “While we anticipated a post-stimulus slowdown in these categories … we didn’t anticipate the magnitude of that shift,” Brian Cornell,Target’s chief executive, said in a Wednesday earnings call. “When we talk to our guests, they often express their concerns about a host of rapidly changing conditions, ranging from geopolitics to the high and persistent inflation they’ve been experiencing.”

Recessionary risks will put a ceiling on interest rates, which is why we may have seen the peaks of interest rates already in this tightening cycle. That said, the Fed Funds futures have yet to reflect this changing sentiment.

Lower-credit borrowers are beginning to fall behind in auto loans and credit cards. Delinquencies are rising in these sectors, which should at some point filter through to FHA loans, I suspect. We are still in a historically strong credit environment (stimulus checks plus a healthy labor market) but if we do see a recession credit quality will deteriorate. 30 day mortgage delinquency rates are at 2.8%, which is down 40% from last year.