Morning Report: ISM strong, tight labor market, Fed Funds still see a coin toss for 2 hikes this year.

Vital Statistics:

Last Change
S&P futures 2737 10
Eurostoxx index 380.51 3.77
Oil (WTI) 75 1.06
10 Year Government Bond Yield 2.87%
30 Year fixed rate mortgage 4.52%

Stocks are up this morning as emerging markets rally overnight. Bonds and MBS are flat.\

Today should be quiet as markets close early ahead of the 4th of July holiday.

Manufacturing continued to plow ahead in June, according to the ISM PMI Index. The responses from the survey participants show that the trade war is having some impact. One food and beverage company mentioned that they were shifting some production to Canada in order to escape Chinese retaliatory tariffs on US products. Inflationary pressures are present in higher commodity prices, and we are seeing secondary pressure from transportation (higher oil prices and driver shortages are pushing up prices here). Pretty much every commodity is seeing price increases, and there are material shortages in aluminum, steel, and electronic components. Overall, this is a strong manufacturing reading, which is usually associated with 5.2% GDP growth. Of course, manufacturing isn’t the driver of the economy it used to be, but it is still a strong reading.

The Fed is going to pay close attention to this report, particularly the part about labor shortages. From their standpoint, inflationary pressures from commodity price inflation are generally considered transitory and therefore temporary. An old saw in the commodity markets is that the cure for high prices is high prices. The potential dampening effect from trade battles will also concern them. IMO, until you start seeing wage inflation pick up in a meaningful way the Fed will consider this a push. Note we will get some insight into this on Thursday when the minutes from the June meeting are released.

The Fed funds futures are still handicapping a 76% chance of a 25 bp hike in September and a 45% chance of one in December as well.

Fed Funds probability CME

Construction spending rose 0.4% in May, and is up 4.5% on an annualized basis. Residential construction was up 0.8% MOM and 6.6% YOY, as an increase in private resi construction was offset by a drop in public housing spending. Manufacturing construction took a step back, which will be something to watch (could just be noise, but could be trade-related). Meanwhile retail (specifically mall-related construction) is in the doldrums as vacancy rates soar.

Home price appreciation accelerated in May, according to the CoreLogic Home Price index. Prices rose 1.1% MOM and are up 7.1% YOY. The housing shortage is well-documented, and the problem is most acute at the entry-level. Higher rates and low inventory is also preventing some people from moving. CoreLogic estimates that 50% of the mortgage market has a rate of 3.75% or lower. According to CoreLogic’s model which compares home price appreciation to income appreciation, we are seeing large pockets of overvaluation, particularly in Florida, the West Coast, the sand states, and parts of the Eastern Seaboard. The Midwest remains cheap.

Corelogic overvalued

Trump is reportedly mulling whether to pick a new Chief of Staff. One of the potential candidates is current CFPB Chairman Mick Mulvaney. Mulvaney is currently doing double duty as OMB and CFPB head, so a change for him would be unlikely, but the possibility is still there. Here are the implications of a change and who might replace him.

Labor shortages continue to be an issue in the Midwest. Companies are now less squeamish about hiring ex-cons. In Elkhart, (where the labor market is so tight it sports a 2% unemployment rate and even the KFC is offering sign-on bonuses), companies are hiring convicted felons (except sex offenders) and are waiving drug tests. It is a back-to-the future scenario, where the labor market is suddenly transported back to 1955.

Morning Report: Markets now predicting a 50% chance of 4 hikes this year

Vital Statistics:

Last Change
S&P futures 2724 -6.25
Eurostoxx index 393.28 1.09
Oil (WTI) 71.74 0.78
10 Year Government Bond Yield 3.04%
30 Year fixed rate mortgage 4.57%

Stocks are lower this morning on earnings and retail sales. Bonds and MBS are down on hawkish comments out of Europe.

Retail Sales rose 0.3% in April, according to Census. The control group rose 0.4%. Both numbers were in line with consensus estimates. There is a push-pull effect in the numbers as tax cuts will encourage spending, while higher gas prices will depress it.

Speaking of retail sales, comps at the Home Despot came in lower than expected, although some of that was weather-related. The company noted that traffic in May has been strong. As home affordability gets worse, home improvement projects generally increase as people renovate instead of moving to a nicer home. The builders (and mortgage originators) have noted that the Spring Selling Season has been a dud this year.

The Empire State Manufacturing Survey came in at 20, higher than expected, while homebuilder sentiment improved to 70. Strong pricing is being offset by weak traffic, particularly among the first time homebuyer. Separately, inventories were flat in March, which will probably cause some houses to take down their estimate for first quarter GDP growth.

What would happen if you listed your home at $1? Would the subsequent bidding war get you to the correct price? It certainly would create a huge buzz around your home and that will probably help. That said, there are problems associated with that tactic. First, you will get all sorts of low-ballers who will only clog up the process. More importantly, the sites like Realtor.com, Zillow etc generally have searches with price ranges. In other words, if you expect your house to be worth $500,000 and you list it for $1, it won’t show up if the buyer sets a $400,000 – $600,000 search range.

HUD is seeking comment on the Supreme Court’s Disparate Impact ruling and whether HUD’s current policy is consistent with the ruling. Disparate Impact means that you can get slammed for discrimination even if you didn’t intend to discriminate, but your numbers are not consistent with the population.

The Fed Funds futures now are handicapping a 50% chance of 4 rate hikes this year.

Fed Funds probability CME

A combination of higher budget deficits and low unemployment has Goldman predicting a 3.6% 10 year yield by the end of 2019. This is the first time since WWII when we have had a combination of increasing deficits and falling unemployment. “”The sizeable demand boost provided by the recent deficit-increasing tax cuts and spending cap increases at a time when the economy is already somewhat beyond full employment is a striking departure from historical norms that is likely to contribute to further overheating this year and next and tighter monetary policy in response.” Of course the labor force participation rate is quite low, as is the employment-population ratio, two numbers that are not captured by the unemployment rate. Until you start to see wage inflation, the Fed will be content to go slow.

Morning Report: Jerome Powell agrees with market on interest rates

Vital Statistic:

Last Change
S&P futures 2667 -3
Eurostoxx index 388.93 -0.56
Oil (WTI) 70.09 -0.62
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.55%

Stocks are lower as we await the Trump Administration’s decision on the Iran deal. Bonds and MBS are down small.

The Administration is set to announce later today whether they intend to stay in the Iranian deal or abandon it. Oil has been rallying on expectations Trump will leave.

Jerome Powell said that market expectations (i.e. the Fed Funds futures) are more or less in alignment with the Fed’s expectations for the future path of interest rates. The December Fed funds futures are predicting about a 10% chance of one more hike this year, a 44% chance of 2 more and a 39% chance of 3 more. Over the past month, the central tendency has become more hawkish.

fed funds probability 2

Small Business Optimism remains strong, according to the NFIB. More businesses are planning on increasing capital expenditures, while hiring remains strong and we are seeing evidence of increased compensation. Profitability increased as well, which indicates that productivity is increasing, and that some of this CAPEX is going towards labor-saving technology. Finding qualified workers continues to be the biggest issue surrounding small business. “There is no question that small business is booming,” said NFIB Chief Economist Bill Dunkelberg. “Consumer spending, the new tax law, and lower regulatory barriers are all supporting the surge in optimism across all small business industry sectors.”

Despite the hurricane-related spike in delinquences, overall DQ rates have been falling, according to CoreLogic. Home price appreciation, in addition to more stringent underwriting standards are the driving force behind it. The foreclosure rate is down from 0.8% to 0.5%, and the 30 day DQ rate is down to 4.8% from 5.0%. As you would expect, TX and FL are experiencing rising DQ rates, but the rest of the nation is down.

Tesla stock has more or less recovered from its conference call induces swoon from last week. The bonds are at the lows however, trading at 88. Note there is a divergence also in NFLX, which has bonds in the low 90s, while the stock is a highflyer.

NYS AG Eric Schneiderman resigned from office after reports came out that he abused 4 women. Schneiderman was an AG cut in the same cloth as Eliot Spitzer, and hated the financial industry about as much as he did (FWIW the feeling was mutual). When Spitzer announced his resignation, cheers went up on the floor of the NYSE.

Freddie Mac is getting into the business of providing lines of credit against MSR portfolios. Nonbank servicers face liquidity issues when loans they are servicing go delinquent. They are required to make the mortgage payment to the ultimate investor of the mortgage until the loan is brought current or foreclosed. Banks generally have no problems with this, but nonbank issuers generally don’t have the balance sheet to withstand heavy advances activity. Fannie Mae only requires 6 months of advances, but Ginnie Mae has no similar relief. Policymakers are concerned about the ability of nonbank servicers to withstand a period of prolonged stress if delinquencies spike.

Homebuyer sentiment hit an all-time high according to the Fannie Mae Home Purchase Sentiment Index. “The latest HPSI reading edged up to a new survey high, showing that consumer attitudes remain resilient going into the spring/summer home buying season,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “High home prices and good economic conditions helped push the share of Americans who think it’s a good time to sell to a fresh record high. However, the upward trend in the good-time-to-sell share seen since last spring has done little to release more for-sale inventory. The tightest supply in decades, combined with rising mortgage rates from historically low levels, will likely remain a hurdle for mobility and a persistent headwind for home sales.”