Morning Report: Global bond rout on

Vital Statistics:

 

Last Change
S&P futures 2919.25 -12.25
Eurostoxx index 381.23 -2.61
Oil (WTI) 76.03 -0.38
10 year government bond yield 3.20%
30 year fixed rate mortgage 4.87%

 

Stocks are lower this morning in the face of a global government bond rout. Bonds and MBS are down.

 

Global bond yields are sharply higher this morning. There doesn’t appear to be any particular catalyst, but it is affecting Japanese and German bonds as well as the US. The 10 year yields 3.2% this morning after starting yesterday at 3.08%. Interestingly, the Fed Funds futures haven’t changed at all, so this doesn’t seem to be driven by a re-assessment of Fed policy. If you look at the TIPS market (Treasuries that forecast the change in CPI), there is no change in the market’s assessment of inflation. So this has been largely confined to the long end. The short Treasury trade is one of the biggest trades on the Street, and maybe some big funds put more money to work shorting / underweighting global bonds going into the 4th quarter. 2s-10s are trading at 31 bps.

 

Jerome Powell was interviewed on CNBC yesterday, and signaled that more hikes are on the horizon.  “Interest rates are still acommodative, but we’re gradually moving to a place where they will be neutral,” he added. “We may go past neutral, but we’re a long way from neutral at this point, probably.” Interesting to see him characterizing current policy as “accomodative” when the word was taken out of the September FOMC statement. The “may go past neutral” comment has been cited by some in the press as the catalyst for yesterday sell-off, but the Fed Funds futures don’t reflect that.

 

Job cuts rose to 55,000 in September, according to outplacement firm Challenger, Gray and Christmas. This was driven primarily by announced layoffs at Wells Fargo. “As the job market remains near full employment and companies struggle to find workers, large-scale job cut announcements like the one from Wells Fargo will actually provide the workers necessary for companies to gain momentum and sustain growth,” said John Challenger, Chief Executive Officer of Challenger, Gray & Christmas, Inc.

 

Hurricane Florence appears to have had little impact on initial Jobless Claims which fell to 207,000 last week. As companies ramp up for the fourth quarter, qualified workers are hard to find. That might have been part of the reason for Amazon’s announcement on wages – they have to compete with everyone else for seasonal workers. Note that Fed-Ex is paying pilots bonuses of $40-$110k to keep them from retiring.

 

Lennar reported 3rd quarter earnings yesterday, which were decent, but forward guidance (partially driven by Hurricane Florence) was disappointing, and the stock sold off 2%. Orders increased, but its Q4 forecast was below estimates. The whole sector was hit yesterday as well, as a combination of higher mortgage rates and input costs are creating affordability problems. Most of the metrics were hard to compare YOY because of the CalAtlantic transaction.

 

Factory orders increased 2.3% in August driven by transportation orders. This is the fastest pace since September last year.

 

Investors are bailing on high-yield debt, as spreads to Treasuries are at post-crisis lows and rates are going up. With bond-like upside and stock-like downside, the risk-reward for the asset class is deteriorating. IMO, some of the action we are seeing in the stock and bond markets may simply be a re-emergence of money market investment vehicles which paid so little during the ZIRP years that investors didn’t bother with them. With short term rates pushing 3%, the asset class is making sense again.

 

high yield bond spreads

 

Of course the other asset class that has been moribund since the crisis has been the private label MBS market. While there are governance issues left be sorted out, higher absolute rates will go a long way towards bringing back that sector (and the type of lending that accompanies it). Mortgage REITs who have feasted on MBS thrown overboard in 2009 and 2010 will have to replace that paper with new issuance.

Morning Report: Strong ADP numbers

Vital Statistics:

 

Last Change
S&P futures 2939 10.25
Eurostoxx index 384.7 2.78
Oil (WTI) 75.25 0.07
10 year government bond yield 3.08%
30 year fixed rate mortgage 4.78%

 

Stocks are higher after the ADP jobs report came in gangbusters. Bonds and MBS are flat as we head into a day with 5 Fed speakers.

 

The ADP jobs report came in stronger than expected, with 230,000 private sector jobs added in September. This is well higher than the 180,000 estimate the Street has penciled in for Friday’s report.  The market will be focusing on the wage data more than the payroll data with the employment situation report, however.

 

ADP jobs report

 

Mortgage applications were flat last week as we head into the seasonally slow Q4 and Q1 time of the year. “Rates were little changed last week, following the most recent [Federal Open Market Committee] meeting where the Fed announced another rate hike based on the health of the economy and job market as expected, “said MBA Associate Vice President of Economic and Industry Forecasting Joel Kan. “Short-term rates have been increasing but long-term rates have held steady, which should not pose too much of a headwind to home purchase activity, especially given the potential demand from demographic factors.”

 

The ISM Non-Manufacturing Index hit a record high last month (albeit only going back to 2008). We saw a huge jump in the employment index of almost 6 percentage points, and continued strength in new orders. Tariff worries have taken a step back, and prices are rising, but not uncontrollably. Labor shortages were mentioned as an issue.

 

Mortgage fraud risk is increasing, as higher home prices encourages buyers to pad their financial situation to qualify for a loan. There are online services which will produce fake pay stubs and answer VOE calls, (for “novelty” purposes of course). This is in addition to the other more typical ploys, which include holding out a rental as owner-occupied. Most of the risk in in the wholesale, not retail channel, and we are nowhere near the liar loans of the bubble days. Worst places for fraud risk: NY and NJ, where glacial foreclosure timelines add insult to injury.

 

They’re still worried about deflation. Charles Evans said that inflation hasn’t gone up as much as the Fed would like. Fiscal policy is very pro-cyclical at the moment, and the expansion is long in the tooth.

 

The Tesla saga has taken another interesting turn. The SEC thought they had a settlement with Musk over the infamous 420 tweet (where he tweeted that he was planning to take Tesla private at $420 a share price, and that he had financing lined up).  The SEC sued him for making false statements that impacted the share price, and he got off relatively light, with a fine to be shared with the company, and a requirement that he step down from the Board for 2 years. Now, Musk is telling the Board that he will quit the company if they don’t fight for him. One thing is for sure: getting into public spats with the SEC is generally not good for your stock price.

 

I am surprised Amazon stock is holding up given the announcement yesterday. Although the company declined to provide any financial guidance, it is hard to see how the company escapes without a significant bite in its earnings. To make matters worse for the company, cash flow will be impacted as employee bonuses for many workers will now be paid in cash versus stock. AMZN earnings last year: $3 billion. AMZN stock compensation last year $4 billion. I guess bulls on AMZN are betting that this holiday shopping season is going to be so great that the increased costs don’t matter. But a company trading at 78x expected earnings doesn’t have a lot of margin for error, especially if its cost structure is going to more closely mirror that of its bricks-and-mortar competitors. I am sure the politics behind the announcement will be a fascinating tale.

 

 

Morning Report: More anecdotal evidence of wage inflation

Vital Statistics:

 

Last Change
S&P futures 2926.5 -3.75
Eurostoxx index 381.96 -1.98
Oil (WTI) 75.37 0.07
10 year government bond yield 3.07%
30 year fixed rate mortgage 4.71%

 

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

 

Home prices rose 0.1% MOM and 5.5% YOY during August, according to CoreLogic. This growth rate was the slowest pace in two years, and reflects the decline in affordability due to higher rates and prices.  The areas of undervaluation are concentrated primarily in the Midwest, parts of the South and parts of inland CA.  One thing to keep in mind is that overvaluation / undervaluation is based on incomes and is therefore a moving target.

 

Corelogic overvalued

 

Speaking of incomes, Amazon has just increased its minimum wage to $15 an hour and will lobby Washington to increase the Federal minimum wage as well. Amazon has been under relentless pressure from the left, and finally gave in. Lobbying for a hike in the Federal minimum wage is interesting. Perhaps that was the price Amazon had to pay to get the left to leave it alone, however Amazon probably can afford to pay its workers higher wages than the brick and mortar retailers with which it competes. So it might make business sense for them to do that. Amazon already punches well below its weight margin-wise, so the Street might not like it so much.

 

Bottom line for rates: we are seeing enough anecdotal evidence of increasing wages that it is going to start showing up in the numbers. The big question is whether it throws the Fed off their planned normalization policy. Janet Yellen (who probably is representative of most of the FOMC voting members) wanted to let the labor market run hot for a while. I don’t think Powell is any different. Until we see a move up in the core PCE inflation ratings, I don’t think the Fed will deviate from its plan to wrap up this tightening cycle next year. We have had a lot of hikes already in 2018, and rate hikes act with a 3 month to 1 year lag.

 

Aside from labor, rising oil prices are something to watch as well. The Fed generally focuses on core inflation (ex-food and energy) but eventually higher commodity prices become embedded into other prices. Oil is trading at $75 right now, and OPEC seems happy to let the price run. There is talk of $100 oil again.