Morning Report: Awaiting the Fed

Vital Statistics:

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

The FOMC decision is due at 2:00 pm today. Investors will be looking for language that suggests a pause in rate hikes. We are seeing more Fed officials call for a pause given the First Republic situation. The Fed Funds futures are overwhelmingly predicting 25 basis points today, but the June futures are now assigning a below 10% chance of another 25. Late last week, that number was about 25%.

Larry Summers was interviewed on Bloomberg TV yesterday, and the interviewer asked about reports that up to half of US banks would have negative equity if everything was marked to market. I personally have not seen such reports, but that is a remarkable statistic if true.

Larry’s answer didn’t push back against that claim, however he called it somewhat alarmist because it didn’t take into account that many banks have deposit rates below the interest rate earned on these Treasuries and MBS assets, so they are earning a spread and that below-market rate deposits could be considered asset-like. Of course the problem with that theory is that the bank isn’t in control of that asset. It doesn’t get to determine whether it stays on the balance sheet – the depositor does.

Ultimately, we are talking about Treasuries and MBS and these assets are money good. Now commercial real estate (especially office) is struggling and that could dent the banks.

The economy added 296,000 jobs in April, according to the ADP Employment Report. This was well above expectations and is higher than the forecast for Friday’s jobs report. Pay gains overall rose 6.7%, although the pace of gains is moderating. Job changers saw an increase of 13.2%, a percentage point lower than the previous month and the lowest level since November 2021.

“The slowdown in pay growth gives the clearest signal of what’s going on in the labor market right now,” said Nela Richardson, chief economist, ADP. Employers are hiring aggressively while holding pay gains in check as workers come off the sidelines. Our data also shows fewer people are switching jobs.”

Manufacturing jobs fell, as did professional and business services. Leisure and hospitality accounted for over half the job gains.

Between the banking situation and the inflation situation, the Fed is in a bind. The surest way to fix the banking system is to lower rates, while the inflation situation is not fixed yet. The easiest path is probably to pause and wait to see how things shake out.

The services economy improved in April, according to the ISM Services Index. Employment decelerated, while new orders increased. Prices advanced as well. “There has been a slight uptick in the rate of growth for the services sector, due mostly to the increase in new orders and ongoing improvements in both capacity and supply logistics. The majority of respondents are mostly positive about business conditions; however, some respondents are wary of potential headwinds associated with inflation and an economic slowdown.”

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Morning Report: Job openings decline

Vital Statistics:

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

Construction spending rose 0.3% MOM in February, according to Census. This was up 3.8% compared to a year ago. Residential construction spending was down 0.2% MOM and 10% on a YOY basis. It is interesting how much single family and multi-family construction spending has diverged.

Lending Tree is down some 22% this morning after reporting a disappointing quarter. Mortgage revenues were down big, but home equity was a bright spot. Given the home affordability problems as well as the lock-in effect (i.e. hate the house, love the mortgage) we are probably going to see more emphasis on reno products, and HELOCs are another good way to do some business while we wait for rates to fall.

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The number of job openings decreased to 9.6 million, according to the latest JOLTS jobs report. This was down 384,000 from February and 1.6 million from December 31. The quits rate, which tends to predict wage inflation, fell to 2.5%. The quits rate was 2.9% a year ago.

The job openings rates were highest in leisure / hospitality, especially arts and entertainment. I guess the world needs more poets.

Morning Report: Manufacturing continues to contract

Vital Statistics:

Stocks are flattish this morning after First Republic Bank was seized by regulators over the weekend. Bonds and MBS are down.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The Fed Funds futures are predicting about a 80% chance of a 25 basis point hike this week. Besides the FOMC meeting, the other big piece of data will be the jobs report on Friday.

First Republic Bank was seized by the FDIC over the weekend. JP Morgan will acquire the bank for $10.6 billion. JP Morgan will also get loss coverage from the FDIC of 80% on all acquired loans. The underlying assumption of the deal was that FRB’s loans were marked at 87.

Separately, the Fed’s review of the Silicon Valley Bank situation is here. It basically lays the blame on deregulation and limiting the regulatory burden on the banking system: “In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory action,” the report says, adding that this may have “in some cases led staff not to take action.”

I still find the fact that the Fed didn’t even consider the scenario of rising interest rates in its stress tests to be the biggest surprise. Especially since their policies made that scenario happen. The assets that got the bank in trouble were Treasuries and MBS, but just because an asset doesn’t have credit risk doesn’t mean it has no risk.

The US manufacturing economy improved in April, according to the ISM Manufacturing survey. That said, it remains in contraction territory.  “The U.S. manufacturing sector contracted again; however, the Manufacturing PMI® improved compared to the previous month, indicating slower contraction. The April composite index reading reflects companies continuing to manage outputs to better match demand for the first half of 2023 and prepare for growth in the late summer/early fall period. Demand eased again, with the (1) New Orders Index contracting, but at a slower rate, (2) New Export Orders Index slightly below 50 percent but improving, (3) Customers’ Inventories Index entering the low end of ‘too high’ territory, a negative for future production and (4) Backlog of Orders Index continuing in strong contraction. Output/Consumption (measured by the Production and Employment indexes) was positive, with a combined 4.4-percentage point upward impact on the Manufacturing PMI® calculation. The Employment Index indicated slight expansion after two months of contraction, and the Production Index logged a fifth month in contraction territory, though at a slightly slower rate. Panelists’ comments continue to indicate near equal levels of activity toward expanding and contracting head counts at their companies, amid mixed sentiment about when significant growth will return. Inputs — defined as supplier deliveries, inventories, prices and imports — continue to accommodate future demand growth. The Supplier Deliveries Index indicated faster deliveries, and the Inventories Index dropped further into contraction as panelists’ companies manage inventories exposure. The Prices Index moved back into ‘increasing’ territory, at a moderate level, after one month of marginally decreasing prices.

Morning Report: Inflation remains high

Vital Statistics:

S&P futures4,140 -11.75
Oil (WTI)75.320.57
10 year government bond yield 3.45%
30 year fixed rate mortgage 6.45%

Stocks are lower this morning after disappointing earnings from Amazon. Bonds and MBS are up.

Personal Incomes rose 0.3% in March, while spending was flat. The all-important PCE Price Index rose 0.1% MOM while the core rate rose 0.3%. The headline number rose 4.2% YOY while the core rate was up 4.6%. Inflation continues to move down, although it is well above the Fed’s target range.

This probably won’t change the Fed’s plans to hike 25 basis points next week. The market sees a 90% chance for another 25 basis points next week, and then a 25% chance of another 25 in June. After that, the betting is that rate cuts soon follow.

Employment costs rose 1.2% in the first quarter, according to the BLS. On an annualized basis, employment costs rose 4.5%. Private industry workers saw a 4.8% increase in compensation. Service workers saw increases up to 6%. The rise in service wages is a particular focus for the Fed.

The National Multifamily Housing Council reports that the apartment market is beginning to loosen. “Apartment operators reported an uptick in vacancies and concessions this quarter,” noted NMHC’s Vice President of Research Caitlin Sugrue Walter. “And while some of this softness can be attributed to seasonality, investors remain concerned about the coming wave of supply in some markets and the prospect of slower economic growth in 2023. Only 11% of Quarterly Survey respondents believe that the Fed will be able to achieve a soft landing this year in its effort to rein in inflation. The transaction market, meanwhile, remains at a virtual standstill, with current apartment owners unwilling to offer buyers the lower prices necessary to compensate for both this diminished economic outlook and the elevated cost of debt.”

You can see below how much multifamily units have been coming onto the market. We are at levels last seen since the mid 80s.

Morning Report: GDP growth slows dramatically in Q1

Vital Statistics:

S&P futures4,098 22.0
Oil (WTI)74.53 0.19
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.40%

Stocks are higher this morning after Meta’s numbers surprised to the upside. Bonds and MBS are down.

GDP growth fell to 1.1% in the first quarter, according to the BEA. This was a substantial miss as the Street was looking for a 2% gain. Interestingly, yesterday’s Atlanta Fed GDP Now estimate was spot-on, although the prior week’s estimate was 2.5%.

A slowdown in inventory and homebuilding were drags on GDP growth, while increases in income and spending were positive components. The PCE price index rose 4.2% in the first quarter compared to 3.7% in the fourth quarter. If you strip out food and energy, Q1’s PCE rose 4.9% compared to 4.4% in Q4.

Pending Home sales fell by 5.2% in March, according to the NAR. “The lack of housing inventory is a major constraint to rising sales,” said NAR Chief Economist Lawrence Yun. “Multiple offers are still occurring on about a third of all listings, and 28% of homes are selling above list price. Limited housing supply is simply not meeting demand nationally.”

That said, it isn’t all bad as NAR is more optimistic about the rest of the year: “Sales in the second half of the year should be notably better than the first half as job gains continue and more favorable mortgage rates are expected,” said Yun. “Sales of new homes are already matching 2019 pre-COVID activity and are expected to increase in 2023, largely due to plentiful inventory in this segment of the market.”

Do you think next week will be the last Fed rate increase? Recent comments from Fed officials run the gamut from hawkish to dovish and tightening credit conditions in the wake of recent bank failures contrast with surprisingly resilient economic indicators. What will it mean for the mortgage industry if this is the final rate hike? Register for the first Agile Trader Talk webinar as Tawab Abawi explores these questions with industry veterans Chris Maloney of BOK Financial and Ian Lyngen of BMO Capital Markets. Agile is working to create a better MBS market through digital platforms and industry analysis; register for the End of QT? Mortgage Markets & the Fed Webinar and subscribe to the Agile newsletter to stay in touch with future coverage.  

Sandra Thompson at FHFA put out a statement on the new LLPAs for Fannie and Freddie. These LLPA changes (increasing for high FICO, decreasing for low FICO) have garnered a lot of attention in the media. FHFA says that these LLPA adjustments are being made to better take into account the risk profiles of these loans – in other words low FICO LLPAs were too big in the past. Of course they are basing this on expected performance, and since the COVID-19 pandemic delinquencies have in fact been low. Whether that will continue into the future is an open question given that forbearance might be messing with the numbers.

Things are indeed bad in the office commercial real estate space. The Wall Street Journal has a piece on a building in San Francisco which is for sale and might trade 80% lower than its estimated value in 2019. It is 75% vacant. Nearly 30% of San Francisco’s office space is vacant – about 6x the pre-pandemic level. “We’re all really on the edge of our seats to see the first office trade in San Francisco,” said J.D. Lumpkin, executive managing director at real estate services firm Cushman & Wakefield.

Office REIT Vornado recently suspended its common stock dividend for the rest of the year, and might pay its end-of-2023 dividend with cash or a combination of cash and stock. Interestingly, they authorized a $200 million buyback, as if that will mollify shareholders. Suspend the dividend, but authorize a buyback? Weird.

Office real estate will almost certainly weigh on bank balance sheets, and will probably make banks a little more risk-averse.

Morning Report: Good earnings soothe the market

Vital Statistics:

S&P futures4,103 10.0
Oil (WTI)76.49-0.59
10 year government bond yield 3.41%
30 year fixed rate mortgage 6.39%

Stocks are higher this morning after good numbers from Microsoft. Bonds and MBS are up.

Durable Goods orders rose 3.2% in March, which was well above Street expectations. If you strip out transportation, they rose 0.3%. Core Capital Goods, which can be considered a proxy for business capital expenditures fell 0.4%.

Mortgage Applications rose 3.7% last week as purchases rose 4.6% and refis increased 1.7%. “Both conventional and government home purchase applications increased last week. However, activity was still nearly 28 percent below last year’s pace, as high mortgage rates and low supply have slowed the market this year, even as home-price growth has decelerated in many markets across the country,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Refinance applications also increased last week but remained at half of last year’s levels. Although incoming data points to a slowdown in the U.S. economy, markets continue to expect that the Fed will raise short-term rates at its next meeting, which have pushed Treasury yields somewhat higher. As a result of the higher yields, mortgage rates increased for the second straight week to their highest level in over a month, with the 30-year fixed rate now at 6.55 percent.”

Small cities in the Midwest topped the list of the Wall Street Journal’s Emerging Housing Markets Index. These markets include many in Indiana, including Elkhart, Fort Wayne and Lafayette. With remote work becoming more of a permanent fixture in American life, it was probably only a matter of time before people started fleeing the expensive urban areas and moved to the much more affordable South and Midwest. “While it has become more expensive, it is still more affordable than a lot of other areas of the country,” said Brett Lueken, managing broker at Century 21 The Lueken Group in Lafayette.

Fears of an implosion in the commercial real estate space haven’t yet shown up in Blackstone Mortgage Trusts’s numbers. The mortgage REIT which focuses on CMBS reported an increase in book value per share and earnings which comfortably covered the dividend. The stock yields 14%.

Homebuilder Taylor Morrison reported an increase in first quarter earnings as gross margins improved. The cancellation rate fell to 14%, which is still elevated but approaching more normal levels.  “Following a strong early start to the year, positive sales momentum accelerated further into March, consistent with typical seasonal patterns despite the uncertainties facing the market. In total, during the quarter, our gross sales orders improved to a healthy monthly pace of 3.4 per community, the highest level since the third quarter of 2021, while our cancellation rate declined to more normalized levels at 14% of gross orders. This drove our monthly net sales pace to 2.9 per community as compared to 1.9 in the fourth quarter and 3.1 a year ago. This momentum has carried through the first three weeks of April, with our sales running at a pace of approximately 3.1 net orders per community. Meanwhile, leading indicators—including sales traffic, mortgage pre-qualifications and digital home reservations, which remained our top conversion source at a rate of 40% in the first quarter—point to continued strength.”

Luxury apartment landlord Equity Residential reported an increase in earnings per share. Same store rental increase came in at 3.9%, which is interesting given that Equity Residential has a lot of West Coast exposure (especially in expensive California urban MSAs) and real estate prices have been falling there.

Morning Report: Home Prices still exhibit positive growth

Vital Statistics:

S&P futures4,140-19.0
Oil (WTI)77.79-0.93
10 year government bond yield 3.43%
30 year fixed rate mortgage 6.46%

Stocks are lower this morning as tech earnings continue to come in. Bonds and MBS are up.

Consumer confidence fell in April, according to the Conference Board. “While consumers’ relatively favorable assessment of the current business environment improved somewhat in April, their expectations fell and remain below the level which often signals a recession looming in the short-term,” said Ataman Ozyildirim, Senior Director, Economics at The Conference Board. “Consumers became more pessimistic about the outlook for both business conditions and labor markets. Compared to last month, fewer households expect business conditions to improve and more expect worsening of conditions in the next six months. They also expect fewer jobs to be available over the short term. April’s decline in consumer confidence reflects particular deterioration in expectations for consumers under 55 years of age and for households earning $50,000 and over.”

New Home Sales rose 9.6% MOM in March but were down 3.4% compared to a year ago. The median new home price was $449,800 which was up about 3% compared to a year ago.

House prices rose 0.5% MOM and 4% on a YOY basis according to the FHFA House Price Index. “U.S. house prices increased slightly in February,” said Dr. Nataliya Polkovnichenko, Supervisory Economist, in FHFA’s Division of Research and Statistics. “This increase was, in part, due to a decline in mortgage rates by more than half a percentage point from the peak reached in early November as well as historically low housing inventory.”

The Case-Shiller Home Price Index reported a 0.2% MOM gain in February, and a 2.0% annual increase. “The results released today pre-date the disruptions in the commercial banking industry which began in early March. Although forecasts are mixed, so far the Federal Reserve seems focused on its inflation-reduction targets, which suggests that interest rates may remain elevated, at least in the near-term. Mortgage financing and the prospect of economic weakness are therefore likely to remain a headwind for housing prices for at least the next several months.”

First Republic Bank is down about 30% this morning after disclosing that $70 billion in deposits fled the bank during the first quarter. This was a 35% drop. The bank has suspended its dividend on its common and preferred stock and is taking steps to reduce expenses.

Agency mortgage REIT AGNC Investment reported first quarter earnings yesterday. MBS spreads widened a touch compared to the end of 2022, however they remain tighter than the end of Q3 2022, which represented the widest since the 2008 financial crisis. Tangible Book Value per share fell from $9.84 to $9.41.

AGNC so far has managed to maintain its monthly $0.12 dividend while just about every other mREIT has been forced to cut theirs. Even if the Fed doesn’t pause next month, mortgage rates still can have some downside from tightening MBS spreads. Lower fixed income volatility will help things a lot.

Morning Report: Big week for data

Vital Statistics:

S&P futures4,154-3.0
Oil (WTI)77.44-0.43
10 year government bond yield 3.53%
30 year fixed rate mortgage 6.50%

Stocks are flattish this morning as earnings continue to come in. Bonds and MBS are down.

The week ahead will have a lot of economic data including house prices, new home sales, GDP and Personal Incomes / Outlays. The Personal Incomes / Outlays report on Friday will contain the Personal Consumption Expenditures index, which is the Fed’s preferred measure of inflation. There won’t be any Fed-speak as we are in the quiet period ahead of next week’s FOMC meeting.

The Fed Funds futures are pricing in a 90% chance of a 25 basis point hike next week. The June futures see a 25% chance for another 25 basis point hike, and the futures start pricing in rate cuts by the end of the year.

The market sees first quarter GDP at 2%. The Atlanta Fed’s GDP Now Index sees Q1 GDP at 2.5%. The Chicago Fed National Activity Index showed the economy growing at a below trend pace in March, similar to February.

Hedge Funds are short Treasuries across the board, with CFTC data showing a record short position in the 10 year Treasuries. This would appear to be a bet that the Fed will keep hiking rates well above the market’s forecast of 5%. That said, if rates kind of stall out here, we could see a short covering rally this summer. We will get a read on MBS spreads tonight when mortgage REIT AGNC Investment reports its earnings.

I spent some time on earnings reports in this week’s Weekly Tearsheet on Substack. Check it out and please consider subscribing.

Is commercial real estate the next shoe to drop in the banking sector? Some market watchers think the commercial real estate market is in for some rough sledding, especially the office market. The office market in particular is struggling as remote work is reducing demand for space. The vacancy rate for office reached 12.9%, which was worse than anytime during the Great Recession.

This is in some ways a replay of the 1970s, when people fled the cities to the suburbs and companies relocated operations. In other words, this is a secular change, not a cyclical one. Lower interest rates might not make all that much of a difference.

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Morning Report: Economic growth is picking up in April

Vital Statistics:

S&P futures4,155 3.0
Oil (WTI)78.17 0.79
10 year government bond yield 3.52%
30 year fixed rate mortgage 6.47%

Stocks are lower this morning as earnings continue to come in. Bonds and MBS are up small.

The economy is accelerating again, according to the Flash Composite PMI report from S&P Global. “The latest survey adds to signs that business activity has regained growth momentum after contracting over the seven months to January. The latest reading is indicative of GDP growing at an annualized rate of just over 2%. Growth is also reassuringly broad-based, led by services thanks to a post-pandemic shift in spending away from goods, though goods producers are also reporting signs of demand picking up again. Jobs growth has accelerated alongside the resurgence of demand, aided by reports of vacancies being more easily filled, reflecting improved supply of candidates and higher wages. However, the upturn in demand has also been accompanied by a rekindling of price pressures. Average prices charged for goods and services rose in April at the sharpest rate since September of last year, the rate of inflation having now accelerated for three successive months. This increase helps explain why core inflation has proven stubbornly elevated at 5.6% and points to a possible upturn – or at least some stickiness – in consumer price inflation.”

The national delinquency rate fell below 3% for the first time, according to the latest info from Black Knight. There is generally a seasonal aspect to this as DQs fall in March due to tax refunds. Foreclosure starts and rates increased however we are still well below pre-pandemic levels. I suspect that mortgage forbearance is still playing a part in distorting the numbers.

The Fed is re-thinking its decision to loosen the stress test requirements for banks with under $250 billion in assets. Under the relaxed rules, only the bigger banks were required to add unrealized gains / losses to their portfolio of available for sale securities. The Feds think this might have allowed Silicon Valley Bank to hide its problems. That said, Silicon Valley Bank wasn’t hedging the interest rate risk on its portfolio and that was the issue. The rule change might have tipped off regulators and the markets that something was wrong a bit earlier but the bank would still have failed.

Despite the decrease in median home prices in NAR’s Existing Home Sales report, asking prices are still up about 2.5% on a year-over-year basis. That said, any positive pricing momentum in the real estate market seems to be fading as affordability constraints remain an issue.

Active inventory continues to rise, with the number of homes for sale increasing 49% on a year-over-year basis.

Morning Report: The Index of Leading Economic Indicators signals a recession

Vital Statistics:

S&P futures4,147-31.0
Oil (WTI)77.67-1.49
10 year government bond yield 3.55%
30 year fixed rate mortgage 6.54%

Stocks are lower this morning as earnings continue to come in. Bonds and MBS are up.

Existing home sales fell 2.4% in March, according to the National Association of Realtors. Sales were down 22% on a year-over-year basis. “Home sales are trying to recover and are highly sensitive to changes in mortgage rates,” said NAR Chief Economist Lawrence Yun. “Yet, at the same time, multiple offers on starter homes are quite common, implying more supply is needed to fully satisfy demand. It’s a unique housing market.”

The median home price fell 0.9% on a YOY basis to $379,300. Days on market fell to 29 days.

The Conference Board’s Index of Leading Economic Indicators fell by 1.2% in March. “The U.S. LEI fell to its lowest level since November of 2020, consistent with worsening economic conditions ahead,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “The weaknesses among the index’s components were widespread in March and have been so over the past six months, which pushed the growth rate of the LEI deeper into negative territory. Only stock prices and manufacturers’ new orders for consumer goods and materials contributed positively over the last six months. The Conference Board forecasts that economic weakness will intensify and spread more widely throughout the US economy over the coming months, leading to a recession starting in mid-2023.”

The Fed’s Beige Book showed the economy deteriorated in recent weeks. Overall, we are seeing evidence that pricing pressures are abating and the labor market is softening.

“Overall economic activity was little changed in recent weeks. Nine Districts reported either no change or only a slight change in activity this period while three indicated modest growth. Expectations for future growth were mostly unchanged as well; however, two Districts saw outlooks deteriorate. Consumer spending was generally seen as flat to down slightly amid continued reports of moderate price growth…On balance, residential real estate sales and new construction activity softened modestly. Nonresidential construction was little changed while sales and leasing activity was generally flat to down. Lending volumes and loan demand generally declined across consumer and business loan types…Employment growth moderated somewhat this period as several Districts reported a slower pace of growth than in recent Beige Book reports. A small number of firms reported mass layoffs, and those were centered at a subset of the largest companies. Some other firms opted to allow for natural attrition to occur, and to hire only for critically important roles…Overall price levels rose moderately during this reporting period, though the rate of price increases appeared to be slowing. Contacts noted modest-to-sharp declines in the prices of nonlabor inputs and significantly lower freight costs in recent weeks. Nevertheless, producer prices for finished goods rose modestly this period, albeit at a slightly slower pace. Selling price pressures eased broadly in manufacturing and services sectors. Consumer prices generally increased due to still-elevated demand as well as higher inventory and labor costs. Prices for homes and rents leveled out in most Districts but remained at near record highs. Contacts expected further relief from input cost pressures but anticipated changing their prices more frequently compared to previous years.”

Homebuilder D.R. Horton reported a 33% decrease in earnings per share, however guidance cheered the Street, which sent the stock up 7%.

“The spring selling season is off to an encouraging start with our net sales orders increasing 73% sequentially from the first quarter. Despite higher mortgage rates and inflationary pressures, demand improved during the
quarter due to normal seasonal factors, coupled with our use of incentives and pricing adjustments to adapt to changing market conditions. Although higher interest rates and economic uncertainty may persist for some time, the supply of both new and existing homes at affordable price points remains limited, and demographics supporting housing demand remain favorable.”