Morning Report: The Fed worries about the yield curve

Vital Statistics:

       Last    Change
S&P futures 2903 3
Eurostoxx index 386.36 .8
Oil (WTI) 68.91 0.02
10 Year Government Bond Yield 2.87%

30 Year Fixed rate mortgage                                                    4.58%

Stocks are higher this morning on optimism over trade talks with Mexico. Bonds and MBS are down.

We saw a strong buildup of inventory in July, both at the retail level and the wholesale level. Inventory growth was negative in the second quarter, which depressed GDP growth slightly. This improvement in inventories will provide a boost to the third quarter numbers. Durable goods and autos led the increase, with retail inventories up 0.4% and wholesale inventories up 0.7%.

Redbook reported that same store sales rose 5.1% last week, which was the third fastest pace this year. This bodes well for the back-to-school numbers which are the best predictors of the holiday shopping season. Consumption has been generally strong and these numbers bear that out.

Consumer confidence jumped to 133.4 in August according to the Conference Board. This is the highest level since late 2000.

House prices rose 6.2% in June, according to the Case-Shiller home price index.  Las Vegas, San Francisco, and Seattle reported double-digit increases. The laggards included New York, Chicago and Washington DC which reported low single-digit gains. Las Vegas is one of the fastest growing US cities in terms of population and employment growth, which explains the rise there. Seattle and San Francisco has restricted supply along with foreign demand. On the other side, the Northeast continues to stagnate.

The Urban Institute looked at mortgage denial rates along demographic lines and found that most of the studies that report discrimination overstate denial rates because they fail to take into account incomes and credit scores. While they still found some evidence of racial disparity it is much lower when you correct for these things. Not sure if the difference is statistically significant though. Given that CRA loans are worth more than traditional loans (all things being equal) it is surprising that there is any difference at all.

As the long end of the curve continues to rally, we will have a steady diet of recession prediction stories in the business press. The latest Reuters story cites a Federal Reserve study that suggests the market may be warning of a potential recession: “In light of the evidence on its predictive power for recessions, the recent evolution of the yield curve suggests that recession risk might be rising,” wrote San Francisco Fed research advisers Michael Bauer and Thomas Mertens.

The flattening yield curve provides plenty of fodder for the Wall of Worry, however there are a couple of things to bear in mind. First, the yield curve almost always flattens during a tightening cycle. Take a look at the chart below, and you can see the yield curve flatten as short term rates rise.

10 year, Fed funds

The behavior of the yield curve is 100% normal. Not only that, longer term interest rates are being held artificially low due to the behavior of central bankers throughout the world. The Fed is still buying Treasuries, albeit at a slower pace, while Japanese and European central bankers are pushing down long-term rates, which influences US rates. The signal-to-noise ratio of the yield curve is extremely low right now. Finally, the short Treasury trade is probably the biggest macro bet on the Street right now. Every wiseguy is short, and that means you will sometimes get these rallies for no apparent reason.

Morning Report: Moody’s downgrades Chase’s jumbo status

Vital Statistics:

Last Change
S&P futures 2888 11
Eurostoxx index 385 0
Oil (WTI) 68.79 0.02
10 Year Government Bond Yield 2.82%
30 Year fixed rate mortgage 4.58%

Stocks are higher this morning on news that the US and Mexico might strike a deal on NAFTA. Bonds and MBS are flat.

We should have a quiet week heading into the Labor Day weekend. We will get GDP on Wednesday and Personal Incomes / Personal spending on Thursday and those are probably the only potential market-moving reports.

Mohammed El-Arian believes there is a 60% chance that Trump’s hard line on trade will result in a better deal for the US. There is a 15% chance that Trump’s stance could result in a beakthrough with China (similar to Reagan’s approach with the USSR during the Cold War), and another 25% chance that we go into a full blown trade war. He stressed that the US’s role as the world’s biggest consumer matters: “I’ve said from day one, it’s just a matter of time until other countries realize that their best approach is to collaborate with the U.S. and fix things that are broken,” El-Erian said.

Moody’s downgraded Chase’s jumbo underwriting rating to “above average” from “strong” based on concerns over the percentage of loans that come from its delegated correspondent channel. Moody’s also dinged them over their proprietary LOS (licensed from Quicken), disliking the look and feel of it. Chase obviously disputes the downgrade, and defended their underwriting. “We respectfully disagree with the rating and feel it’s based on insufficient information. While we provide select correspondent lenders with delegated underwriting authority, we also then conduct individual underwriting reviews on roughly half of those loans. These are high-quality loans that perform well,” Amy Bonitatibus, chief marketing and communications officer of Chase Home Mortgage, said in an email.

Elon Musk ended his proposed buyout of Tesla late last week. The Street never took it seriously to begin with, and was highly skeptical of his claim that funding for the deal was secured. The SEC is investigating the “funding secured” comment, which sounds like it was based largely on the existence of a pitch book, not any sort of letter from an investment bank (not even a “highly confident” letter).

Layoffs continue in the mortgage biz. Wells let go 600 people, mainly in servicing and retail fulfillment. Lower volumes and margins contributed to a 33% drop in mortgage banking income for Wells in the second quarter.

Economic activity decelerated in July, according to the Chicago Fed National Activity Index, which is a meta-index of 85 economic indicators. Production-related indicators decelerated, while employment-related indicators improved. The 3 month moving average fell as well.

Morning Report: Jerome Powell speaks at Jackson Hole

Vital Statistic:

Last Change
S&P futures 2865 6.75
Eurostoxx index 383.72 0.32
Oil (WTI) 68.91 1.08
10 Year Government Bond Yield 2.85%
30 Year fixed rate mortgage 4.58%

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

Another slow news day. Low level talks between China and the US over trade didn’t really go anywhere.

Durable Goods orders fell 1.7% in July on weak aircraft orders, but the core capital goods rate jumped 1.4%, which shows another month of strong business investment, particularly business equipment. Many economists had been skeptical that cutting corporate taxes would increase capital expenditures, but it looks like it has. Theory certainly predicted it would.

Jerome Powell is speaking in Jackson Hole this morning. There probably won’t be anything market moving, but just be aware. The conference will focus on a academic papers for the most part. The agenda is here. One of the papers argues that the Fed should continue to hike rates, even in the absence of current indications of inflation, if the unemployment rate is below the long-term sustainable rate. Since monetary policy acts with a lag, a low unemployment rate can increase inflationary pressures before monetary policy takes effect.

The Fed faces two major risks of “moving too fast and needlessly shortening the expansion, versus moving too slowly and risking a destabilizing overheating,” said Mr. Powell. “I see the current path of gradually raising interest rates as the [Federal Open Market Committee’s] approach to taking seriously both of these risks. In other words, expect maybe 2 more hikes this year, and maybe one or two more next year.

The Fed funds futures increased their handicapping of a Dec hike slightly, to 68% (Sep is a given). Longer term, the September 2019 futures predictions look like this:

fed funds futures

The central tendency seems to be 2 more hikes this year, one more next year, and then the Fed takes a break. Slightly more people think the Fed stops after 2 hikes than those who think the Fed does 4 or more.

St. Louis Fed President James Bullard would vote to maintain the current Fed Funds rate through the end of the year. “If it was just me, I’d stand pat where we are and I’d try to react to data as it comes in,” he said Friday in an interview with CNBC’s Steve Liesman. “I just don’t see much inflation pressure. … I’m an inflation hawk, but I just don’t see that developing. … I just don’t think this is a situation where we have to be pre-emptive.” He also sees the economy slowing next year, and in 2020.

The Senate Banking Committee voted 13-12 along party lines to advance the nomination of Kathy Kraninger to run the CFPB. Remember if Kraninger is rejected, Mick Mulvaney continues to run the agency, which was probably the plan all along.

Morning Report: No surprises in the FOMC minutes

Vital Statistics:

Last Change
S&P futures 2858 -2.75
Eurostoxx index 384.09 0.07
Oil (WTI) 67.46 -0.4
10 Year Government Bond Yield 2.81%
30 Year fixed rate mortgage 4.58%

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

The FOMC minutes didn’t offer anything too surprising. Most participants said it would be appropriate to raise rates soon, which wasn’t a surprise – the Fed Funds futures have a Sep hike as pretty much a sure thing. They worried about how trade could be a downside risk to the economy, especially if it affects business sentiment, investment and employment. They mentioned that in the “not too distant future” monetary policy will no longer be viewed as accomodative. This statement seems to hint that rate hikes should wind up next year, provided inflation remains around these levels. Note that the head of the Dallas Fed suggested that the tightening cycle might be done once we get 75 – 100 basis points higher on the Fed Funds rate.  Bonds didn’t react to the minutes at all, and the Fed Funds futures didn’t budge either.

There wasn’t much talk about reducing the size of the balance sheet, which is more or less on autopilot right now. As the yield curve flattens, you would think the Fed would consider getting more aggressive on the balance sheet unwind. Maybe not on the mortgage backed securities side, but on the Treasury side. If credit is still widely available and the demand is there, why not? If the ducks are quacking, feed ’em.

Central Bankers are meeting in Jackson Hole today. There usually isn’t much in the way of market-moving statements out of these things, but just be aware.

Initial Jobless Claims fell to 210,000 last week. We are bumping around levels not seen since 1969. When you consider the fact that the US population was only 200 MM back then (compared to 325 MM today), it is even more impressive. It certainly has economists scratching their heads.

Home prices rose 0.2% in June and 1.1% for the second quarter, according to the FHFA House Price Index. The second quarter’s pace was the slowest increase in 4 years, which shows that higher interest rates are beginning to have an effect on prices. Prices did rise in all 50 states and 99 out of 100 MSAs. 5 states (NV, ID, DC, UT, and WA) had double digit increases. The Las Vegas MSA had the biggest increase – almost 19%. The laggards were CT, AK, ND, LA, and WV.

FHFA by state

Heidi Heitkamp, a moderate Democrat from North Dakota says she will not support Kathy Kraninger to run the CFPB. She said she was inclined to vote yes, however she is concerned about Kraninger’s experience in consumer protection and also felt she “lacked empathy” for consumers and didn’t believe in the Bureau’s mission. Heitkamp has been supportive of regulatory relief, which means she was a gettable vote. Kraninger’s nomination looks largely to fall along partisan lines now.

New Home Sales fell 1.7% MOM to 627,000, which was below the Street estimate of 649,000. It is up 12.8% on a YOY basis however. The new home inventory situation is getting more balanced, with 5.9 month’s worth of supply. As always, the question is whether that inventory represents the oversupplied luxury market or the undersupplied starter market.

Morning Report: Existing Home Sales fall

Vital Statistics:

Last Change
S&P futures 2856 -5.75
Eurostoxx index 383.91 -0.25
Oil (WTI) 67.32 0.89
10 Year Government Bond Yield 2.82%
30 Year fixed rate mortgage 4.58%

Stocks are modestly lower this morning after Paul Manafort was found guilty and Michael Cohen copped a plea. Bonds and MBS are flat.

Paul Manafort was found guilty of fraud and tax charges and there was a mistrial on the other charges. Nothing was found on the Russian front. Ex Trump lawyer Michael Cohen pled guilty to FEC violations, which relates to the Stormy Daniels case. Whether this ends up getting legs remains to be seen. FWIW, the markets are saying it is no big deal.

We will get the FOMC minutes today at 2:00 pm. Given the lack of liquidity in the markets, we could see some market movement in what should otherwise be a non-event.

Mortgage applications rose for the first time in 6 weeks as purchases rose 3% and refis rose 6%. Overall they rose 4.2%. Mortgage rates were unchanged, so that is a surprising jump in refi activity. Given that the index is sitting at lows not seen since the turn of the century, it doesn’t take much of a bump in activity to move the index.

Existing home sales fell again for the fourth month in a row. They fell 0.7% on a MOM basis and are down 1.5% on a YOY basis. This is the fifth straight month of YOY declines. It looks like much of the decline was attributable to weakness in the Northeast. The median house price rose 4.5% to 269,600.  Current estimates of median income are around 61,500, so that puts the median house to median income ratio around 4.4x. While other measures of housing affordability remain decent, this one is flashing red for valuations overall. The MP / MI ratio ignores interest rates, which are the biggest determinant of affordability, but over time house prices correlate with incomes, and it wouldn’t be a surprise to see home prices begin to take a breather.

Median House Price to Median Income Ratio

Fed Chairman Jerome Powell assured Senator Tim Scott that the Fed remains independent despite the jawboning from Trump. Powell said in a radio interview: “We do our work in a strictly nonpolitical way, based on detailed analysis, which we put on the record transparently, and we don’t … take political considerations into account,” Powell told the radio show. “I would add though that no one in the administration has said anything to me that really gives me concern on this front.” Separately, Dallas Fed Chairman Robert Kaplan said that the Fed only needs to hike 3 or 4 more times to get to neutral.

Morning Report: Inventory continues to fall, albeit at a slower pace

Vital Statistics:

Last Change
S&P futures 2862 4
Eurostoxx index 384.93 1.7
Oil (WTI) 67.47 1.04
10 Year Government Bond Yield 2.83%
30 Year fixed rate mortgage 4.58%

Stocks are higher this morning as earnings season winds down. Bonds and MBS are down.

Same store sales rose 4.7% last week, which is indicative of a strong back-to-school shopping season. BTS is a good predictor of the holiday shopping season, which would support strong GDP growth for the rest of the year. Consumption is about 70% of US GDP. Current projections are looking at north of 3% growth for the year.

The Fed Funds futures are now handicapping a 96% chance of a Sep hike and a 63% chance of a Sep and Dec hike. Meanwhile, the yield curve continues to flatten.

Trump made some comments about Fed Chairman Jerome Powell at a fundraiser, saying that he expected him to be a “cheap money guy” and didn’t expect him to raise interest rates. He also tweeted that he is “getting no help” from the Fed. While publicly discussing monetary policy is not a normal thing for the President to do, wishing rates were lower is. The only politicians who want higher rates are the ones not in power. He also called the Europeans and the Chinese currency manipulators. Under any other President this would be big, but the dollar and the bond market largely ignored it. It  shows that markets are largely dismissing “Donald being Donald” communiques from the WH.

The YOY declines in inventory that have bedeviled the industry are beginning to moderate, at least according to Redfin. Inventory was down 5.8% in July, which is lower than the double-digit decreases we had been seeing. The median sales price rose 5.3%. Homes went under contract in 35 days, which is 3 days faster than a year ago. Activity is slowing in some of the hotter markets however, especially Washington DC. The inventory issue won’t be fixed until we get housing starts back to some semblance of normalcy, which means a few years of 2MM units before returning to historical averages of around 1.5MM.

inventory

Toll Brothers reported strong numbers this morning, which has sent the stock up 11%. Revenues were up 27% and deliveries were up 18%. Backlog rose 22% in dollars and 13% in units. They also bought back about $137 million worth of stock, which accounts for about 70% of earnings. Robert I. Toll, executive chairman, stated: “We believe there is room for continued growth in the new home market in the coming years. Household formations have been increasing and in many regions the aging housing stock may not satisfy the lifestyles of today’s buyers. Yet new home production has not kept pace with the growth in population and households. On the single-family side, housing starts, other than during the anemic years of this recovery, are at their lowest level since 1970. In addition, existing home values have increased, providing potential move-up and empty nester customers with more equity that they can put toward a new home purchase. We believe these two groups, along with the growing number of millennials starting to buy homes, are all sources of potential new demand in the coming years.”

I find it interesting that he talks about the low level of housing starts, while at the same time spending 70% of Toll’s net income on buybacks. Certainly the actions don’t seem to match the words.

Morning Report: Fannie Mae revises downward 2018 housing forecast

Vital Statistics:

Last Change
S&P futures 2855.5 3.8
Eurostoxx index 383.49 2.43
Oil (WTI) 65.92 0.02
10 Year Government Bond Yield 2.84%
30 Year fixed rate mortgage 4.58%

Stocks are higher this morning on optimism of a deal with China. Bonds and MBS are up small.

Late August is a generally dull time to begin with, and this week promises more of the same. We will get some housing data (Existing home sales, new home sales, FHFA price index) and one possible market-moving report (durable goods) but that is about it. We will get the FOMC minutes on Wednesday as well.

Liquidity is drying up in the bond market as it usually does this time of year. Note that the short bond position is one of the biggest on the Street, so we could see some quick rallies in the 10 year.

Flagstar has been released from special oversight that limited its corporate options to pay dividends, make acquisitions, etc.

Luxury apartments in NYC are falling in price, after years of torrid growth. Some are blaming the new tax laws, however some could be from falling foreign demand. We are seeing the same thing in London. Note that luxury properties in the suburbs of NYC are doing the same thing. You can’t give away properties priced at $1MM +

Fannie Mae cut their housing forecast for 2018 for the 4th time this year. They are looking for $1.67T in originations this year and $1.7T next year. The 30 year fixed rate mortgage is expected to average 4.5% this year and 4.7% next year. They are also forecasting a major slowdown in GDP growth, from 3% this year to 2.3% next year.