ECB – The Daily Tearsheet

Morning Report: Two new Fed nominees, weak payroll growth

Vital Statistics:

	Last	Change
S&P futures	2986.25	6.4
Oil (WTI)	56.75	0.9
10 year government bond yield		1.96%
30 year fixed rate mortgage		4.06%

Stocks are higher this morning as we are approaching detente in the US-China trade spat. Bonds and MBS are higher.

Bonds are rallying globally, with the German Bund yield hitting a record low of -39 basis points. Ex-IMF Chair Christine Lagarde is in the running to replace Mario Draghi as the head of the ECB. She is considered to be more of a politician, so the markets are interpreting her nomination to be bond-bullish. US rates will be influenced by overseas bond markets, so that means lower rates here at least at the margin.

Christopher Waller and Judy Shelton are the latest Trump picks to join the Federal Reserve Board. Judy Shelton has been vocal in criticizing the Fed’s practice of paying interest on excess reserves, and has questioned the effectiveness of the current regime of floating exchange rates versus the gold standard and the gold exchange standards of yesteryear. While there is a 0% chance we go back to some sort of hard-asset backed currency, between the serial bubbles of the past 40 years and the hyper-inflation of the 1970s, the economic record of post-Bretton Woods era (basically from when Nixon closed the gold window) has been mixed.

Construction spending fell 0.8% MOM and 2.3% YOY in May. Residential construction continues to be an issue, falling 0.6% MOM and 11.2% YOY.

Manufacturing expanded in June, according to the ISM Manufacturing report. That said, it decelerated compared to May. Tariffs remain the largest concern. New Orders were flat, while employment and production increased.

Mortgage Applications were more or less flat last week, as purchases increased 1% and refis fell 1%. Mortgage rates were unchanged-to-slightly lower, depending on the product. We have left the tightening-driven doldrums of 2016-2018 and approaching more normal levels. Here is the MBA Mortgage Index going back 20 years to give some perspective:

Private payrolls increased by 102,000, according to the ADP Employment Report. This is the second weak-ish reading in a row. Jobs were created in education and health as well as professional and business, while the construction sector lost jobs. Note the Street is looking for 160,000 new payrolls in Friday’s jobs report. Separately, initial jobless claims fell to 221k last week. You can see the drop-off in hiring in the ADP chart below:

Morning Report: Housing starts fall

Vital Statistics:

	Last	Change
S&P futures	2910	13.25
Oil (WTI)	51.78	-0.15
10 year government bond yield		2.03%
30 year fixed rate mortgage		4.15%

Stocks are higher as we begin the 2 day FOMC meeting. Bonds and MBS are up smartly on statements out of the ECB.

US rates are pushing towards 2% this morning after ECB President Mario Draghi signaled that the central bank could roll out further stimulus if inflation fails to materialize. The German Bund yields -32 basis points this morning (a record low), and US interest rates will have a hard time rising in this sort of environment. Simply put, bond investors will rotate out of bonds paying nothing into bonds paying something, even if they have to bear currency risk. It is preferable to locking in a sure loss by holding Bunds.

Housing starts fell to 1.24 million units in May, which was below expectations, but the prior two months were revised upward. Starts were down on a month-over-month and a year-over-year basis. Building Permits cam in at 1.29 million, which was more or less flat MOM and YOY.

Homebuilder sentiment slipped in June, primarily due to weakness in the Northeast and the West. That said, the index is solidly in the mid-60s, which is an overall strong level. Home prices have become stretched relative to incomes, but falling interest rates are offsetting that slightly. Rising costs for land and labor are making starter homes unaffordable for many first time homebuyers.

30 day delinquencies fell by 0.3% in March to a rate of 4.0%. Delinquencies are still being driven by hurricane-related issues. The foreclosure rate fell from 0.6% in March 2018 to 0.4% in March of 2019. Separately, ATTOM reported that there were 56,152 foreclosure filings in May, up 1% YOY, but down 22% from a year ago. Completed foreclosures were down 50%. The states with the highest foreclosure inventory are New Jersey, Florida, Delaware, Illinois.

Morning Report: median earnings rising slower than average earnings

Vital Statistics:

	Last	Change
S&P futures	2808	-2.5
Eurostoxx index	386.74	1.76
Oil (WTI)	67.62	-0.46
10 Year Government Bond Yield		2.85%
30 Year fixed rate mortgage		4.51%

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

Mortgage Applications fell 2.5% last week as purchases fell 5% and refis rose 2%. The refi share rose to 36.5%.

Housing starts hit their lowest level since September last year, falling to 1.17 million annualized. This is a huge drop from the strong May print of 1.33 million. The Midwest and the South explain the declines, which was both in single family and multi. June weather was generally good, so that isn’t the explanation. Building Permits fell as well, although not as dramatically. They came in at 1.27 million. The Midwest accounted for most of the decline in permits. Housing starts tend to be volatile, but the moving average is turning down, which is worrisome.

Despite the drop in starts, builder confidence remains strong, at least according to the NAHB. The index was flat at 68, which is an elevated number. Pricing remains strong, but the supply is not there. Rising material costs are becoming an issue as lumber tariffs raise costs. So far builders are able to pass these costs on, but there is a limit, especially if wage inflation remains below house price inflation. The median house price to median income ratio is getting back to extreme levels, and interest rates are not going to come to the rescue this time around.

Jerome Powell begins his second day of testimony on Capitol Hill. There was nothing market-moving yesterday, so expect more of the same. Yesterday, his message was that the US economy has clear sailing ahead with strong growth and moderate inflation. With regard to the potential trade war, Powell downplayed the risks to the economy and said there will be a benefit if it turns out that Trump’s actions lower tariffs overall in the global economy. The US generally has much lower tariffs than its trading partners, and Trump has already made the offer to eliminate all US tariffs if our trading partners eliminate theirs. Separately, Powell said that it would ultimately be better for the US if the GSEs were off the government balance sheet. That is pretty much a universal opinion in DC these days, as the US taxpayer bears the credit risk of the majority of the mortgage market.

Median weekly earnings have not kept pace with the CPI lately, which means workers are losing ground, at least according to the latest survey out of the BLS. It shows that the median weekly wage rose 2% in the second quarter versus an increase in the CPI of 2.7%. Interestingly, the average hourly earnings increase during Q2 was 2.64% in April, 2.74% in May and 2.74% in June. It seems strange that the difference between average wage inflation and median wage inflation would be so stark, which would imply that wages are mainly rising at the high end, not the lower end. Note the other BLS measure of wage inflation, the employment cost index, shows comp growth of 2.9%, which takes into account benefits. For the most part, average hourly earnings have been rising faster than the core PCE index:

New York, Connecticut, New Jersey, and Maryland sued the government yesterday over the state and local tax deduction cap. The lawsuit if probably more for show than anything and doesn’t seem to have much chance of success. Some of the states are looking at workarounds, allowing people to “donate” to charitable funds which go to funding state and local services. Charitable deductions are still deductible. At the end of the day, the biggest issue to states like NY and NJ are the property taxes. NY and NJ have some of the highest property taxes in the country, where people routinely pay $20 – $30k or more. That explains at least partially why you can’t find buyers for luxury properties in the Northeast.

The ECB concludes that QE may have helped the rich, but it helped the poor more. While QE did boost asset prices (housing, bonds, stocks etc) it also boosted growth, which more than offset the increase in asset prices. “Low short rates do hurt savers via a direct effect, that is a reduction in income on their assets . . . however [low rates] also benefit savers, like all other households, via an indirect effect — that is, the reduction in their unemployment rate and the increase in the labour income,” the paper, called “Monetary policy and household inequality”, said. “The indirect effect dominates . . . The paper also finds that [QE] reduced inequality, mainly through a reduction of the unemployment rate of poorer households.”

Note that this contradicts the observation between median and average earnings. If QE was actually decreasing inequality, you should see median earnings growth close to average earning growth or even slightly higher. Not way below.