Morning Report; LEI shows strong growth ahead

Vital Statistics:

Last Change
S&P futures 2808 -8.25
Eurostoxx index 386.86 -18
Oil (WTI) 68.23 -0.53
10 Year Government Bond Yield 2.87%
30 Year fixed rate mortgage 4.51%

Stocks are lower as earnings continue to come in. Bonds and MBS are down.

Initial Jobless Claims fell to 207,000 last week, which is the lowest level since 1969. Despite the tightness of the labor market, wage growth is tough to come by.

I have discussed at length the disconnect between the Northeast and the rest of the country when it comes to the real estate market. It turns out that not only does the real estate market lag, so does mortgage banking. Last year was a rough year for mortgage banking, and the typical profit per loan was about 31 basis points. That varied by region, with the Midwest in the lead at 39 basis points while the Northeast lagged at 8.

profits by region

The Fed’s Beige Book characterized the economy as strong, and said that labor shortages are beginning to impede growth. Engineers, skilled construction workers, truck drivers, and IT professionals are in short supply. So far increasing input prices are not translating into higher inflation – corporate margins are taking the hit. Residential housing continues to improve ever so slowly, and commercial real estate is flat. Overall, the picture points to a strong economy, with room to run. The lack of pricing pressures gives the Fed the leeway to go slow as they get off the zero bound.

The Conference Board echoed this assessment, with the Index of Leading Economic Indicators increasing 0.5% in June. The LEI is still rising faster than the CEI (basically the future indicators are showing that growth should accelerate) which means we have no sign of a slowdown.

Leading economic indicators

Kathy Kraninger, the Administration’s nominee to run the CFPB, will appear before the Senate Banking Committee today. Little is known about her views on financial regulation. Congressional aides have said that she will have enough support to pass the Committee on a party-line vote. In her prepared remarks, she said she will continue Mick Mulvaney’s work of balancing the need for consumer protection with the need to treat the financial sector fairly. Suffice it to say, having come from OBM, she doesn’t really fit the type of bureaucrat who would normally be tapped to run the CFPB, and that may be the point. If her nomination bogs down, Mick Mulvaney can continue to run the agency.

Interesting stat: 70% of the Millennials who own a home have buyer’s remorse. Many used their retirement savings to fund the down payment, which is generally a bad move. Many first time home buyers completely underestimate closing costs as well. Others underestimated the costs of upkeep, which is around $16,000 a year. I suspect many of these lessons are learned by every generation who buys their first home.

The CoreLogic Mortgage Fraud Risk Index rose 12% in the second quarter compared to a year ago. An increase in borrowers taking on loans for multiple properties (i.e more professional investors) appeared to drive the increase.

Morning Report: Quits rate jumps in May

Vital Statistics:

Last Change
S&P futures 2781 -11
Eurostoxx index 382.05 -4.2
Oil (WTI) 73.29 -0.82
10 Year Government Bond Yield 2.85%
30 Year fixed rate mortgage 4.53%

Stocks are lower this morning after Trump threatened tariffs on $200 billion worth of Chinese goods. Bonds and MBS are flat.

China has vowed to retaliate if the Trump Administration follows through on its threat to impose 10% tariffs on about $200 billion worth of Chinese goods. Since China imports far less than $200 billion from the US, they may have to come up with other measures to retaliate – anything from denying visas to limiting tourism and increasing regulatory measures. Strategists are beginning to warn that the trade war could derail the recovery.

Inflation at the wholesale level increased in June, according to the PPI. The headline number rose 0.3% MOM / 3.4% YOY. Ex food and energy, it was up 0.3% / 2.8% and ex food energy and trade services 0.3% / 2.7%. Services and motor vehicles drove the increase.

Donald Trump nominated Brett Kavanaugh to the Supreme Court yesterday. He is generally a regulatory skeptic, and has ruled against overreach in the past. He has already weighed in on the CFPB, which he believes is unconstitutional. From CFPB vs PHH, writing for the majority: “The CFPB’s concentration of enormous executive power in a single, unaccountable, unchecked Director not only departs from settled historical practice, but also poses a far greater risk of arbitrary decision-making and abuse of power, and a far greater threat to individual liberty, than does a multi-member independent agency. The overarching constitutional concern with independent agencies is that the agencies are unchecked by the president, the official who is accountable to the people and who is responsible under Article II for the exercise of executive power.” That said, Kennedy was already considered a vote against the CFPB, so the nomination won’t move the needle there.

Kavanaugh has also ruled against the EPA, which generally ignored the “cost” side of the “cost / benefit” analysis of regulations during the Obama Administration. Overall the regulatory environment for the financial industry could get a little easier with Kavanaugh on the Court.

Speaking of the CFPB, Brian Johnson has been tapped to be the #2 of the agency. He replaces Leandra English, who resigned last week.

Small business optimism remains elevated despite trade concerns, according to the NFIB Small Business Optimism Survey.  Employment continues to grow, with 1 in 5 firms adding employees in June on net. Sales are up overall, but margins appear to be facing pressure from higher labor and input prices. Credit needs are being fully met.

Job openings fell to 6.6 million in May, which was just off the record high of 6.8 million set in April. Hires were strong at 5.8 million, led by health care and social assistance. The big number was the quits rate, which is one of the best leading indicators of wage inflation. It rose to 2.4%.

quits rate

The big question remains: how much slack is there really in the labor market? Most of the official numbers imply there is none. Yet, there is only modest wage inflation. I suspect the employment-population ratio tells the real story, and that number has yet to really recover from the Great Recession. Demographics are part of the story, but as people work longer, the assumption of 65 = retirement might have to change. I suspect many of those who are retired would gladly take a job if offered.

For the construction sector, the number of unfilled jobs hit a record high. That sector has been facing labor constraints for quite some time, and this partially explains why housing starts have been so far below what is needed to meet demand.

construction labor market

Mortgage Applications increased 2.5% last week as purchases rose 7% and refis fell 4%. Last week included the 4th of July, so there are all sorts of adjustments baked into that number. Refis fell under 35%, the lowest number since August 2008. ARMS decreased to 6.3%. Overall rates fell about 3-4 basis points last week.

Meanwhile, the MBA’s mortgage credit availability index improved last month as increases in conventional and jumbo availability offset a contraction in government.

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.

FNMA chart

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.

Morning Report: Almost a third of all MSAs are overvalued

Vital Statistics:

Last Change
S&P futures 2771 -0.75
Eurostoxx index 383.16 -1.13
Oil (WTI) 65.91 0.84
10 Year Government Bond Yield 2.93%
30 Year fixed rate mortgage 4.57%

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

Initial Jobless Claims fell by 3,000 to 218,000, while the Index of Leading Economic Indicators increased by 0.2%, below expectations. This index is predicting that growth will moderate in the coming months. Note that Goldman has taken its Q2 GDP estimate up to 4%, which is a torrid pace.

Mortgage Applications rose 5.1% last week as purchases rose 4% and refis rose 6%. Mortgage rates were more or less unchanged for the week.

Existing Home Sales fell 0.4% last month to a seasonally adjusted annual rate of 5.43 million. Existing Home Sales are down 3% on a YOY basis, making this the third consecutive month with a YOY decline. The median house price hit a record, rising 4.9% to $264,800. While restricted supply has been an ongoing issue, the market is beginning to feel the pinch of rising rates and prices. The first time homebuyer accounted for 31%, which is a decrease and well below the historical norm of 40%. At current run rates, we have about 4.1 month’s worth of inventory. Some realtors noted that potential sellers are pulling their homes off the market for fear they won’t find a replacement. We need a dramatic increase in home construction to fix the issue and so far we are seeing modest increases.

Speaking of home price increases, the FHFA reported that prices rose 0.1% MOM in April and are up 6.4% YOY. Since the FHFA index ignores jumbo and non-QM, this is prime first-time homebuyer territory. Home price appreciation is beginning to converge as the laggards like the Mid-Atlantic (which covers NY and NJ) are picking up steam. The dispersion a year ago was huge.

CoreLogic estimates that a third of all MSAs are now overvalued. The last time we hit this level was early 2003, just before the bubble hit its stride. It is natural to ask if we are in another bubble, and IMO the answer is “no.” The term “bubble” gets thrown around so much that it has lost its meaning. The necessary conditions for a bubble (magical thinking on the part of buyers and the financial sector) just aren’t there. China has a bubble. Norway has a bubble. The US does not.

CoreLogic overvalued metros

The US coastal and Rocky Mountain areas have the most overvalued residential real estate, but aside from that it is still cheap / fairly valued elsewhere. Either the overvalued MSAs will start building more homes, or the employers in those MSAs will begin to move more operations to cheaper areas. You can see that already with Amazon.com de-emphasizing Seattle. Some MSAs become to cheap to ignore (the Rust Belt, for instance) and others become so expensive that companies cannot attract entry-level talent anymore. For a hotshot MIT data scientist, working at Google or Facebook sounds very cool, but if you can’t afford an apartment are you really going to be willing to work there?

Foreclosure starts fell in May to 44.900, which is a 17 year low. The foreclosure rate of 0.59% is the lowest in 15 years. At the current rate of decline, the foreclosure inventory is set to hit pre-recession levels later this year. The Northeast still has a foreclosure backlog to deal with, but the rest of the country has moved on.

FHFA regional

HUD is asking for public input into its disparate impact rules, which were dealt a blow at SCOTUS. Disparate impact is a highly controversial legal theory that says a company is guilty of discimination even if they didn’t intend to discriminate – if the numbers don’t match the population the lender is guilty, no questions asked. That theory was dealt a blow with a 2015 ruling that said the plaintiff must be able to point to specific policies of the lender that explain the disparate impact. HUD is now looking to tweak the language to conform to this ruling.

Incoming CFPB nominee Kathy Kraninger is getting some static from Democrats due to her position at DHS. They are asking questions about her role in the zero tolerance policy and child separations. Elizabeth Warren is putting a hold on her nomination until she answers these questions. That may not be a disappointment to the Administration however. The gameplan may be to slow-walk a new CFPB nominee in order to keep current Acting CFPB Chairman Mick Mulvaney at the helm of the agency.

Morning Report: Housing starts jump despite increasing lumber prices

Vital Statistics:

Last Change
S&P futures 2752 -28
Eurostoxx index 382.86 -3.1
Oil (WTI) 64.89 -0.96
10 Year Government Bond Yield 2.88%
30 Year fixed rate mortgage 4.57%

Stocks are lower this morning on increasing trade tensions with China. Bonds and MBS are up.

Trump threatened $200 billion in sanctions on Chinese goods, which sent global markets down and bonds up. This is in addition to the $50 billion in tariffs he threatened on Friday. Stock market investors are swapping out of S&Ps and Nasdaqs into smaller cap stocks, as they are more insulated from international trade tensions.

Housing starts improved to 1.35 million in May, which is up 5% MOM and 20% YOY. Building permits came in at 1.3 million, down 5% MOM, but up 8% YOY. Most of the activity was in the Midwest, where they increased by 100k. The Northeast was down, while everywhere else was flattish. Tariffs on Canadian lumber certainly aren’t helping. Lumber prices peaked in May and are starting to decline, but they have had quite the run. The NAHB report yesterday discussed lumber prices are hurting builder confidence.

lumber

Trump formally nominated Kathleen Kraninger to replace Mick Mulvaney as the head of the CFPB. This promised to be a contentious confirmation fight, and the usual suspects are already complaining. That may actually work out in the Administration’s favor however. The tougher the confirmation fight, the longer Mick Mulvaney can remain in place and fix some of the excesses of the Bureau. Under the Vacancies Act, Mulvaney’s term as Acting Director expires on June 22. He can remain in place while her nomination is pending. If she is defeated, he would get another 210 days. If that nominee is defeated, he gets another 210. So basically, this gambit would keep Mick Mulvaney in place until 2020.

Where are Millennials moving? Where the jobs are.

Morning Report: Will the US economy have a Wile E Coyote moment in 2019?

Vital Statistics:

Last Change
S&P futures 2765.5 -19
Eurostoxx index 385 -3.9
Oil (WTI) 65.16 0.1
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.57%

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

We will get a lot of housing-related data this week, but nothing should be market-moving. We will get housing starts and building permits tomorrow, existing home sales on Wednesday, and house prices on Thursday. Otherwise, should be a relatively quiet week.

The NAHB Housing Market Index (a sentiment indicator for the homebuilders) fell to 68 last month from 70. Rental markets are softening in some of the more pricy MSAs.

OMB official Kathy Kraninger is supposedly the front-runner to replace Mick Mulvaney as the permanent director of the CFPB. The confirmation process will probably take at least through the end of the year. She is not viewed as any sort of financial regulatory expert, so expect to see a lot of objections from Democrats over the nomination.

Ben Bernanke thinks the US economy will have a Wile E Coyote moment in 2019 or 2020 when the tax cut stimulus wears off. His point is that we are enacting fiscal stimulus at “exactly the wrong time” when the economy is already at full employment. Of course the statement about full employment is debatable. The unemployment numbers indicate we are, but the employment-population ratio does not. The employment-population ratio currently stands at 60.4%, and pre-crisis, we were around 63%. That 2.6% difference works out to be about 8.5 million people. We are getting some modest real wage growth (average hourly earnings are up 2.7% YOY and the core PCE index is growing at 2%) however broad-based wage growth probably isn’t going to happen until the EP ratio gets back up around 63%. Yes, there is a demographic element to this with the baby boomers retiring, but that is overplayed. Many people who are retiring in their 60s would rather work. You can see just how bad the Great Recession was. Most of the gains that started in the 60s with women entering the workforce were given back. The “retiring boomers” narrative has a kernel of truth in it, but it isn’t driving it.

employment population ratio

The FAANG stocks are now worth more than the entire UK stock market. While people talk about short Treasuries as being the most crowded trade on the Street, it doesn’t hold a candle to the FAANGs

FAANG

Goldman’s model now suggests the US economy grew at 4% in the second quarter. Friday’s Empire State Manufacturing Survey was the catalyst for the upgrade.

The government is trying to clarify the Volcker Rule, which prohibits banks from proprietary trading. So far, it seems to be clouding the issue as opposed to clarifying it. Ultimately trades held for less than 60 days are considered proprietary trades although there is a carve-out for hedging and market-making. Given the drop in commissions over the past 20 years, and sub-penny bid ask spreads, the economics of market-making are terrible to begin with, but the regulatory uncertainty probably seals the deal. The next crash is not going to be pretty.

Morning Report: Big week ahead

Vital Statistics:

Last Change
S&P futures 2782 -0.5
Eurostoxx index 386.55 1.43
Oil (WTI) 65.12 -0.61
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.59%

Stocks are flattish this morning ahead of a busy week. Bonds and MBS are down small.

This is a big week with the FOMC meeting on Tuesday and Wednesday, the ECB, and also a slew of economic data, particularly inflation data. The FOMC meeting will dominate, and we will also get a fresh new set of projections. The Street will focus on the inflation projections, especially as we continue to get anecdotal evidence of wage inflation.

The G7 met over the weekend, and it largely consisted of Donald Trump playing Al Czervik to the Bushwood global elite. There is talk about us doing permanent damage to our allies, but these events are largely messaging affairs and nothing much concrete ever comes out of them. There were a bunch of threats and counter-threats over trade barriers, and the message from the Administration was that the US has historically accepted the short end of the stick on these trade deals in the name of free trade in general, but those days are over. Will anything actually come from this? Probably not, which is why the markets don’t care.

Trump left the G7 meeting early to head to the Singapore Summit to meet with Kim Jong Un.

CFPB Director Mick Mulvaney said on Friday that he fired the 3 advisory boards because they were simply too big. He said that many participants were uncomfortable being candid at these meetings, and that “There is actually some good information that can pass when you sort of turn the cameras off.” Mulvaney has also been frustrated by leaks coming out of the agency, and he hopes this will help. Mulvaney also intends for the CFPB to go out “in the field” and have more town hall discussion meetings.

The interest rate on excess reserves is a real “inside baseball” statistic that could hold some clues on how the Fed intends to proceed going forward. The Fed is worried that conditions are tightening in the money markets and there are less excess reserves (excess reserves in another name for “dry powder” in the banking system). If there is less dry powder (or lending capacity) in the system then borrowers will have to accept higher rates in order to access these funds. The Fed funds rate is already close to the high end of the target range, which is worrying the some on the FOMC. The Fed started unwinding its QE balance sheet, letting about $100 billion of its $4.5 trillion sheet run off. We are already seeing a swoon in emerging markets. Bottom line: tightening financial conditions could cause the Fed to take a breather sooner than anticipated.

Fed assets

Rising interest rates and home prices are not deterring potential home purchasers, as the Fannie Mae Home Purchase Sentiment Index hit a new high in May. “The HPSI edged up to another survey high in May, bolstered in part by a fresh record high in the net share of consumers who say it’s a good time to sell a home. However, the perception of high home prices that underlies this optimism cuts both ways, boosting not only the good-time-to-sell sentiment but also the view that it’s a bad time to buy, and presenting a potential dilemma for repeat buyers,” said Doug Duncan, senior vice president and chief economist at Fannie Mae.