Morning Report: Strong ADP number

Vital Statistics:

Last Change
S&P futures 2818 1.75
Eurostoxx index 389.71 -1.9
Oil (WTI) 67.7 -1.06
10 Year Government Bond Yield 2.99%
30 Year fixed rate mortgage 4.62%

Stocks are higher this morning after good earnings from Apple. Bonds and MBS are down.

Japanese government bonds got shellacked overnight, with yields rising 8 basis points, which is causing reverberations throughout global bond markets. 8 basis points is a lot in one day regardless, but when rates were only 5 bps to begin with, it is quite the move.

Donald Trump threatened more tariffs with China. We seem to be going back and forth between detente and escalation.

The FOMC announcement is scheduled to be released at 2:00 pm EST. No changes in rates are expected, however the action will be in the statement and the interpretations for a December hike. While Trump’s criticism of the Fed’s rate hikes was unfortunate, things have been testier between the Central Bank and the Executive branch in the past. LBJ shoved William (take away the punch bowl just as the party is getting going) McChesney up against the wall in the Oval Office.

Mortgage Applications fell 2.6% last week as purchases fell 3% and refis fell 2%. We saw a 7 basis point increase in conforming rates to 4.84%. The government share of mortgages increased.

The private sector added 219,000 jobs in July, according to the latest ADP report. The Street is looking for 190,000 in Friday’s report, but as always, the bond market will be looking more at average hourly earnings than the headline payroll number. Construction added 17,000 jobs, while business services added 47,000 and healthcare added 49,000.

ADP jobs report

Manufacturing decelerated slightly in July, but continued to its torrid pace. As expected, much of the talk is about steel tariffs and when those costs will get passed on to consumers. Labor is becoming a bottleneck as well – it is causing capacity constraints.

Construction spending fell 1.1% in June (which missed estimates) and is up 6.5% on a YOY basis. Resi construction was down on a MOM basis, but increased 8.7% on an annual basis.

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.

Jun-Mar dot plot comparison

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.

Morning Report: Mortgage Credit Availability eases

Vital Statistics:

Last Change
S&P futures 2792 4
Eurostoxx index 388.99 1.46
Oil (WTI) 65.94 -0.41
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.62%

Stocks are higher as we await the FOMC decision. Bonds and MBS are flat.

The FOMC decision is set to come out at 2:00 pm EST. Investors are going to probably focus most closely on the dot plot to get a sense of whether we get 1 or 2 more hikes this year. Generally speaking, the dot plots have been a bit more hawkish than the Fed Funds futures market.

Inflation appears to be picking up at the wholesale level (kind of echoes what we were seeing yesterday in the NFIB Small Business Optimism report). The Producer Price Index rose 0.5% MOM / 3.1% YOY, which was higher than expectations. Much of the pressure came from higher energy prices. Trade (which is a function of the dollar) was the other catalyst. Ex-food and energy, prices rose 0.1% MOM / 2.6% YOY. The Fed does pay attention to this number, however the PCE index is their preferred measure of inflation, and it is sitting close to their target.

Mortgage applications fell 2% last week. Both purchases and refis fell by the same amount.

Mortgage Credit Availability rose in May by 1.5% as a dwindling refi market is encouraging originators to widen the credit box. While the index has been steadily rising since 2011 when it was benchmarked it is nothing like the bubble, where credit was orders of magnitude tighter.

MCAI

The business press warns that liquidity is going to dry up during the next crisis. While Dodd-Frank claims to allow market making (and not proprietary trading), there is no doubt that banks are going to be completely uninterested in sticking their necks out during the next sell-off. Even worse will be ETF investors who think an exchange traded fund gives them a liquidity risk “free lunch”. (It isn’t like I am investing in junk bonds – I am investing in an ETF that invests in junk bonds – its different!) When the underlying assets of that ETF go no-bid, so will the ETF.

Ever wonder why servicing values in states like NY, NJ, and CT are so low? The foreclosure process can stretch out for years. In this case, the occupants made their last payment in June 2010.

Speaking of the Northeast, all real estate is local as they say. While the West Coast sees sales close in weeks, luxury properties languish for years in the Northeast. The tony NYC suburb of New Canaan, CT has banned “for sale” signs, because there are too many of them (although the excuse is that people shop on line). There is definitely a bifurcation line in the NYC suburbs – below $750k you can move the property, above that good luck. And $1.5 million or more, forget about it.

From the NAHB: rental inflation is moderating. Meanwhile, home equity hits a new high.

Morning Report: Big week ahead

Vital Statistics:

Last Change
S&P futures 2782 -0.5
Eurostoxx index 386.55 1.43
Oil (WTI) 65.12 -0.61
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.59%

Stocks are flattish this morning ahead of a busy week. Bonds and MBS are down small.

This is a big week with the FOMC meeting on Tuesday and Wednesday, the ECB, and also a slew of economic data, particularly inflation data. The FOMC meeting will dominate, and we will also get a fresh new set of projections. The Street will focus on the inflation projections, especially as we continue to get anecdotal evidence of wage inflation.

The G7 met over the weekend, and it largely consisted of Donald Trump playing Al Czervik to the Bushwood global elite. There is talk about us doing permanent damage to our allies, but these events are largely messaging affairs and nothing much concrete ever comes out of them. There were a bunch of threats and counter-threats over trade barriers, and the message from the Administration was that the US has historically accepted the short end of the stick on these trade deals in the name of free trade in general, but those days are over. Will anything actually come from this? Probably not, which is why the markets don’t care.

Trump left the G7 meeting early to head to the Singapore Summit to meet with Kim Jong Un.

CFPB Director Mick Mulvaney said on Friday that he fired the 3 advisory boards because they were simply too big. He said that many participants were uncomfortable being candid at these meetings, and that “There is actually some good information that can pass when you sort of turn the cameras off.” Mulvaney has also been frustrated by leaks coming out of the agency, and he hopes this will help. Mulvaney also intends for the CFPB to go out “in the field” and have more town hall discussion meetings.

The interest rate on excess reserves is a real “inside baseball” statistic that could hold some clues on how the Fed intends to proceed going forward. The Fed is worried that conditions are tightening in the money markets and there are less excess reserves (excess reserves in another name for “dry powder” in the banking system). If there is less dry powder (or lending capacity) in the system then borrowers will have to accept higher rates in order to access these funds. The Fed funds rate is already close to the high end of the target range, which is worrying the some on the FOMC. The Fed started unwinding its QE balance sheet, letting about $100 billion of its $4.5 trillion sheet run off. We are already seeing a swoon in emerging markets. Bottom line: tightening financial conditions could cause the Fed to take a breather sooner than anticipated.

Fed assets

Rising interest rates and home prices are not deterring potential home purchasers, as the Fannie Mae Home Purchase Sentiment Index hit a new high in May. “The HPSI edged up to another survey high in May, bolstered in part by a fresh record high in the net share of consumers who say it’s a good time to sell a home. However, the perception of high home prices that underlies this optimism cuts both ways, boosting not only the good-time-to-sell sentiment but also the view that it’s a bad time to buy, and presenting a potential dilemma for repeat buyers,” said Doug Duncan, senior vice president and chief economist at Fannie Mae.

Morning Report: The push-pull of monetary policy

Vital Statistics:

Last Change
S&P futures 2732 3.75
Eurostoxx index 391.38 -1
Oil (WTI) 70.81 0.11
10 Year Government Bond Yield 2.98%
30 Year fixed rate mortgage 4.55%

Stocks are higher this morning as trade tensions with China eased somewhat over the weekend. Bonds and MBS are down small.

The Trump Administration is pushing Congress to get a long-term funding deal done by the August recess.

There won’t be much in the way of market-moving data this week – housing starts and retail sales will be the only possibilities. We will have Fed-speak every day however.

As the yield curve flattens, it is attracting more and more attention. Chris Whalen argues that Fed manipulation of the curve is the driving force behind the flattening. By paying interest on excess reserves, the Fed has pushed up short term rates far further than demand for credit would imply – in fact he argues that if the Fed stopped paying interest on excess reserves, the Fed Funds rate would get cut in half. On the other side of the coin, fears of taking losses on its QE portfolio has caused the Fed to hold down long-term rates. Finally, he argues that the reason for the growth in nonbank lending has been due to unwritten guidance from the government to the big banks: don’t go lower than 680 on FICO scores. There is a conflict between macroprudential regulation and monetary policy, which is inhibiting credit growth despite the FOMC’s attempts to stimulate it. Whalen argues that credit growth is not high enough to really stimulate a recovery and that is due to hard caps the regulators have imposed on commercial and industrial lending, construction finance, and multifamily lending. I wonder if credit is behind the lack of housing construction despite such high demand.

As rates rise, we are seeing more and more money flow into passively-managed bond funds. One of the interesting dynamics of passively managed indices is the self-reinforcing mechanism of the investing itself. For example, look at the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google). Their weight in the S&P 500 is based on their market caps. So, as these companies outperform the S&P 500, their weighting in the index increases, which causes passive investors to buy more in order to maintain their weighting. It becomes a self-fulfilling prophecy. Here is where it gets strange in bond-land. Companies with the most debt end up dominating the index. So in theory, as a company gets more risky (by issuing more debt), passive investors demand more of their debt. So unlike passive equity investment, which builds on strength, passive bond investing builds on weakness. This means that there should be much more room for index outperformance with actively managed bond funds than with passively managed bond funds.

Interesting chart from David Stockman:

HNW to DPI

If the ratio of net worth to income is going to revert to the mean, that means either asset prices are going to crash, or incomes are going to rise. I think the latter is what will occur.

Morning Report: Awaiting the Fed

Vital Statistics:

Last Change
S&P futures 2652 0.25
Eurostoxx index 387.17 2.14
Oil (WTI) 67.45 0.19
10 Year Government Bond Yield 2.99%
30 Year fixed rate mortgage 4.55%

Stocks are flat as we await the FOMC decision. Bonds and MBS are down small.

Mortgage Applications fell 2.5% last week as purchases fell 2% and refis fell 4%.

The economy added 204,000 jobs last month according to the ADP Employment Report. This was higher than expectations and is above the Street estimate for Friday’s jobs report. Medium sized firms (50-500 employees) added the most jobs, and Professional and Business Services sector had the most growth. Construction added a lot of jobs as well.

ADP by sector

The FOMC announcement is scheduled for 2:00 pm EST today. No changes in rates are expected, but investors will be looking to see if the Fed changes its language about inflation running below target. The latest PCE index came in at 2%, which is the Fed’s target. The second-order question will be to see whether the Fed changes their 2% rate from a symmetric target to a ceiling. The most likely outcome will be a “steady as she goes” statement and any changes will be communicated at the June meeting with a fresh set of economic forecasts. Today’s announcement should be a nonevent.

The Fed Funds futures are predicting a 6% chance of a hike at the May meeting and a 94% chance of a 25 basis point hike at the June meeting.

The labor shortage is so acute in the Rust Belt that some towns are paying people to move there. Most of these small towns have a major demographic problem – younger workers moved to the cities in response to the Great Recession, leaving only the older workers who are now retiring. The fear is that labor shortages will prompt employers to leave, which will create a downward spiral.

Consumer advocates worry that Mick Mulvaney is not going to blow up the CFPB, but will neuter it with a thousand cuts. That said, the rhetoric from the left is a bit overblown. Mick Mulvaney said: “When I took over, we had roughly 26 lawsuits ongoing,” he told the House Appropriations Committee on April 18. “I dismissed one, because the other 25 I thought were pretty good lawsuits.”