Morning Report: Ginnie is increasing scrutiny of non-bank lenders

Vital Statistics:

 

Last Change
S&P futures 2642 0
Eurostoxx index 357.3 2.93
Oil (WTI) 52.35 0.36
10 year government bond yield 2.73%
30 year fixed rate mortgage 4.62%

 

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

 

Despite the end of the shutdown, we will have to wait for economic data. Two big reports this week – GDP and personal incomes – have been delayed.

 

Economic activity picked up in December, according to the Chicago Fed National Activity Index. Production-related indicators and employment drove the increase. Note that the CFNAI is a meta-index of a number of announced economic indices, and the government shutdown has decreased the amount of data going into the index. We’ll see the same effect next month as well, so the index won’t be as accurate as it usually is. Regardless, the CFNAI is an amalgamation of previously released data, so it doesn’t move markets.

 

Ex-Fed Head Narayana Kochlerakota thinks the Fed should consider easing at the next meeting. His argument is that the Fed has been falling short in maintaining inflation at its 2% target and that notwithstanding the latest unemployment data we are still not at full employment. He is looking at the percentage of prime age people (age 25-54) who are currently employed. We are just south of 80%, and were closer to 82% during the late 90s. Given that the number of prime age people in the US is roughly 100MM, then we have about 2 million more jobs to create in order to get to back to where we want to be. Interestingly, he not only advocates maintaining the current balance sheet, he thinks it should increase about 4% a year to grow in lockstep with the economy.

 

employment population ratio

 

Guess what has been one of the best performing assets so far this year (almost tripled in under a month). If you guessed the GSEs, you would be correct. The market is betting that shareholders won’t get wiped out when / if housing reform happens this year. Check out this chart of Fannie Mae:

 

fnma chart

 

Ginnie Mae is stepping up oversight of its partners, particularly non-bank lenders, telling some that they must improve some financial metrics before they will be granted more commitment authority, which is the ability to securitize FHA and VA loans. The government is concerned that non-bank lenders have replaced a lot of the traditional banks in servicing government loans. Indeed, they have – nonbanks now service 61% of government loans, up from 34% at the end of 2014. FHA was largely a backwater of the mortgage market pre-crisis, however post crisis, it has picked up the load that subprime left. Servicers for government loans have a lot more liquidity demands than servicers for GSE loans – and in a downturn the advances liability could take out undercapitalized mortgage bankers. VA lenders can face what is called no-bid risk, which can be a disaster for many servicers without a line of credit to cover advances and loan buyouts.

Morning Report: Jerome Powell stresses flexibility

Vital Statistics:

 

Last Change
S&P futures 2587.75 -6.75
Eurostoxx index 348.54 -0.31
Oil (WTI) 52.94 0.34
10 year government bond yield 2.72%
30 year fixed rate mortgage 4.48%

 

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

 

Initial Jobless Claims fell to 216,000 last week.

 

Jerome Powell stressed that the Fed has the flexibility to be patient in raising rates and will react to new data as appropriate. “Especially with inflation low and under control, we have the ability to be patient and watch patiently and carefully as we … figure out which of these two narratives [slowdown or inflation] is going to be the story of 2019,” Powell said at the Economic Club of Washington. Separately, St. Louis Fed President James Bullard said that the Fed had “reached the end of the road” in this tightening cycle.

 

The Fed Funds futures have retraced some of their December move and are now forecasting that the Fed will do nothing in 2019. In November, they were forecasting another hike in 2019, and then swung to forecasting a cut in December. They are now more or less agreeing with James Bullard that this tightening cycle is in the books.

 

fed funds futures

 

Bonds largely ignored the Fed Speak and stocks were more focused on punishing the mall based retailers and department stores, many of which had a difficult holiday shopping season.

 

Fannie Mae reported another drop in delinquencies, as the SDQ percent fell to .76% of their portfolio from .79% a month ago and 1.12% a year ago. The DQ rate for loans originated during the bubble years is 4.5%. The DQ rate for loans originated since is .33%.

 

It is looking more and more likely that Trump will declare a national emergency to allocate funds to the wall and to re-open the government. It will then be up to the courts to decide if such a move is legal, which opens up a new can of worms as the executive branch continues its decades-long path of power consolidation.

Morning Report: October was hard on MBS investors

Vital Statistics:

 

Last Change
S&P futures 2728 4
Eurostoxx index 364.84 0.76
Oil (WTI) 62.92 -0.35
10 year government bond yield 3.21%
30 year fixed rate mortgage 4.96%

 

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

 

The highlight of this week will be the FOMC meeting on Wednesday and Thursday. Typically they fall on Tuesday and Wednesday, but I guess they moved it for election day this year. No changes in monetary policy are expected and the Fed Funds futures market is assigning a 93% probability of no change in rates. Aside from the FOMC meeting, the only other market moving news will be PPI on Friday. Whatever happens Tuesday is probably not going to be market-moving. Best bet: Ds narrowly take the House, Rs retain the Senate, gridlock rules Washington.

 

October was a rough month for MBS investors, the kind folks who set our rate sheets. MBS underperformed Treasuries by 37 basis points, the worst since immediately after the election. Yes, the Fed is reducing the size of its MBS holdings, but that isn’t what makes MBS outperform and underperform. Volatility in the Treasury markets can be great for bond investors, but is is toxic for MBS investors.  You can see we October was a period of high volatility in the bond market (shown below with a “VIX” for Treasuries). Volatility causes losses losses for MBS investors and makes them less likely to “bid up” securities, which translates into a phenomenon where rates don’t improve as much as you would think when rates fall, and negative reprices happen frequently.  The Fed’s reduction of its balance sheet has been going on for years, and it isn’t all of a sudden going to manifest itself in rates.

TYVIX

 

Fannie and Freddie reported strong numbers and paid about $6.6 billion to Treasury between them. Fannie Mae has paid in total about $172 billion to Treasury since the bailout.

 

Jerome Powell thinks the current period of low inflation and low unemployment could last “indefinitely.” Historically, inflation usually increased as unemployment fell (which was measured by the Phillips Curve). He thinks that relationship has broken down over time. He notes that the last two booms were not ended by goods and services inflation, they were ended by burst asset bubbles. Since we don’t seem to have any asset bubbles brewing at the moment, this set of affairs could last a while. I wonder how much of the historical unemployment / inflation was due to union contracts which included explicit inflation cost of living increases. Regardless, he is correct that we don’t have anything resembling a stock market bubble or real estate bubble, and changes in inventory management have probably done a lot to get rid of the historical cause of recessions, which is an inventory glut.

 

Isn’t this a perfect encapsulation of the cognitive dissonance in the business press right now? They don’t like the guy in office, so they constantly feel like the economy is awful (Consumer confidence is definitely a partisan phenomenon). Classic example of why you always have to take consumer confidence numbers (and the business press) with a grain of salt….

Cognitive DIssonance

 

Morning Report: Housing starts jump

Vital Statistics:

Last Change
S&P futures 2908.75 -3
Eurostoxx index 378.74 0
Oil (WTI) 69.94 0.09
10 year government bond yield 3.05%
30 year fixed rate mortgage 4.78%

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

Mortgage applications increased last week despite a big uptick in rates. The overall index rose 1.6%, driven by a 4% increase in refis and a 0.3% increase in purchases. FWIW, I wonder if there is some sort of strange adjustment related to the Labor Day holiday going on. Rates hit a 7 year high, with the conforming 30 year fixed hitting 4.88%.  ARMs increased to 6.5% of all activity.

Housing starts rose to an annualized pace of 1.28 million in August, which is up over 9% on a MOM and YOY basis. Permits disappointed however, falling just under 6% on a MOM and YOY basis. Multi-fam (which is notoriously volatile) drove the decline in permits and the increase in starts. Single family permits were up about 6%. Geographically, the action was in the West and South, while the Northeast and Midwest were flat / barely up.

Housing starts will probably take a step back in the next few months as construction workers will be occupied rebuilding North Carolina.  Labor remains an issue for new home construction, but the tariff-driven spike in lumber prices is over, and futures are trading at 18 month lows.

lumber

Fannie Mae thinks growth has peaked for this cycle and that the second quarter’s torrid growth rate of 4.2% was artificially boosted by inventory build ahead of tariffs. This had the effect of borrowing growth from future quarters. In all fairness, they are probably correct – a 4.2% growth rate is so far above historical trend that it is almost by definition unsustainable. Housing continues to punch below its weight as affordability issues weigh on sentiment. Note that the number of people saying it is a good time to buy a house has hit the lowest level since the survey began 8 years ago. Blame rising rates and home price appreciation outstripping income growth.  FWIW, they are somewhat bearish on consumer spending going into the 4th quarter, which seems to defy a lot of data we are getting about retailer activity.

Insured losses form Hurricane Florence will be in the $1.7 to $4.6 billion range.

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.

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.