Morning Report: Futures predicting another cut in two weeks

Vital Statistics:

 

Last Change
S&P futures 3039 -70.25
Oil (WTI) 46.46 -0.29
10 year government bond yield 0.94%
30 year fixed rate mortgage 3.28%

 

Stocks are down again on coronavirus fears. Bonds and MBS are up with the 10 year trading below 1% again.

 

The Fed’s rate cut doesn’t seem to be having the desired effect. Volatility in the markets continues, and to be honest, I don’t see how cutting interest rates is going to make any difference. The markets don’t have a credit availability issue, and lower rates aren’t going to entice people to take a cruise all of a sudden. The Fed is also running out of ammo if we do experience a recession.

 

Speaking of rate cuts, the Fed Funds futures are handicapping a 50% chance of a 25 basis point cut and a 50% chance of a 50 basis point cut at the March meeting in two weeks. The December futures are assigning a 27% chance we go back to zero.

 

fed funds futures

 

The Coronavirus has certainly been a double-edged sword for mortgage originators. The MBA Mortgage applications index increased by 15% last week as purchases fell 3%, but refis rose 26%.

 

“The 30-year fixed rate mortgage dropped to its lowest level in more than seven years last week, amidst increasing concerns regarding the economic impact from the spread of the coronavirus, as well as the tremendous financial market volatility,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “Refinance demand jumped as a result, with conventional refinance applications increasing more than 30 percent. Given the further drop in Treasury rates this week, we expect refinance activity will increase even more until fears subside and rates stabilize.”

“We are now at the start of the spring homebuying season,” Fratantoni added. “While purchase applications were down a bit for the week, they are still up about 10 percent from a year ago. The next few weeks are key in whether these low mortgage rates bring in more buyers, or if economic uncertainty causes some home shoppers to temporarily delay their search.”

 

 

If the March Fed Fund futures are correct, we could be looking at mortgage rates with a 30 year fixed rate mortgages with a 2 in front of them. While this could generally be a good thing for mortgage bankers, people that hold mortgage servicing rights are about to get a 2×4 to the side of the head as prepay speeds accelerate. And their broker dealers are asking for more margin as rates rally. The best of times, the worst of times…

 

Optimal Blue, the loan pricing engine many bankers use has experience record volume and has been experiencing latency issues as a result. Unfortunately Optimal Blue was making some tech migrations when all of this hit.

 

The CFPB may get its wings clipped at the Supreme Court. At issue is whether the President can replace the Director of the CFPB without cause. The Trump Administration is siding with the Plaintiff in this case and is refusing to defend the Agency’s structure. The House has sent its general counsel to defend the agency. While SCOTUS probably won’t go so far as to rule that the agency be disbanded, it is likely to rule that the President is free to appoint a director that shares his ideology.

 

 

Morning Report: Rates hit fresh lows as Coronavirus infects the markets.

Vital Statistics:

Last Change
S&P futures 2910 -40.25
Oil (WTI) 44.97 -1.79
10 year government bond yield 1.05%
30 year fixed rate mortgage 3.44%

 

Stocks are lower as the Coronavirus knocks down global equities. Bonds and MBS are up.

 

Washington State has reported the second US death due to Coronavirus, and one case has been reported in New York City. Globally there have been 87,000 cases and 3,000 deaths. The total number of confirmed cases in the US is 75. Most of the cases center around a nursing home in Kirkland, WA.

 

The 10 year is trading close to 1% as the market is anticipating a move out of the Fed, the ECB, and maybe the Bank of Japan to lower rates.  Fed Chairman Jerome Powell made a statement on Friday saying:

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

This statement caused a big shift in the Fed Funds futures. The March Fed Funds futures are now calling for a 50 basis point cut. My guess is that we would have an intra-meeting cut if the sell-off continues this week, and then another 25 basis points in March. Oh, and guess what the central tendency is for December. 50 – 75 bps in the FF rate. In other words, 100 basis points in cuts this year.

fed funds futures march 2020

 

Those sorts of moves seem to anticipate a recession in the US this year. Unless this turns into a major pandemic in the US, that seems unlikely. You generally don’t see recessions with 3.6% unemployment. However, supply shocks out of Asia will definitely slow things down. FWIW, the Fed Funds futures are predicting a recession, and that seems to be a stretch unless you start seeing tens of thousands of cases in the US.

 

The OECD is predicting that the coronavirus will lop about .5% off global growth this year, from 2.9% to 2.4%, which is a best case scenario. This scenario assumes that Coronavirus remains largely contained in Asia. If major outbreaks happen in Europe and the US, we would be looking at 1.5% global growth this year.

Morning Report: Market signalling March rate cut

Vital Statistics:

 

Last Change
S&P futures 3070 -39.25
Oil (WTI) 46.77 -1.79
10 year government bond yield 1.28%
30 year fixed rate mortgage 3.54%

 

Stocks are lower this morning on overseas weakness and Coronavirus fears. Bonds and MBS are up again.

 

The 10 year is trading at 1.28%, but MBS are lagging the move. Be patient with rates, as it will take MBS and rate sheets a few days to catch up. The Fed Funds futures are now handicapping a 58% chance of a March rate cut. A week ago it was 9%. What a difference 250 S&P handles makes…

 

New home sales rose 7.9% MOM in January, and is up 18.6% on a YOY basis. This is the highest level in 12 years. Mild weather and lower interest rates may have been a driver.  Speaking of new home sales, Toll Brothers reported lower than expected earnings, and blamed it on Coronavirus and CA sales.

 

new home sales

 

The second estimate for fourth quarter GDP came in at 2.1%, in line with the advance estimate a month ago. Consumption was a touch below expectations at 1.7%, as was inflation at 1.3%. In other economic data, durable goods orders fell 0.2% which was better than expectations. Ex-transportation, they rose 0.9% and capital goods orders (which are a proxy for capital expenditures) rose 1.1%. Finally, initial jobless claims rose to 219,000 last week.

 

Interesting on the flight to safety trade – gold is up. bitcoin is not.

 

 

Morning Report: Fed Week

Vital Statistics:

 

Last Change
S&P futures 3144 -6.25
Oil (WTI) 58.59 -0.64
10 year government bond yield 1.81%
30 year fixed rate mortgage 3.98%

 

Stocks are slightly lower as we head into a Fed Week. Bonds and MBS are up.

 

There are two big events this week: the FOMC meeting on Tuesday and Wednesday and the spate of new Chinese tariffs expected to take effect at the end of the week. We will get some interesting economic data in productivity, inflation and retail sales, but with the Fed on the sidelines trade and overseas markets will be driving interest rates.

 

The Fed Funds futures are predicting no changes to interest rate policy at the meeting this week. The June 2020 futures are predicting a roughly 50/50 chance of another rate cut.

 

The average size of a first-time homebuyer’s mortgage was $231,974 for the first 3 quarters of 2018 and was up 4.2% on a YOY basis.

 

first time mortgage size

 

Interesting stat courtesy of the Harvard Joint Center for Housing Studies: annual household growth over the next 10 years is expected to be 1.2 million per year. With housing starts around the same level, we are not taking into account functional obsolescence and deterioration.

 

Is a homeowner who sells his house via iBuyers (think Zillow and Opendoor) leaving money on the table? Turns out the average discount to market value is about 1.3%. The typical fee charged an iBuyer is around 7%. So the total costs is 8.3%. Compare that to using traditional realtors and paying 6%, along with the expense of showing the home, etc. Essentially the seller is paying for convenience, which is a non-contingent offer in a week, with no showing necessary. In this case the fee is about 2.3%, which represents the additional fee of 1% the iBuyer charges along with the 1.3% market value discount.

 

Paul Volcker, the Fed Chairman who slayed the 1970s inflation dragon has passed away.

Morning Report: Why mortgage rates don’t exactly mirror Treasury rates

Vital Statistics:

 

Last Change
S&P futures 2788 7
Oil (WTI) 59.1 0.1
10 year government bond yield 2.26%
30 year fixed rate mortgage 4.24%

 

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

 

First quarter GDP was revised downward from 3.2% to 3.1%. Increased exports offset a downward revision in residential fixed investment (homebuilding). The inflation number was also revised downward and is well below the Fed’s 2% target. The Fed funds futures are now forecasting a more than 80% chance of a rate cut this year.

 

Initial Jobless Claims ticked up to 215k from 212k the prior week.

 

In market environments like yesterday, I always seem to get the following question: “Brent, the 10 year is down from 2.4% to 2.25% over the past two weeks. I just ran a scenario and only saw a small improvement in pricing. How come?” The short answer to that question is that mortgage rates are tied to the prices of mortgage backed securities which are influenced, but not determined by the 10 year. (This is why my opening statement always talks about bonds and MBS – they are different animals and will behave differently to changing market conditions)

 

To make things even more complicated, mortgage backed securities will behave differently depending on the coupon. Take a look below at what a typical MBS screen looks like. This lists the TBAs (stands for to-be-announced) mortgage backed securities that correspond to Fannie Mae loans. If you do a Fannie Mae loan, it is probably going to go into one of these securities. You can see that there is a different security for each month of delivery and note rate. On the far left hand side you can see the coupon groupings. It starts at 3%, then goes to 3.5%, then to 4% and so on. The delivery months are also listed: June, July, and August. Note that the price falls as you go out in the future. This is why a 45 day lock costs more money than a 15 day lock.

 

During the day, mortgage backed securities will trade and prices will be updated pretty frequently. So, if the 10 year bond rate falls by, say 5 basis points, you could see the implied yield of the Fannie 4% of August drop by 5 basis point, 2 basis points, whatever. It will be a function of the supply and demand for that mortgage backed security. Since these prices are the inputs to the rate sheets you see every day, this is the security that really matters, not the 10 year.

 

MBS

 

If you take a look at the 4% coupon, you’ll see them trading at just under 103. An investor who buys a mortgage backed security is paying 103 for a bond that will pay 100 at some time in the future. Why would a rational investor do that? The answer lies in the interest. The 4% interest payment is higher than the corresponding rate you would get on the benchmark Treasury, which is 2.375%. That difference is the compensation for paying more than par. The investor is betting that they will get that extra interest for a long enough period to cover the extra 3 points they paid. If the mortgages pay off earlier than expected, then the investor is out of luck. This is why early refinancings are a no-no and why Ginnie Mae is taking action to prevent early refinancings of VA loans.

 

So, when interest rates fall, like we have seen over the past couple of days, the rates on mortgages don’t fall in lockstep. MBS investors will re-evaluate their prepayment models and figure out the right price to pay given the fact that the period they will get that extra interest has changed. Before, they might have expected to get it for, say 7 years. Now they expect to get it for 6 years. When they crunch the numbers, they come up with a right price to pay for that 4% mortgage backed security. And the price for that mortgage backed security will then be used for everyone’s rate sheets. To make things even more complicated, the change in price for a 3% security will differ from a 4% security. The name for this whole phenomenon is called convexity, and it gets into some gnarly bond math. But the punch line about convexity is that mortgage backed securities have a lot of it, which causes them to behave differently than the 10 year. So, when you see on CNBC that the 10 year bond yield fell 10 basis points, you can’t expect to see a corresponding 10 basis point improvement in mortgage rates. It just doesn’t work that way.

Morning Report: New home sales still anemic historically

Vital Statistics:

 

Last Change
S&P futures 2821  9
Eurostoxx index 380.4 1.8
Oil (WTI) 58.12 -0.14
10 year government bond yield 2.60%
30 year fixed rate mortgage 4.28%

 

Stocks are higher this morning on overseas strength, particularly in China and Japan. Bonds and MBS are up.

 

New Home Sales fell to 607,000 in January, according to the Census Bureau. This is down 7% MOM and 4% YOY. New Homes Sales is a notoriously volatile number, and the margin for error is generally in the mid-teens %. Still 607,000 is roughly in line with historical averages over the past 50 years. That said, population has grown since then, so it isn’t really comparable. Take a look at the chart below, which is new home sales divided by population – we are still only at levels associated with the depths of prior recessions. In other words, we are still in very early innings with the housing recovery, and you can make an argument that the recovery hasn’t even begun yet.

 

new home sales divided by population

 

Industrial Production rose 0.1% in February, and January’s initial 0.6% drop was revised upward to -0.4%. Manufacturing production fell 0.4%, while January’s 0.9% drop was revised upward to -0.5%. Capacity Utilization fell to 78.2%, while Jan was revised up again. So, Feb wasn’t great, but January wasn’t as bad as it initially appeared to be.

 

We have entered the quiet period for the Fed ahead of their meeting next week. No rate hikes are expected, although we will get new economic forecasts and a new dot plot. Sentiment regarding the Fed has changed massively over the past few months. As of now, the the Fed funds futures are estimating that there is a 75% chance the Fed does nothing this year, and a 25% chance they cut rates by 25 basis points. The fed funds futures are pricing a 0% chance of a hike. While Trump’s jawboning of the Fed was bad form, and you generally don’t want to see presidents doing that, you also can’t escape the fact that the Fed Funds futures and the markets think he was right!

 

 

Morning Report: Home sizes decrease

Vital Statistics:

 

Last Change
S&P futures 2664 -6
Eurostoxx index 357.22 -1.11
Oil (WTI) 51.69 0.06
10 year government bond yield 3.06%
30 year fixed rate mortgage 4.89%

 

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

 

We have a lot of Fed-speak today, with 4 different speeches. As we approach the December Fed meeting, the markets will hang on every word, looking for clues about 2019. The Fed funds futures are increasing their probability of a December hike, which is up to 80% compared to 66% a month ago.

 

Economic growth accelerated a touch in October, according to the Chicago Fed National Activity Index. The CFNAI is a meta-index of some 85 different statistics, and in October employment-related numbers (things like unemployment and initial jobless claims) were the drivers. Production-related statistics slowed a touch, but overall the economy is growing above trend.

 

Median home sizes are falling, as more and more builders focus on building starter homes. Home sizes rose during the housing bust as the luxury end of the market was about the only segment that was working. This trend was exacerbated by debt levels and employment uncertainty for the first time homebuyer. In addition, the Millennial generation tended to favor urban areas, and builders focused on apartment building. Now, we are seeing a glut of properties at the high end, and strong demand for starter homes as the first time homebuyer moves to the suburbs. Note that the latest existing home sales data had the first time homebuyer share at 31%. Historically, that number has been closer to 40%.

 

home sizes

 

Signs of things to come? The Dallas home market is cooling off, as affordability issues bite. The Dallas market is a little different than the typical US housing market – Texas has some limitations on cash-out refinances that meant it largely avoided the big boom / bust of the real estate bubble. Prices are 50% higher than they were in 2007, which is similar to MSAs like San Francisco. On the other hand, Dallas homebuyers are more likely to finance their purchases than the typical foreign cash buyer on the West Coast. Builders have a glut of inventory and are cutting prices / adding features to move properties.