Fed Funds rate – The Daily Tearsheet

Morning Report: Housing is coming back

Vital Statistics:

	Last	Change
S&P futures	3003.75	4.25
Oil (WTI)	58.37	-0.94
10 year government bond yield		1.78%
30 year fixed rate mortgage		4.00%

Stocks are flattish as we await the FOMC decision at 2:00 pm EST today. Bonds and MBS are up.

Housing starts increased 12.3% MOM and 6.6% YOY to a seasonally adjusted annual rate of 1.36 million. This is the highest in 12 years. July was revised upward as well. Building Permits rose 7.7% MOM and 12% YOY to 1.4 million, which is close to historical levels (non-population adjusted). This data seems to comport with the MBA’s 30% rise in purchase activity. Permit activity increased the most in the Northeast, while falling in the Midwest.

Mortgage applications were flat last week despite a huge back up in rates. There was also an adjustment for Labor Day, so that will affect the numbers. Purchases rose 6%, while refis fell 4%. The average rate on a 30 year fixed rose 19 basis points to 4.01%, and government loans increased share.

CFPB Chair Kathy Kraninger believes her job security is unconstitutional and supports a Supreme Court review of a case pending before the 9th Circuit. Essentially, Dodd-Frank made the head of the CFPB basically untouchable – the President can only fire “for cause” and not at the discretion of the White House. “From the Bureau’s earliest days, many have used the uncertainty regarding this provision’s constitutionality to challenge legal actions taken by the Bureau in pursuit of our mission,” Kraninger wrote to staff. “Litigation over this question has caused significant delays to some of our enforcement and regulatory actions. I believe this dynamic will not change until the constitutional question is resolved either by Congress or the Supreme Court.” Given that the case is currently in front of the liberal 9th Circuit (aka the Nutty Ninth) the current structure will almost certainly be upheld and it will go to SCOTUS.

Some inside-baseball stuff: Despite the bet that the Fed will cut rates to a range of 175-200 basis points today, the Fed had to intervene yesterday to prevent the Fed Funds rate from breaching the top of the current 200-225 basis point range. The cause was a shortage of dollars in the money markets ahead of Q3 interim tax payments and a big Treasury bond issue. This caused overnight repo rates to surge to 500 basis points on Monday, and the punch line is that this problem might push the Fed to increase the size of its balance sheet, which means more QE. This stems from a change in how the Fed mechanically manages the Fed Funds rate in the immediate aftermath of the financial crisis. How will it affect mortgage markets? Not directly, however issues with financing / hedging and rate volatility will negatively impact mortgage rates, at least at the margin.

Morning Report: Surprise refi boom

Vital Statistics:

	Last	Change
S&P futures	2850	-24.5
Oil (WTI)	52.746	-.94
10 year government bond yield		1.63%
30 year fixed rate mortgage		3.86%

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

New Zealand cut its short term interest rate more than expected, which sent sovereign yields lower overnight. The German Bund is approaching negative 60 basis points, and UK Gilts just dropped below a 50 basis point yield. All of this pushed US Treasury yields down to 1.62% overnight and we are now sitting at 1.63%. 2s-10s are at 10 basis points, and the September Fed Funds futures are now pricing in a 100% chance of a cut, with a 1/3 chance of 50 bps and a 2/3 chance of 25 bps.

Mortgage rates have been falling along with the drop in yields, but they have been lagging the move. We are seeing compression high up in the rate stack, which means that the higher note rates are not improving by much. Why is that? Prepayment fears. Given the drop in rates, it is a risky bet to pay 105 for for a Fannie 4.5% coupon bond when the 2.5% are trading at par. Those 4.5% MBS might prepay so quickly you won’t make up for that extra premium you paid. Hedging issues are also coming into play here, as MBS investors generally abhor rate volatility and we have been getting a lot of it. Bottom line, this is good news for mortgage bankers, but prepare to be disappointed when you run new scenarios. Rates are better, but not by as much as you would expect.

Mortgage applications increased 5.3% last week as purchases decreased 2% and refis increased 12%. On a YOY basis, refis are up 116%. Take a look at the chart of the MBA refi index below. Houston, we have a refi boom. Now if we could only do something about housing starts….

Lost in the noise about interest rates was another strong job openings report. The JOLTs job openings came in better than expected at 7.35 million and the prior month was revised upward to 7.38 million. The quits rate was flat at 2.3%.

Morning Report: Fed Funds forecasts and mortgage rates.

Vital Statistics:

	Last	Change
S&P futures	2895.75	0.75
Oil (WTI)	51.89	-0.62
10 year government bond yield		2.11%
30 year fixed rate mortgage		4.12%

Stocks are flat this morning as we enter Fed week. Bonds and MBS are flat as well.

The big event this week will be the FOMC meeting which starts Tuesday. Given the disconnect between the market’s perception of the road ahead and the Fed’s prior forecast, something has to give. FWIW, the market is now assigning a 20% chance they will ease by 25 basis points at this meeting. By the December meeting, the market is forecasting the FOMC will cut rates either 2 or 3 times!

Compare that to the March 2019 dot plot, which showed most members of the FOMC thought rates would be unchanged for the year and about 1/4 of the members wanted to see a rate hike:

If the Fed Funds futures are correct and we are looking at a 1.5% Fed Funds rate, where will mortgage rates go? If history is any guide, probably nowhere. The last time the Fed Funds rate was around 1.5% (late Dec 2017), the 30 year fixed rate mortgage (according to the MBA) was in the low 4% range, in other words, right about here. Long term rates have already priced in the move. MBA 30 year FRM chart:

Quicken Loans settled with the DOJ over false claims allegations regarding FHA origination going back to 2015. The case was dismissed and Quicken settled for $32.5 million with no admission of guilt. Quicken fought the case the entire way, and eventually narrowed it down to a tiny fraction of what the Obama Administration wanted. Quicken Vice Chairman Bill Emerson said: “I think the current HUD administration realized how faulty the previous administration’s tactics were, and frankly, as we’ve said before, we viewed them as extortionist tactics and we just could not go along with that,” Emerson said. “We know we didn’t do anything wrong and so we continued to fight, and if that somehow caused the new administration to evaluate it differently, then great.”

Ed Demarco discusses the ways that private capital can be drawn back into the mortgage market. First, the CFPB’s ATR and QM rules need to change to bring down the allowable DTI ratios on Fannie and Freddie loans to that of the rest of the market. This is known as the QM patch, which basically says that any loans that meet F&F criteria meet the ability to repay test. The problem is that the QM laws specify a max DTI ratio of 43% and the GSEs allow up to 50%. This gives Fan and Fred a huge advantage over other lenders. The second issue revolves around the SEC and refining the data definitions in the registration rules. Third, Fan and Fred have all sorts of mortgage performance data that is unavailable to the broader market, and leveling the playing field would mean allowing other participants to see that data. Note however that DeMarco is only looking at the issue from the standpoint of originators. Buyers of private label securities have other issues that are still unresolved, especially when the issuer of the bonds also retains servicing. There is a conflict of interest issue that must be resolved as well. I discussed this about a year ago in Housing Wire.

Profitability improved for independent mortgage bankers in the fist quarter of 2019. Average revenue per loan came in at $9584, while average cost per loan was $9,299, or a net gain of $285 per loan, compared to a loss of $200 a loan in the fourth quarter. It looks like mortgage bankers reported a loss in the first quarter of 2018 as well.

Morning Report: Strong wage growth in December

Vital Statistics:

	Last	Change
S&P futures	2480	32.75
Eurostoxx index	338.85	4.35
Oil (WTI)	48.05	0.95
10 year government bond yield		2.61%
30 year fixed rate mortgage		4.43%

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

Jobs report data dump:

Nonfarm payrolls up 312k, street expectation 177k
Average hourly earnings up 0.4% MOM / 3.2% YOY, street expectation 0.3% / 3.1%
Labor force participation rate 63.1%, November 62.9%
Unemployment rate 3.9%, street expectation 3.7%

Overall a strong report. The uptick in the unemployment rate was a surprise, but is still below 4% and the labor force increased by quite a bit. Wages are increasing smartly, rising 3.2%. Those in the press (and DC) hoping for recessionary data will be disappointed with this report.

Yesterday, we touched 2.57% on the 10 year bond yield. If you were hoping to see that reflected in mortgage rates, you were probably disappointed. MBS are lagging the move in Treasuries (as usual).

The action in the Fed funds futures is truly astounding. There has been a complete sea-change in market perception over the past month. Look at the January 2020 futures (a year from now). Implied probability of another hike in 2019? Zero. Chance of a rate cut? Better than 50/50. Note the implied probabilities a month ago versus today. The market is saying the Fed overshot.

Compare that to the dot plot from the December meeting which suggests another 50 basis points of hikes:

This is an astounding change in sentiment in just a month. It is certainly possible that the Fed Funds futures have it wrong, but it is clear the market and the Fed aren’t seeing the future even remotely the same.

Chinese demand is collapsing, as evidenced by falling consumption tax receipts. People have known that China has a real estate bubble and a shaky banking system for a while, but bubbles generally go on for longer than anyone ever expects. With the Chinese pulling out of the hot US markets, we are seeing a decline in places like Manhattan, where the median apartment price fell below $1 million for the first time in 3 years. There is a 16 month supply of luxury apartments in Manhattan, compared to an overall 4.5 month supply of existing homes for sale in the US. 6.5 month’s worth is generally considered a balanced market. The same thing is happening in the hot West Coast markets.

Kathy Kraninger, the new head of the CFPB sent an email to staffers saying that the agency will “continue to vigorously enforce the law,” but keep in mind “costs and benefits” and “maintain an open mind, without presumption of guilt.” So, she sounds like a continuation of the Mick Mulvaney approach and not a return to the Cordray “regulation by enforcement” model.

Mr Cooper bought IBM’s $48 billion servicing portfolio.

Morning Report: The real reason why markets are selling off

Vital Statistics:

	Last	Change
S&P futures	2355.25	13.5
Eurostoxx index	335.24	-1.43
Oil (WTI)	53.35	0.82
10 year government bond yield		2.74%
30 year fixed rate mortgage		4.60%

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

Not a lot of news to work with, but most of the business press is fixated on the stock market sell-off and trying to craft a narrative that Trump (or the government shutdown) is behind it. This is nonsense. There is a sea change in the market’s perception that the Fed has overshot, and you can see it the chart below, which shows the expected Fed Funds rate for a year from now.

Right now, the central tendency is that there will be no more rate hikes in 2019. But take a close look at the implied probabilities today and compare them to where they were a month ago. At the end of November, the markets figured there was a 23% chance that there would be no further changes, a 37% chance of one more hike, and a 25% chance of two more hikes. Look at the probabilities now: 59% chance the Fed does nothing in 2019, a 17% probability they hike 25 basis points, and a 19% probability the next move is a rate cut. That is a tremendous change in market perception in just under a month, and THAT is what is driving the markets. Not the government shutdown. Not Trump jawboning Powell about interest rates, especially since the markets are saying that Trump is right. Hard for the business press to massage that point.

FWIW, the Atlanta Fed is predicting Q4 GDP to come in at 2.7%. If there is a recession coming in 2019, today’s numbers sure are not signalling one.

There is concern in the economy that housing is slowing down, but in all honesty, housing never really recovered all that much, at least as far as building is concerned. We still have such a deficit between supply and demand that any fears of another 2008 – style market collapse are misplaced. Bottom line: the US taxpayer has been bearing the credit risk of 90% of all new origination over the past 10 years. The banking system does not have the mortgage credit risk issues it did during the bubble days – the private label mortgage market does not have the footprint it did a decade ago.

There is fear of a drop in global demand, and that is what the declines in commodity prices are saying. The Chinese economy is living on borrowed time, as they have a massive real estate bubble that will burst at some point. Europe continues to muddle through, and Japan’s start-stop economy is beginning to hiccup again. Fears of a global economic slowdown are a valid fear, however the punch line from that is ultimately lower global interest rates, which is a plus for the US, not a negative.

Morning Report: Delinquencies rebound

Vital Statistics:

	Last	Change
S&P futures	2683	19
Eurostoxx index	354.73	1.46
Oil (WTI)	66.9	0.07
10 year government bond yield		3.12%
30 year fixed rate mortgage		4.93%

Stocks are higher this morning despite a huge sell-off in Asian shares last night. Bonds and MBS are flat.

Stocks got walloped yesterday yet again, making this month the worst since the bad days of the financial crisis. There really isn’t much of a catalyst to hang your hat on – just general overseas selling and the risk-off trade. I think part of this is a rotation back into the short term interest rate market. CDs are now paying over 2%, after having paid nothing for years. A moribund asset class is coming back, and stocks are going to feel the brunt of it.

With the NASDAQ officially down 10% from the high, and the S&P 500 pushing close to it, where do you think the VIX is? Just over 25, which isn’t even the high for the year. If you are hoping we have hit capitulation, we haven’t.

Home price appreciation decelerated in August, according to the FHFA House Price index. Prices rose 0.3% MOM and 6.1% YOY. The red-hot Pacific and Mountain MSAs have decelerated, while many of the laggards (Mid-Atlantic) are seeing improved performance.

New Home Sales fell dramatically in September on both a month-over-month and annual basis. They fell to a seasonally-adjusted annual rate of 553,000, which is down 5.5% MOM and over 13% YOY. With current inventory at 327,000 units, we have over 7 month’s worth of inventory, which would be characterized as a buyer’s market (6 – 6.5 months is considered “balanced.”). Note that new home sales can be extremely volatile but it confirms what we have been seeing in the homebuilder ETF – affordability is beginning to deter buyers.

“Modest to moderate.” was how the Fed’s Beige Book characterized economic growth. “Modest to moderate” was pretty much how the Fed characterized everything from 2010 to 2016. This is a downgrade from “brisk,” “solid” or “strong” – words the Fed has been using recently to characterize the economy. The Beige Book is a more qualitative assessment of the economy, so parsing the language is about the only thing you have to work with. The Fed has been expecting the economy to slow due to trade wars. If the economy is beginning to slow, the Fed might want to take a breather and let the recent rate hikes take effect before making any further moves. The Fed also noted that housing continues to underperform.

The sell off has affected the Fed Funds futures market. A week ago, the markets were handicapping a 80% chance for a hike. It is now down to 74%. A March 2019 hike is now a coin toss.

Delinquencies spiked in September, rising 13% for the biggest jump since November 2008. Hurricane Florence hit areas saw DQs rise by 38%, although there is a seasonal aspect to DQs – they typically rise during September and January.

Morning Report: Fed hikes rates as expected

Vital Statistics:

	Last	Change
S&P futures	2786	8
Eurostoxx index	389.9	1.7
Oil (WTI)	67.03	0.39
10 Year Government Bond Yield		2.94%
30 Year fixed rate mortgage		4.61%

Stocks are higher after the FOMC raised interest rates a quarter of a point. Bonds and MBS are up.

As expected, the Fed raised the Fed funds rate by 25 basis points to a range of 1.75% – 2%. The economy is clicking on all cylinders, with unemployment down, consumer spending up and business investment increasing. They took up their estimates for 2018 GDP growth to 2.8% from 2.7%, took up core PCE inflation to 2% from 1.9% and took down their unemployment rate forecast to 3.6% from 3.8%. The dot plot was increased slightly and the Fed funds futures shifted to a 60/40 probability of 2 more hikes this year.

Bonds initially sold off on the announcement, touching 3% at one point, but have since rallied back. The ECB also announced that it will stop buying bonds in September, depending on the data. Bunds are rallying on that statement and the 10 year could be rallying on the relative value trade. The Fed noted that longer-term inflation expectations have not changed, and they didn’t change their outlook for inflation from 2019 onward. One other thing of note: the Fed is going to start having press conferences after every meeting in order to disabuse people of the idea that the Fed can only hike in December, March, June and September.

In other economic news, initial jobless claims fell to 218,000 last week, while retail came in way higher than expected, rising 0.8% for the headline number and 0.5% for the control group, which excludes gasoline, autos and building materials. Restaurants and apparel were the big gainers, increasing 1.3% and 1.5%. Consumer discretionary spending is back, as the FOMC statement indicated. Finally, import and export prices were higher than expected, with increasing energy prices pushing up imports and higher ag prices increasing exports.

Outgoing Republican Congressman Darrell Issa is supposedly one of the finalists who will be appointed as the head of the CFPB. The Administration has said that it will abide by its June 22 deadline to appoint a permanent head of the CFPB. Acting Chairman Mick Mulvaney is not involved in the selection process. Mark McWatters, a former banking regulator is another top choice, and probably makes more sense than Issa.

The May real estate market was the strongest on record, according to Redfin. Prices rose 6.3% and the average home was on market 34 days. In Denver, the time on market was under a week. Over a quarter of the homes sold in May went over their listing price. San Jose saw a price increase of 27% YOY to a median home price of over $1.2 million.

Note that rents rose by 3.6%, which is tilting the rent-vs-buy decision a little. Interestingly, Sam Zell, a famous real estate financier, thinks the multifam market is topping and should become less attractive going forward.

Affordable home advocates are touting a statistic that shows a minimum wage worker cannot afford a 2 bedroom apartment anywhere in the country. That is an awfully high bar – heck entry level investment bankers can’t afford a 2 bedroom apartment either. That is why young adults usually have roommates. I get there is a shortage of affordable housing, but that is a completely disingenuous statistic. Sam Zell is probably correct, however there could in fact be a glut of luxury apartments and a shortage of affordable ones.