Construction Spending – The Daily Tearsheet

Morning Report: The government hires and advisor for Fannie and Freddie

Vital Statistics:

	Last	Change
S&P futures	3289	43.25
Oil (WTI)	51.38	1.02
10 year government bond yield		1.59%
30 year fixed rate mortgage		3.63%

Stocks are higher after Chinese markets held up overnight. Bonds and MBS are down.

Construction spending fell 0.2% in November, but was up 5% on a YOY basis. Residential construction was up 1.4% MOM and up 5.8% YOY. Public residential construction was up almost 30% YOY.

Manufacturing performed better than expected in January, with the ISM Manufacturing Index rising to 50.9. This is a sharp rebound from December, which indicates that trade issues are in the rear view mirror.

The government is considering an expansion of the Federal Home Loan Bank’s customer base to include non-bank lenders and mortgage REITs. Federal Home Loan Bank borrowers generally get a sweetheart deal on financing, usually much better than even overnight repo lines. The reason? government subsidies. Note that some mortgage REITs currently do have FHLB lines, but I guess they want more mortgage REITs in the business. The Feds have been frustrated by the large banks, who have shied away from all but the most credit-worthy borrowers.

FHFA has hired an advisor to help recapitalize Fannie Mae and Freddie Mac. Houlihan Lokey won the deal. This will allow Fan and Fred to hire their own advisors for the equity sale. This is part of the government’s plan to decrease its footprint in the mortgage market. The share sale could top $125 billion, which would dwarf the largest IPO ever (Saudi Aramco in December) by a factor of 5. Lots of details remain, but progress is being made.

Morning Report: The Fed cuts rates

Vital Statistics:

	Last	Change
S&P futures	2983	0.5
Oil (WTI)	57.51	-1.04
10 year government bond yield		2.00%
30 year fixed rate mortgage		4.07%

Stocks are flat after the Fed cut interest rates 25 basis points. Bonds and MBS are up.

The Fed cut the Fed Funds rate by 25 basis points yesterday, which was in line with what the markets were expecting. Bonds sold off (rates higher) initially but eventually worked their way back to unchanged on the day and rates are lower this morning. The volatility in bonds did widen MBS spreads a little, which means that mortgage rates didn’t necessarily follow the 10 year yield lower.

The markets seemed to take the fact that Esther George and Eric Rosengren dissented in stride. Both voted against cutting rates. Jerome Powell’s press conference was a bit surreal given that his body language gave the impression he didn’t actually believe his “insurance cut for maintaining the recovery” narrative very much. If you watch the press conference, you’ll see him struggle with a question from Bloomberg’s Michael McKee regarding how cutting interest rates in an economy awash in capital will have any effect. Powell mentioned slowdowns in Europe and China several times, and that probably gave away the game. This was a rate cut in response to global weakness, certainly not US economic numbers nor Trump’s jawboning. Since using monetary policy as a tool to help foreign economies is not in the Fed’s job description, he can’t come right out and say it.

You can’t help the feeling that global central banks have engineered a sovereign debt bubble globally and now have no idea what to do about it. Their exit strategy is to create inflation, which would send money out of bonds, but cutting rates is causing bonds to get more expensive, exacerbating the bubble. The result has been a situation that makes zero economic sense: why would anyone pay to lend money, let alone to a government with a debt to GDP ratio of 240% (Japan)? I guess it is one of those things that people will eventually wake up to en masse. In other words, “it won’t matter until it matters, and then it will be the only thing that matters.” But the #1 rule of bubbles is that they go on longer and go further than anyone expects.

The Fed funds futures moved marginally in response to the rate cut. The markets are now pricing in about an 85% chance of one more cut this year, and are handicapping a better than 50% chance of a cut in September.

The Wall Street Journal is reporting that the FHA is going to announce a move to lower the limit for cash out refinances to 80 LTV from 85 LTV. “The risk at 85% is more than what we think is appropriate to bear and more than what we think we should expose taxpayers to,” said Keith Becker, the FHA’s chief risk officer. This change will bring FHA loans in line with Fannie and Freddie which cap cash outs at 80%.

In another change, a HUD proposal has been circulated that would reverse an Obama-era standard for fair lending – the disparate impact standard – and replace it with a 5-step framework to demonstrate that discrimination occurred. In other words, it will put the burden of proof back on the regulator to prove the lender intended to discriminate. I don’t have the actual proposal, so there isn’t much to go on quite yet.

In other economic news today, initial jobless claims came in at 215k, construction spending fell 1.3% and the ISM Manufacturing index slipped to 51.2.

Morning Report: Toll disappoints and the government targets VA cash-outs

Vital Statistics:

	Last	Change
S&P futures	2657	-42
Eurostoxx index	346.51	-7.2
Oil (WTI)	51.46	-1.45
10 year government bond yield		2.90%
30 year fixed rate mortgage		4.83%

Stocks are lower this morning as the global sell-off continues. Bonds and MBS are up.

While stocks are moving lower, the big news these days is the bond market rally. What appeared to be window-dressing last Friday (a sub 3% yield on the 10-year) has just kept going. A lot of market commentators have been scrambling to come up for a reason. Trade tensions make a convenient, if unsatisfying explanation. China and the US have reached an agreement to cool things off for 90 days, which should be good news. Economic data has been strong, and while we have had some slightly dovish comments out of the Fed, it is nothing dramatic. It feels like a major asset allocation trade out of equities into fixed income, but who or why is anyone’s guess. In other words, this could be just random noise, and therefore temporary. Note that 2s/10s (the difference in yield between the 10 year and the 2 year) got to single digits. Historically such behavior would signal a slowdown, but the Fed’s footprint in the Treasury market wasn’t so large before.

The business press is pushing out all sorts of “recession imminent?” articles, but if you read the ISM report on manufacturing, you will see nothing of the sort. New orders, production, and employment are all at historically very strong levels. The business press mirrors the mainstream media, and they are talking their ideological book a little.

In terms of MBS trading, they lagged the move big-time. On Tuesday, where yields touched 2.88% we saw only a couple of investors re-price for the better. So, all of those LOs who were running scenarios hoping to see an improvement were disappointed. TBAs did increase by 6 or 7 ticks, but the aggregators largely ignored it.

Construction spending fell 0.1% MOM in September, but was up almost 5% YOY. Residential construction fell 0.5% MOM and rose about 1.7% YOY. Lodging and office construction were up high / mid teens YOY, but resi (42% of total construction spending) continues to lag.

Speaking of resi construction, Toll Brothers reported a big drop in orders (down 13% in units / 15% in dollars). The cancellation rate jumped from 7.9% to 9.3%. Toll was one of the first builders to recover from the slowdown, making big bets on luxury urban apartments along with their traditional McMansion fare. California is the problem area, which is being hit by higher prices, higher rates, diminished foreign demand and new tax treatment. The whole sector was smacked, with the homebuilder ETF down about 5%. The XHB is down about 25% from its mid January levels.

Mortgage applications rose 2% last week as purchase activity rose 1% and refis rose 6%. Mortgage rates dropped about 4 basis points.

The VA is taking a closer look at predatory behavior in VA lending. From the Federal Register on November 30:

“VA is concerned that certain lenders are exploiting cash-out refinancing as a loophole to the responsible refinancing Congress envisioned when enacting section 309 of the Act. VA recognizes there are certain advantages to a veteran who wants to obtain a cash-out refinance, and VA has no intention of unduly curtailing veterans’ access to the equity they have earned in their homes. Nevertheless, some lenders are pressuring veterans to increase artificially their home loan amounts when refinancing, without regard to the long-term costs to the veteran and without adequately advising the veteran of the veteran’s loss of home equity. In doing so, veterans are placed at a higher financial risk, and the lender avoids compliance with the more stringent requirements Congress mandated for less risky refinance loans. Essentially, the lender revives the period of subprime lending under a new name.”

The government has already dealt with the serial refinancings by adding new seasoning requirements for loans to be eligible for standard Ginnie MBS, but that was about protecting MBS investors. This is different. For many veterans, it may sound like a great deal to be able to lop 50 bucks off your monthly payment and maybe get to skip a month or two, but that 3.3% funding fee is expensive, even though you get to finance it. If you are doing a VA cash-out to refinance credit card debt, it amounts to an expensive debt consolidation loan, though the drop in your rate and the tax treatment does offset that a bit.

Morning Report: Blowout jobs report

Vital Statistics:

	Last	Change
S&P futures	2752	12.25
Eurostoxx index	364.42	2.24
Oil (WTI)	63.42	-0.46
10 year government bond yield		3.18%
30 year fixed rate mortgage		4.89%

Stocks are higher this morning after a strong employment report. Bonds and MBS are down.

Jobs report data dump:

Nonfarm payrolls up 250,000
Unemployment rate 3.7%
Average hourly earnings up 3.1%
Labor force participation rate 62.9%
Employment-Population ratio 60.6%

Overall, an exceptionally strong report, with nothing to dislike. Strong wage growth, increasing labor utilization rates, low unemployment. Simply put, this is a blowout jobs report, the best we have seen in years.

The sell-off in the stock market was beginning to push the Fed Funds futures towards the dovish direction, but this report pretty much ended that. While we will get one more job report before the December FOMC meeting, it is looking like we are going to see another 25 basis points.

Productivity increased 2.2% in the third quarter, which was a deceleration from the 2.9% we saw in Q2. Unit labor costs rose 1.2%. We are seeing rising compensation costs (up 3.5%) while output is also up. Rising comp costs are much higher than the inflation rate, and while it is easy to focus solely on wages, the cost of an employee is more than just wages – it includes benefits and other regulatory costs as well.

Construction spending was flat in August and rose 7.2% YOY. Residential construction rose 0.5% MOM and 4.9% YOY. Office and lodging rose smartly on a YOY basis. Interestingly, education building is still going strong, just as the tail end of the Millennial generation is graduating. You would think colleges would figure out how to compete on price, but for the moment they are competing on amenities and infrastructure. Which is partly why college is so expensive. There is going to be a reckoning, IMO when a demographic dearth of students meets falling affordability driven by rising interest rates.

Manufacturing slowed somewhat last month according to the ISM Manufacturing Survey, however it remains robust, despite what is going on with trade. That said, many of the comments from survey participants noted that prices are rising, partially driven by tariffs. Supply lines are stretched and more firms are running at capacity. That said, the higher anecdotal capacity utilization isn’t translating into the numbers, at least not compared to historical norms:

Rising interest rates have pulled back corporate bond issuance. Corporate bond issuance is often the canary in the coal mine for the economy and therefore bears watching. Many companies tapped the markets during the ZIRP years to refinance pre-crisis debt and the fund stock buybacks, so perhaps the comparisons aren’t really all that valid. Investor appetite is waning, however that may be due to the fact that shorter duration paper is beginning to earn a return, so funds are getting defensive with the Fed in tightening mode. So far we aren’t seeing a material widening of credit spreads. Still, in the summer of 2007, a few leveraged buyouts were unable to sell the paper from M&A deals, and the buyside went on a buyer’s strike against structured products. At the time, nobody had any idea what it would turn into.

Morning Report: Out: NAFTA. In: USMCA.

Vital Statistics:

	Last	Change
S&P futures	2933	14.75
Eurostoxx index	384.63	1.45
Oil (WTI)	73.2	-0.09
10 year government bond yield		3.09%
30 year fixed rate mortgage		4.71%

Stocks are higher this morning after NAFTA was saved over the weekend. Bonds and MBS are down small.

Canada and the US reached an agreement late last night to keep Canada in NAFTA (which will be renamed). The biggest change in NAFTA makes it harder for automakers to build in Mexico, where labor is cheaper. Canada got to keep a trade dispute mechanism. The treaty will go to Congress for approval. “It is a great deal for all three countries, solves the many deficiencies and mistakes in NAFTA, greatly opens markets to our Farmers and Manufacturers, reduce Trade Barriers to the U.S. and will bring all three Great Nations closer together in competition with the rest of the world,” wrote Trump last night. There is a press conference scheduled for 11:00 am.

Manufacturing continues to impress, with the ISM survey coming in at 59.8. New orders decelerated, while production and employment accelerated. Tariffs continue to weigh on manufacturers, and the clarity of having NAFTA (sorry USMCA) off the table should help somewhat, but we still are nowhere near any sort of resolution with China. Still, the market is strong, and labor issues remain. Wages are going to increase. They have to.

The CFPB’s head of fair lending is under fire for blog posts in the past, where hate crimes were discussed. The blog post in question is a mock legal debate – hardly an inflammatory screed – and is largely a thought crime for entertaining the notion that hate crimes are often hoaxes. Still, some of the employees at the CFPB are having issues with it. Ultimately, most of the CFPB staffers are holdovers from the Cordray “push the envelope” days, and they are chafing under the new approach of the CFPB – “enforce the law as written and then stop.”

This should be a big week ahead with the jobs report on Friday and a lot of Fed-speak. The snapback rally in the 10 year appears to be over, and the new NAFTA agreement definitely points to more expensive cars in the future. That could be offset by lower ag prices, but we will see. Don’t know how lumber will be affected either, but building materials are big inputs to inflation, especially housing inflation.

Mortgage rates increased by 3 basis points during September, making this the 10th month in a row where they have increased. This is affecting affordability, and the share of homes selling above their listing price declined. The drop is mainly in the super hot markets on the West Coast, but there is no doubt that home price appreciation is moderating. Either wages have to catch up or home prices are going nowhere for a while. With rates pushing 5%, will we see a slowdown in housing? Probably not – Zillow estimates that 6% is the number to watch.

Construction spending increased by a hair in August, increasing 0.1% MOM. On a YOY basis, we are still up 6.5%. Residential construction fell, and was up only 4.1% YOY. Where was the activity? Office and commercial.

The Atlanta Fed cut their third quarter growth rate estimate to 3.6% from 3.8%. Still think consumption could surprise to the upside for the year, but want to hear what the retailers report for back to school.

Morning Report: Strong ADP number

Vital Statistics:

	Last	Change
S&P futures	2818	1.75
Eurostoxx index	389.71	-1.9
Oil (WTI)	67.7	-1.06
10 Year Government Bond Yield		2.99%
30 Year fixed rate mortgage		4.62%

Stocks are higher this morning after good earnings from Apple. Bonds and MBS are down.

Japanese government bonds got shellacked overnight, with yields rising 8 basis points, which is causing reverberations throughout global bond markets. 8 basis points is a lot in one day regardless, but when rates were only 5 bps to begin with, it is quite the move.

Donald Trump threatened more tariffs with China. We seem to be going back and forth between detente and escalation.

The FOMC announcement is scheduled to be released at 2:00 pm EST. No changes in rates are expected, however the action will be in the statement and the interpretations for a December hike. While Trump’s criticism of the Fed’s rate hikes was unfortunate, things have been testier between the Central Bank and the Executive branch in the past. LBJ shoved William (take away the punch bowl just as the party is getting going) McChesney up against the wall in the Oval Office.

Mortgage Applications fell 2.6% last week as purchases fell 3% and refis fell 2%. We saw a 7 basis point increase in conforming rates to 4.84%. The government share of mortgages increased.

The private sector added 219,000 jobs in July, according to the latest ADP report. The Street is looking for 190,000 in Friday’s report, but as always, the bond market will be looking more at average hourly earnings than the headline payroll number. Construction added 17,000 jobs, while business services added 47,000 and healthcare added 49,000.

Manufacturing decelerated slightly in July, but continued to its torrid pace. As expected, much of the talk is about steel tariffs and when those costs will get passed on to consumers. Labor is becoming a bottleneck as well – it is causing capacity constraints.

Construction spending fell 1.1% in June (which missed estimates) and is up 6.5% on a YOY basis. Resi construction was down on a MOM basis, but increased 8.7% on an annual basis.

Morning Report: No, we are not in another housing bubble

Vital Statistics:

	Last	Change
S&P futures	2716	10
Eurostoxx index	387.8	4.74
Oil (WTI)	66.4	-0.63
10 Year Government Bond Yield		2.92%
30 Year fixed rate mortgage		4.48%

Stocks are higher after a Goldilocks employment report. Bonds and MBS are down.

Jobs report data dump:

Payrolls up 223,000 (expectation was 190,000)
Unemployment down to 3.8%
Labor force participation rate 62.7% (a drop)
Average hourly earnings up 0.3% / 2.7%

The Street was looking for wage growth of 0.2% MOM, but the annual number was in line with expectations. The wage growth print shouldn’t move the needle as far as the Fed is concerned. The employment – population ratio increased a tad as the population increased by 183k and the number of employed increased by 293k. We saw another good jump in construction jobs. Bottom line, a good report for equity markets, and a push for the bond market.

In merger news, Citizens Bank is acquiring Franklin American Mortgage. This deal should vault Citizens into a top-15 mortgage lender, bulk up its servicing portfolio and diversify its origination mix.

Italy has found a solution to its political crisis with a new coalition government that will be installed on Friday. Treasury yields should probably be higher, however tough trade talk out of the Trump Administration is keeping them lower. Even the International Steelworkers is against new tariffs, and if you can’t even get the unions on your side it says a lot…

Hard to believe it is here already, but the hurricane season is just beginning. CoreLogic estimates that 7 million homes are at risk in what NOAA expects to be a normal or above normal season. Note the National Flood Insurance program is set to expire right in the middle of the season.

Construction spending increased in April, according to the Census Bureau. Residential construction rose 4.4% MOM and 9.7% YOY.

Manufacturing accelerated in May, according to the ISM report. Employment expanded sharply. New order and production also grew.

As usual, the ISM report showed employers having difficulty finding qualified labor. Labor shortages are a theme these days, but you aren’t seeing the growth in wages you would expect. I wonder if part of the issue is application tracking systems, which seize on keywords and therefore have to be gamed somewhat. How many applicants are unaware of this or are simply bad at it? And if so, how many qualified workers are being screened out and never get presented before a set of eyes? I suspect ATS are good for companies in bad times, when there are a surfeit of applicants, but work against them when the labor pool is tighter.

An interesting editorial in the Wall Street Journal today about the credit box and the possibility of another housing bubble. The authors point to the way home prices have outstripped income growth and posits that a widening credit box (i.e. new 3% down loans from Freddie) are contributing. The authors suggest that underwriters tighten standards, and the government tighten loan parameters to prevent another foreclosure crisis when the market turns.

With regard to home price appreciation, is it due to widening credit standards, or is it due to restricted supply? In other words, is it a housing start problem or a MCAI (mortgage credit availability index) problem? The chart below is of the MBA’s Mortgage Credit Availability Index, which shows a loosening of standards since the bottom, but also demonstrates we are nowhere near the standards that existed during the bubble (and pre-bubble days).

FHA and the GSEs are stepping in on low downpayment loans because there is a complete and utter void in the private market. Prior to the crisis, FHA was a sleepy backwater of the mortgage market, targeted toward low income first time homebuyers. Afterward, its share grew because it was the only game in town. Let’s not conflate FHA mortgages with neg-am pick a pay loans of the bubble years. IMO the issue is a lack of supply (heck the appreciation is the highest in places like San Francisco, where the median price is double the limit on a FHA loan). Housing starts around 2 million for the next several years is what will be needed to cool off home price appreciation (along with the REO-to-rental types ringing the register on their portfolios).

Morning Report: Where is the private label MBS market?

Vital Statistics:

	Last	Change
S&P futures	2645	-1.75
Eurostoxx index	385.49	0.17
Oil (WTI)	67.92	-0.65
10 Year Government Bond Yield		2.96%
30 Year fixed rate mortgage		4.56%

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

Construction spending fell 1.7% MOM but is still up 3.6% YOY. Bad weather in the Northeast and Midwest probably drove the decrease. Residential construction was down 3.5% MOM and up 5.3% YOY.

Manufacturing downshifted in April, but is still reasonably strong according to the IS M Manufacturing Report. Steel tariffs were mentioned several times as an issue. A few comments from the piece:

“[The] 232 and 301 tariffs are very concerning. Business planning is at a standstill until they are resolved. Significant amount of manpower [on planning and the like] being expended on these issues.” (Miscellaneous Manufacturing)

“Business is off the charts. This is causing many collateral issues: a tightening supply chain market and longer lead times. Subcontractors are trading capacity up, leading to a bidding war for the marginal capacity. Labor remains tight and getting tighter.” (Transportation Equipment)

The US economic expansion is now the second-longest on record. Low inflation and low interest rates have made that possible. Despite the increase in interest rates, Fed policy is still highly expansionary, so as long as inflation behaves this could go on for a while longer.

House prices rose 1.4% MOM and 7% YOY, according to CoreLogic. About half of the MSAs are now overvalued according to their model.

Acting CFPB Director Mick Mulvaney is looking for ways to save money. Sharing desks and moving to the basement are possibilities. As an aside, this article belongs on the opinion page.

The private label MBS market used to be a $1 trillion market – last year it was only about $70 billion. What is going on? Regulation may appear to be the culprit, but it really isn’t. There are still all sorts of unresolved issues between MBS investors and securitizers. The biggest surround servicing – how do investors get comfort that the loan will be serviced conflict-free, especially if the issuer has a second lien on the property. How do investors get comfort that the issuer won’t solicit their borrower for a refinance? A lack of prepay history is also a problem – it makes these bonds hard to model and price. Many investors also remember the crisis years, when liquidity vanished and investors were unable to sell, sometimes at any price.

Issuers were content for a lot of years to simply feast on easy refi business – rate and term streamlines which were uncomplicated and simple to crank out. Warehouse banks were reticent to fund anything that didn’t fit in the agency / government box, so why not concentrate on the low-hanging fruit? Investors were able to pick and choose from all sorts of distressed seasoned non-agency paper trading in the 60s and 70s. Most of that paper ended up being money good. But in that environment, why would anyone be interested in buying new issues over par? If you are a mortgage REIT, why not buy and lever new agency debt with interest rates at nothing and a central bank that is actively supporting the market?

Now that the easy refi business is gone, will we see a return of this market? Perhaps, but there probably still is a big gulf between what borrowers and investors are willing to accept and the governance issues remain unsolved.