The Daily Tearsheet

Morning Report: 75% of the US Treasury market is under water

Vital Statistics:

	Last	Change
S&P futures	2773.25	10.1
Eurostoxx index	383.72	1.4
Oil (WTI)	74.01	0.21
10 Year Government Bond Yield		2.86%
30 Year fixed rate mortgage		4.50%

Stocks are higher this morning as trade war fears recede. Bonds and MBS are down.

Earnings season begins this week, with a bunch of the big banks reporting on Friday.

The biggest econ data will be the PPI and CPI on Wednesday and Thursday. For the most part it should be a quiet week.

Leandra English has resigned from the CFPB. She was the Deputy Director for Richard Cordray, and believed she should have been given the job instead of Mick Mulvaney. She sued in Court and lost. Now that Kathy Kraninger has been nominated, she is gone.

Donald Trump will announce his SCOTUS pick at 9:00 pm tonight. The favorites are Brett Kavanaugh and Thomas Hardiman.

Interesting stat: 75% of the US Treasury market trades under par. This is the highest percent ever recorded (we started measuring this in the 80s). In the past, it generally peaked around 50%, which happened at the end of Fed tightening cycles and was usually a buying opportunity. I would note that these were in the context of a secular bull market in bonds. In secular bull markets, you buy the dip. We are now in a secular bear market in bonds and that changes the dynamic.

The REO-to-Rental Trade was a big winner over the past several years. Hedge funds and pension funds bought foreclosed properties for pennies on the dollar, fixed them up and rented them out, earning high single digit returns. As home prices rise, you would think these people will start ringing the register. Turns out they are doubling down. Professional investors are buying up homes in urban areas with good schools. This is making things even tougher for the first time homebuyer who is struggling to find a starter homes. That said, it isn’t a ridiculous number – last year major investors bought 29,000 homes, which is a drop in the bucket compared to total existing home sales of 5.45 million.

Morning Report: Goldilocks jobs report and the FOMC minutes

Vital Statistics:

	Last	Change
S&P futures	2740	2
Eurostoxx index	381.23	-0.36
Oil (WTI)	42.31	-0.63
10 Year Government Bond Yield		2.82%
30 Year fixed rate mortgage		4.52%

Stocks are flattish this morning as a good jobs report offsets the new tariffs that went into effect this morning. Bonds and MBS are up.

Jobs report data dump:

Payrolls up 213,000 (street was looking for 190,000)
Unemployment rate 4% (.2% increase, street was looking for 3.8%)
Labor force participation rate 62.9% (.2% increase)
Average hourly earnings +.2% MOM / 2.7% YOY (in line with expectations)

Overall, a good report – strength in payrolls, and an increase in the labor force participation rate. The labor force increased by 600k, where the number of unemployed increased 500k and the number of employed increased 100k. Of those 500k added to the ranks of the unemployed, 200k were re-entrants to the labor force. The achilles heel (at least as far as those looking for wage growth) has been the reservoir of the long-term unemployed. This will help ease some of the labor shortage, which has been a constraint on growth. It will also raise the non-inflationary growth rate for the economy overall, which is kind of like a speed limit. For the Fed, this is a bit of a Goldilocks report – it gives them the breathing room to lift rates gradually which limits the risk of a recession.

The FOMC minutes didn’t really reveal much new information. Most pointed to the strong labor market and cited several statistics (JOLTS, unemployment rate, regional Fed surveys) to point to a tight labor market. “Several” members (i.e. a minority) thought that there was still some slack in the market as the long term unemployed are re-entering the labor market. Note this morning’s jobs report bears that out. The members also discussed the slope of the yield curve, and whether the flattening was telling them anything. Interestingly, only “some” participants thought that the Fed’s asset purchase program (i.e. QE) was affecting the shape of the yield curve, and therefore distorting the information sent from it. Kind of begs the question – if QE didn’t affect the shape of the yield curve, then what was the point? Or even more importantly, why do they still have $4.5 trillion worth of bonds on the balance sheet?

The Fed also thought about the possibility of a trade war and how that would end up slowing down the economy. They also thought that they might have to raise the Fed funds rate further than they had anticipated earlier: “With regard to the medium-term outlook for monetary policy, participants generally judged that, with the economy already very strong and inflation expected to run at 2 percent on a sustained basis over the medium term, it would likely be appropriate to continue gradually raising the target range for the federal funds rate to a setting that was at or somewhat above their estimates of its longer run level by 2019 or 2020.”

The Fed Funds futures turned slightly more hawkish on the minutes, with the probability of a Sep hike increasing from 75% to 80% and the chance of a Sep and Dec hike hitting 53%.

In other economic news, the trade deficit fell to the lowest level in 18 months. Not sure how much of that is due to tariffs already in place.

Tariffs (especially lumber) are wreaking havoc on the entry-level new housing market. Builders generally have to purchase things like land and materials up front before they build and get paid for the construction. When materials prices are artificially supported by tariffs, that increases their risks, and makes them pull back.

Morning Report: Gen X hit hardest by Great Recession

Vital Statistics:

	Last	Change
S&P futures	2733	19.7
Eurostoxx index	382.97	2.89
Oil (WTI)	74.32	0.2
10 Year Government Bond Yield		2.85%
30 Year fixed rate mortgage		4.54%

Stocks are higher this morning on rumors that the Trump Administration is dialing back its plans for tariffs on European autos. Bonds and MBS are flat.

The minutes from the June FOMC meeting are coming out at 2:00 pm today. Be careful locking around then since they could be market-moving.

The service economy continues to plow ahead, according to the ISM Non-Manufacturing Survey. Higher input prices, tariffs, and labor shortages are the biggest worries. Trucking shortgages are increasing prices, and that has the potential to push up inflation since it touches just about every business, at least indirectly.

The economy added 177,000 jobs last month according to the ADP Survey. This was a touch below street estimates. Note that ADP numbers have generally been higher than the government’s for the past several months. The Street is looking for 191,000 jobs in tomorrow’s payroll report. While the payroll number will be important, for the bond market, it will all come down to the average hourly earnings number.

Initial Jobless Claims ticked up to 231,000 last week. Separately, outplacement firm Challenger, Gray and Christmas noted there were 37,000 announced job cuts in May.

Tariffs on about $34 billion worth of Chinese exports are set to go into effect tomorrow. Beijing has announced it will retaliate with more tariffs the “instant it goes into effect.” Trade fears have been weighing on the stock market, and we are seeing some effects in commodity prices. Today’s minutes will probably discuss the issue at length. On one hand, this trade war is pushing up commodity prices, which is inflationary and should encourage the Fed to lean hawkish, at least at the margin. On the other hand, trade wars are an economic drag, which should encourage more dovishness. The Fed generally considers commodity inflation to be transitory, so on net trade wars should encourage dovishness, at least at the margin.

Oil prices have been a problem for while now, as WTI crude now trades close to $75 a barrel. Oil prices have been rising due to Venezuela issues and pressure on Europe to not buy Iranian oil. Trump tweeted that OPEC should increase production, which caused Saudi Arabia to announce it would increase output and Iran to announce that his pressure on them have added about $10 to the price of oil in the first place. At the end of the day however these issues affect North Sea Brent prices, which really only matter to East Coast refineries. The rest of the country uses US domestic oil. Higher gas prices do make consumers surly and the Administration wants to see them down ahead of midterms this fall.

Here are the hottest real estate markets in June, according to Realtor.com. Note it isn’t the names you would think.

Interesting chart in today’s Journal about which breaks down the labor force participation rate by age cohort. The press keeps harping on the job market for entry level workers (essentially the Millennial Generation) however if you look at the labor force participation rate for that cohort, it is lower than the year 2000, but not by much. Nor is the problem the 55+ cohort (baby boomers). They are close to all-time highs. It is Gen X that is the issue – their cohort peaked around 83% in 2000 and now is closer to 80%. It is this generation that was hit hardest by the Great Recession (nailed right during the peak earnings years) and has yet to recover.

Morning Report: ISM strong, tight labor market, Fed Funds still see a coin toss for 2 hikes this year.

Vital Statistics:

	Last	Change
S&P futures	2737	10
Eurostoxx index	380.51	3.77
Oil (WTI)	75	1.06
10 Year Government Bond Yield		2.87%
30 Year fixed rate mortgage		4.52%

Stocks are up this morning as emerging markets rally overnight. Bonds and MBS are flat.\

Today should be quiet as markets close early ahead of the 4th of July holiday.

Manufacturing continued to plow ahead in June, according to the ISM PMI Index. The responses from the survey participants show that the trade war is having some impact. One food and beverage company mentioned that they were shifting some production to Canada in order to escape Chinese retaliatory tariffs on US products. Inflationary pressures are present in higher commodity prices, and we are seeing secondary pressure from transportation (higher oil prices and driver shortages are pushing up prices here). Pretty much every commodity is seeing price increases, and there are material shortages in aluminum, steel, and electronic components. Overall, this is a strong manufacturing reading, which is usually associated with 5.2% GDP growth. Of course, manufacturing isn’t the driver of the economy it used to be, but it is still a strong reading.

The Fed is going to pay close attention to this report, particularly the part about labor shortages. From their standpoint, inflationary pressures from commodity price inflation are generally considered transitory and therefore temporary. An old saw in the commodity markets is that the cure for high prices is high prices. The potential dampening effect from trade battles will also concern them. IMO, until you start seeing wage inflation pick up in a meaningful way the Fed will consider this a push. Note we will get some insight into this on Thursday when the minutes from the June meeting are released.

The Fed funds futures are still handicapping a 76% chance of a 25 bp hike in September and a 45% chance of one in December as well.

Construction spending rose 0.4% in May, and is up 4.5% on an annualized basis. Residential construction was up 0.8% MOM and 6.6% YOY, as an increase in private resi construction was offset by a drop in public housing spending. Manufacturing construction took a step back, which will be something to watch (could just be noise, but could be trade-related). Meanwhile retail (specifically mall-related construction) is in the doldrums as vacancy rates soar.

Home price appreciation accelerated in May, according to the CoreLogic Home Price index. Prices rose 1.1% MOM and are up 7.1% YOY. The housing shortage is well-documented, and the problem is most acute at the entry-level. Higher rates and low inventory is also preventing some people from moving. CoreLogic estimates that 50% of the mortgage market has a rate of 3.75% or lower. According to CoreLogic’s model which compares home price appreciation to income appreciation, we are seeing large pockets of overvaluation, particularly in Florida, the West Coast, the sand states, and parts of the Eastern Seaboard. The Midwest remains cheap.

Trump is reportedly mulling whether to pick a new Chief of Staff. One of the potential candidates is current CFPB Chairman Mick Mulvaney. Mulvaney is currently doing double duty as OMB and CFPB head, so a change for him would be unlikely, but the possibility is still there. Here are the implications of a change and who might replace him.

Labor shortages continue to be an issue in the Midwest. Companies are now less squeamish about hiring ex-cons. In Elkhart, (where the labor market is so tight it sports a 2% unemployment rate and even the KFC is offering sign-on bonuses), companies are hiring convicted felons (except sex offenders) and are waiving drug tests. It is a back-to-the future scenario, where the labor market is suddenly transported back to 1955.

Morning Report: New Down Payment Assistance programs

Vital Statistics:

	Last	Change
S&P futures	2728.75	9.5
Eurostoxx index	379.91	3.04
Oil (WTI)	73.39	-0.06
10 Year Government Bond Yield		2.84%
30 Year fixed rate mortgage		4.52%

Stocks are higher this morning on end-of-quarter window dressing. Bonds and MBS are flat.

Personal incomes rose 0.4% in May while personal spending rose 0.2%. Incomes were in line with estimates, while spending was lower. The June FOMC statement said that consumer spending was accelerating – no evidence of that in this report. Services spending drove the decline, and we could be seeing evidence that higher gasoline prices is affecting discretionary expenditures. Inflation was in line with expectations at the MOM level, and a hair above expectations on an annual basis. The core PCE index ex-food and energy came in at 2%, which is right where the Fed wants it. April’s income and spending numbers were revised downward. Don’t be surprised if strategists take down some of their Q2 GDP forecasts on these numbers.

The Chicago PMI improved to 64 from 62, which is a 5 month high. New Orders and order backlog drove the increase. We are seeing some signs of inflation brewing, with extended lead times, and a 7 year high on the prices paid index. Businesses were asked about how trade was affecting their operations. About 25% said they were having a significant impact, 40% said there was a minimal impact, and the rest were either unsure or insulated from trade issues.

KB Home reported strong numbers, with a 170 basis point increase in gross margins, 10% revenue growth, and a 50% increase in operating income. ASPs were up 4% to 401,800, and order growth was 3%. Backlog was the second highest on record. The stock is up 7% pre-open.

Interesting theory about the lack of construction workers: opiods. Between users and those that have been convicted of crimes related to usage, many workers are shut out of the work force. 80% of homebuilders report shortages in subcontractors.

The Senate will hold hearings on July 12 and 19th for Kathy Kraninger’s nomination to run the CFPB. The conventional wisdom is that she is not intended to be confirmed, but is to be an excuse to keep Mick Mulvaney in charge of the agency.

Deutsche Bank failed its stress test, while State Street, Goldman and Morgan Stanley got dinged.

Many Millennials are struggling to get a down payment for a home, and now some companies are working to help them get it. One company will supply up to a $50,000 downpayment if the borrower rents out a room on Air B&B and shares the income with the company. These loans are appealing to borrowers who might qualify for a FHA or 3% down Fannie loan but don’t want to pay the MI and other costs. While there are fears that we are bringing back the bad old days of the real estate bubble, here is the MBA’s mortgage credit availability index. We are a long way away from the days of the pick-a-pay mortgage.

Morning Report: Second quarter GDP revised downward

Vital Statistics:

	Last	Change
S&P futures	2695	-8.5
Eurostoxx index	376	-3.9
Oil (WTI)	72.39	-0.39
10 Year Government Bond Yield		2.83%
30 Year fixed rate mortgage		4.53%

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

The third estimate for first quarter GDP came in lower than expected, as an upward revision in the price index and a downward revision in consumer spending lowered the third and final estimate from 2.2% to 2%. The price index was revised upward from 1.9% to 2.2%, while consumer spending was revised downward from 1% to 0.9%. Housing was actually a negative in the first quarter. I may sound like a broken record, but from 1959 to 2002, housing starts averaged 1.5 million per year, with a much smaller population. Post-bubble, we have averaged around a million per year. Just to get supply and demand into balance probably requires 2 million starts, which would do wonders for GDP. Incidentally, yesterday’s inventory figures prompted the Atlanta Fed to take up its tracking estimate for second quarter GDP to 4.5%.

The drop in the 10 year yield has probably been influenced by the Fed Funds futures, which have been inching towards one more hike this year as opposed to 2. Current probability levels:

No more hikes: 11%
One more hike 44%
Two more hikes: 42%
Three hikes 2%

While the US economic data probably supports more hikes in interest rates, wage growth remains muted, and the sell-off in emerging markets is being viewed as a canary in the coal mine for global growth. Finally fears of a trade war are bearish for the economy, which would give the Fed another excuse to hold off in either September or December.

Initial Jobless Claims increased to 227k last week, which is still an astoundingly low level. Meanwhile corporate profits were revised upward in the first quarter from 0.1% to 2.7%.

Ben Carson testified in front of the House Financial Services Committee yesterday, where he laid out some of the changes he has implemented at HUD. He has made some changes with the Home Equity Conversion Mortgage program (aka reverse mortgages) to put the insurance fund on sounder footing. He is emphasizing the removal of lead paint and other hazards in HUD housing, and has suspended the Obama-era scheduled cut in the FHA mortgage insurance premium. HUD is concerned about the number of FHA cash-out refinances, which have increased from 45% of refis to 60% in the last year. (As an aside, since rate / term refi opportunities are largely gone, so you would expect to see an increase in the percentage of cash-outs).

Why socially responsible investing sounds like a nice idea, but isn’t a free lunch. You can “do good” but you should be prepared to underperform.

Morning Report: Yield curve continues to flatten

Vital Statistics:

	Last	Change
S&P futures	2727.25	-1.25
Eurostoxx index	379.19	1.85
Oil (WTI)	71.15	0.62
10 Year Government Bond Yield		2.86%
30 Year fixed rate mortgage		4.57%

Stocks are lower despite a moderation in trade rhetoric out of the administration. Bonds and MBS are up.

The yield curve continues to flatten, with the 2s-10s spread at 32 basis points. The media is going to try and make this a narrative about an upcoming recession.

Mortgage applications fell 5% last week as purchases fell 6% and refis fell 4%. Rates increased slightly. So far, we aren’t seeing much evidence that lower rates are helping the business.

Durable Goods orders fell 0.6% in May, which was well below expectations, although the prior month was revised upward. Transportation and defense drove the decline. Core capital goods fell 0.2%, which indicates business capital expenditures took a step back. It is probably too early to say definitively whether tariffs are playing a role here, but it is something to watch. Tariffs are a “cut off your nose to spite your face” sort of policy which can often win votes within a narrow constituency, but hurt everyone else and are a net negative for the economy.

Retail inventories increased 0.4% and wholesale inventories increased 0.5%.

Pending Home Sales fell for the fifth consecutive month, according to NAR. Lawrence Yun, NAR chief economist, says this year’s spring buying season will go down as one of unmet expectations. “Pending home sales underperformed once again in May, declining for the second straight month and coming in at the second lowest level over the past year,” he said. “Realtors® in most of the country continue to describe their markets as highly competitive and fast moving, but without enough new and existing inventory for sale, activity has essentially stalled. With the cost of buying a home getting more expensive, it’s clear the summer months will be a true test for the housing market. One encouraging sign has been the increase in new home construction to a 10-year high,” added Yun. “Several would-be buyers this spring were kept out of the market because of supply and affordability constraints. The healthy economy and job market should keep many of them actively looking to buy, and any rise in inventory would certainly help them find a home.”

While there may be a shortage of single family homes for sale, the market for rentals is getting saturated, at least in major cities. Rents on average rose 2.3% in the second quarter, the weakest increase since 2010. Rents were more or less flat in Seattle, where home price appreciation is in double digits. That is a shocking statistic. In response to the drop in demand for single family houses in the aftermath of the bubble, developers went all-in on apartment construction, particularly in urban areas. Now there is a glut, and landlords are offering incentives to take out a lease. According to REIS, the rental vacancy rate ticked up to 4.8% in the second quarter from 4.3%. Meanwhile, Millennials are getting married, having kids, and looking for single family homes. Perhaps the Great Millennial Migration to the Suburbs is finally upon us.

Lennar reported a big jump in earnings, however this was the first quarter with CalAtlantic, so results aren’t really comparable on a YOY basis. During the quarter, the company used $1.1 billion in cash to redeem some high interest CalAtlantic debt. ASPs rose 11%, however some of that is probably due to CalAtlantic, which is located in higher cost MSAs. Despite rising rates, CEO Stuart Miller reported that demand was strong, and the company still has pricing power to support margins.

Morning Report: Case-Shiller continues to move higher

Vital Statistics:

	Last	Change
S&P futures	2724	1.5
Eurostoxx index	378.31	1.12
Oil (WTI)	68.22	0.14
10 Year Government Bond Yield		2.88%
30 Year fixed rate mortgage		4.57%

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

Consumer confidence slipped in June, according to the Conference Board. The decline, while still high by historical standards, was driven more by a drop in the outlook than it was by a decline in current conditions.

Home price appreciation continued in April, with some real eye-popping moves in a few MSAs. Seattle and Las Vegas were up 13%, YOY, San Francisco was up 11%. Bringing up the rear was Chicago and Washington, up 3%. While the index has hit its 2006 peak, it is important to remember these are nominal (i.e non-inflation adjusted) numbers. If you adjust for inflation, Dallas, Denver and Seattle have regained their bubble peaks, while everyone else is still lower. Inventory is still tight, but the picture is improving.

Housing demand was up 7% in May, according to Redfin. Redfin measures housing demand by counting the number of offers and requests for home tours. Demand is actually down from a year ago, but the market is still a seller’s market.

Fears of a trade war are causing big asset allocations into government bonds. The government bond ETF GOVT saw record volume on Friday of $600 million. Momentum traders are beginning to pile into the long Treasury trade. Morgan Stanley is calling the top in yields. “While trade tensions have yet to negatively impact U.S. economic data noticeably, the Fed has started to hear more concern from business contacts. We see risk that such tension will impact economic data more in the coming months, even if a benign outcome comes to pass eventually.” FWIW, the Fed Funds futures are still handicapping a toss-up between 1 or 2 more hikes this year.

For mortgage originators, trade fears are probably going to help keep the 10 year below 3%, though it probably won’t be enough to bring back refi volume or to save the year.

Speaking of saving the year, in the second quarter cost cutting was a #1 or #2 concern for 30% of all mortgage originators. Last year, only 11% saw cost cutting as a #1 or #2 concern, focusing more on consumer-facing technology and process streamlining. In the first quarter, mortgage bankers reported a loss on production for only the second time in 10 years.

Morning Report: New Home Sales jump

Vital Statistics:

	Last	Change
S&P futures	2745	-14.5
Eurostoxx index	379.79	-5.22
Oil (WTI)	69.07	0.49
10 Year Government Bond Yield		2.89%
30 Year fixed rate mortgage		4.57%

Stocks are lower this morning on continued trade tensions. Bonds and MBS are up

Economic activity decelerated in May, according to the Chicago Fed National Activity Index. Production-related indicators were a drag on the index (probably an effect of trade issues) while employment-related indicators had a positive impact once again. This index is a meta-index of 85 different sub-indices, and while it is backward-looking and generally not market moving, it provides a good global snapshot of the economy.

The trade war is beginning to have some real economic effects as the CFNAI indicated. While it is primarily limited to steel, many companies that use it as an input are raising prices, which is going to have a few negative effects on the economy – first firms that use steel and cannot pass on price increases are probably going to lay off workers, while the inflationary pressures from increased prices will keep the Fed raising interest rates. Retaliatory tariffs from our partners are causing US exporters to shift production overseas. Note that lumber tariffs are increasing the price of home construction, which is another drag on the economy.

Given the recessionary potential of trade wars the shape of the yield curve is going to become a bigger talking point for the business press and will be watched closely by the Fed. The shape of the yield curve essentially means the difference between short term rates and long term rates. The most common description is the 2s-10s spread, which is about 34 basis points at the moment. When the yield curve is strongly upward sloping (in other words, the 10 year yield is a lot higher than the 2 year yield) it generally means one of two things: either (a) the market is worried about inflation, and is therefore requiring a high interest rate to entice people to invest in Treasuries long term, or (b) the economy is so strong that investors prefer to put their money in more risky assets and therefore Treasuries have to offer a higher rate to get people interested. For the most part, the US yield curve has been in the second camp.

As the Fed has been raising the Fed Funds rate, the yield on shorter-term paper (like the 2 year) has been going up faster than the rate on the 10 year. Historically, the yield curve has flattened during tightening cycles, so this is nothing to be alarmed about. If the yield curve inverts, then that has historically been associated with the Fed overdoing it and it is taken as a recessionary signal. In the current environment, the flattening of the yield curve looks more like typical curve behavior during a tightening cycle, and not a signal of a recession. Don’t forget the yield curve has been highly influenced by central bank behavior. The Fed could drive up long-term rates by hinting at the possibility of selling some of its portfolio. Bottom line, the business press will be talking about the curve more and more, especially if the trade war begins to snowball and we start seeing a combination of rising input costs with a slowing out output.

New Home sales increased 6.7% MOM and 14.1% YOY to a seasonally adjusted annual rate of 689,000. This is the highest print since November last year. Interestingly, sales rose in the South, but fell everywhere else. In the West, where the supply shortage is most acute, sales fell by 9% MOM and are flat YOY. Both the median and average sales price fell, which is surprising given the torrid pace of home price appreciation in the home price indices like Case-Shiller and the jump in existing home sales prices according to NAR. It appears that more sales at the lower price points was behind the drop. Luxury sales have been more or less flat for the past year. Eventually tax reform is going to have an effect on the top end of the market, as luxury real estate is simply more expensive due to the changes in mortgage interest and the fact that most of the $1MM+ inventory is in high tax states. We will get more of a read on new homes this week as Lennar and KB both report earnings.

Fears of rising interest rates have clearly had no negative effects on new home sales. Given the acute housing shortage and the fact that rates are still very low historically, this isn’t really a surprise.

The Trump Administration announced a plan to reorganize many governmental agencies. The biggest one would merge the Department of Labor and the Department of Education into one agency. On the housing side, USDA loans would be moved from USDA to HUD, which is where they probably belonged in the first place. VA loans will remain under the VA however. Community Development Block Grants would move to Commerce from HUD. The document discusses the need to reform the GSEs and lays out broad ideas, but nothing concrete.

Morning Report: Trump Admin recommends privatizing the GSEs

Vital Statistics:

	Last	Change
S&P futures	2767	14
Eurostoxx index	384.04	3.19
Oil (WTI)	67.44	1.9
10 Year Government Bond Yield		2.92%
30 Year fixed rate mortgage		4.57%

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

The Trump administration released a set of principles around privatizing the GSEs. It is more or less the same thing as before – the goal is to lessen the government’s footprint in the mortgage market. The idea would be to have Fannie and Fred issue MBS with a catstrophic government guarantee – in other words, some private mortgage insurer would bear the initial losses and the government would only step in if the losses exceeded that number. That is all well and good, however there are all sorts of issues that remain before private label MBS can do the heavy lifting of the mortgage market.

First and foremost, there is a huge gulf between what the MBS investor market requires as a rate of return and current mortgage rates. In a perfect world, PL MBS would trade at similar levels to Fannie / Freddie MBS, but they won’t. There are huge governance issues that need to be resolved. For just one example, will the servicer (who is probably the issuer, who may also have a second lien) service the loan to benefit the MBS holder or themselves? What about reps and warranties? I went into more depth about this whole issue here. These uncertainties need to be priced in, which means that the bid / ask spread between private label and FNMA MBS is so large that nobody would take out a mortgage at the rate the private label investors require. That is a necessary but not sufficient requirement to bring back private money into the US mortgage market.

Taking the GSEs out of conservatorship is going to require legislation, and to be honest it isn’t a priority for either party. As far as DC is concerned, yes it would be nice if the government could lessen its footprint in the mortgage market, but people are getting loans, and the market is functioning normally. It just isn’t a priority.

The US borrower believes that the 30 year fixed rate mortgage is nothing unusual. In fact, it is a distinctly American phenomenon, where the borrower bears no risk. In the rest of the world, mortgages are adjustable rate, and not guaranteed by the government. In other words, the borrower bears the interest rate risk and the bank bears the credit risk. In the US, the bank bears the interest rate risk and the taxpayer bears the credit risk. Upsetting that apple cart is going to be a tough slog politically.

Finally, the news did nothing for the stocks of Fannie and Fred, which continue to languish. When the government took over Fannie and Fred, they left 20% of the common outstanding. This was an accounting gimmick to prevent the government from having to consolidate Fan and Fred debt on its balance sheet (incidentally, this was the reason why LBJ privatized the GSEs in the first place). The government could not take the GSEs through a bankruptcy without creating chaos in the mortgage market. So they left 20% outstanding and decided to deal with the bankruptcy part later. The stock should be worthless, but it is a litigation lottery ticket.

A Federal Judge ruled yesterday that the CFPB’s structure is unconstitutional. The PHH case never made it to SCOTUS, but it will be interesting if this one does. At some point, the CFPBs structure will make it to SCOTUS, and the only one with the standing to defend the agency is the government.