Morning Report: An anticlimactic Fed decision

Vital Statistics:

 

Last Change
S&P futures 2794 -14.75
Eurostoxx index 364.5 -2.58
Oil (WTI) 59.81 -0.86
10 year government bond yield 3.21%
30 year fixed rate mortgage 4.98%

 

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

 

As expected, the Fed made no changes to monetary policy yesterday. The language in the statement was almost identical to the September release, with some small changes regarding the deceleration in business fixed investment. Bonds didn’t have much a of reaction to the decision. The December Fed Funds futures contracts are handicapping a 76% chance of another 25 basis points next month.

 

Initial Jobless Claims ticked up slightly to 214k last week. The labor economy continues to plug along.

 

A lack of housing inventory translates into a “new normal” for home sales, which is about 1 million units less per year than the pre-bubble days – in other words, the early 2000s, before the big jump in sales driven by the bubble years. The problem is that household formation has outstripped homebuilding for over a decade, and if you correct for population growth, we are still way below what is needed.

 

home sales

 

D.R. Horton reported earnings yesterday that missed street estimates and the stock was rocked to the tune of 9%. Earnings were up 41%, but on the call, DHI CEO David Auld said the market was “choppy” and noted some “momentum slipping from the market.” D.R. Horton focuses on starter homes, so this is worrisome given that luxury is already struggling a bit. The whole sector is struggling this year, with the homebuilder ETF down 25% from its high set earlier this year.

Morning Report: Fed Day

Vital Statistics:

 

Last Change
S&P futures 2805 -11
Eurostoxx index 367.48 1.08
Oil (WTI) 61.92 0.45
10 year government bond yield 3.22%
30 year fixed rate mortgage 4.96%

 

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

 

The FOMC announcement will come out at 2:00 pm EST today. No changes in rates are expected, and it should be a nonevent. Don’t expect to see any discussion of the recent sell-off in the stock market. About the only thing that could be interesting would be any discussion of how to quickly to shrink the Fed’s balance sheet, which is sitting at $4.1 trillion in assets, down from a peak of $4.5 trillion. That is still much lower than pre-crisis levels of below $1 trillion.

 

Fed assets

 

Donald Trump indicated that he would entertain an increase in the corporate tax rate if it was used for middle class tax relief. Democrats have complained that the middle class didn’t get a big enough tax cut, and the wealthy / corporations got too big of one. Don’t expect Democrats to bite, however. They want more healthcare entitlement spending and to raise taxes. Republicans aren’t going to vote to raise taxes, period.

 

UBS said it will fight an expected Justice Department civil suit over mortgage backed securities from 2007. They say they weren’t a “significant originator” of these mortgages.

 

The Fannie Mae Home Purchase Sentiment Index dipped in October. Affordability concerns are having an effect, as are higher mortgage rates. Despite the recent strong jobs numbers, more people are beginning to have job security worries. This is even more surprising when you consider that the number of respondents who said the economy is on the right track is at a record high.

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: The Fed hikes as expected

Vital Statistics:

 

Last Change
S&P futures 2914 2.75
Eurostoxx index 385 0.05
Oil (WTI) 72.35 0.77
10 year government bond yield 3.06%
30 year fixed rate mortgage 4.79%

 

Stocks are higher after the Fed hiked rates yesterday. Bonds and MBS are flat.

 

As expected, the Fed raised the Fed Funds rate 25 basis points and removed the term “accomodative” from their statement. The decision was unanimous. The biggest change in the projection materials was an upward bump in GDP estimates for this year and next. The dot plot showed a slight uptick in forecasts (about 7 basis points for this year and next). The dot plot says we are probably looking at another hike in December, 2 more hikes in 2019, and one more in 2020. In other words, the heavy lifting of this tightening cycle has already been done. That said, monetary policy acts with a lag, so the 2018 hikes probably won’t be felt until mid-to-late 2019.  The 2s-10s spread fell to 22 basis points.

 

dot plot comparison jun vs. sep 2018

 

Bonds rallied (rates fell) on the FOMC announcement, which was probably attributable to the largely unchanged dot plot and the fact that rates rose so much leading into the FOMC announcement. Classic “buy the rumor, sell the fact” situation.

 

Durable goods increased 4.5%, driven by a big jump in aircraft orders. Ex-transportation, durable goods orders were roughly flat. Core Capital Goods (a proxy for business capital expenditures) fell 0.5%. Note the Fed mentioned strong business capital investment in the statement yesterday.

 

The final estimate for second quarter GDP was unchanged at 4.2%. The price index and consumption estimates were unchanged as well. This is the fastest pace in 4 years. Meanwhile, corporate profits for the second quarter were revised downward from 6.7% to 6.4%.

 

Initial Jobless claims inched up to 214k last week. Remember these are 50 year lows, and if you consider the fact that the population was 2/3 of current levels back then (along with a military draft) these numbers are astounding.

 

Pending Home Sales fell in August, according to NAR.  Lawrence Yun, NAR chief economist, says that low inventory continues to contribute to the housing market slowdown. “Pending home sales continued a slow drip downward, with the fourth month over month decline in the past five months,” he said.

 

“Contract signings also fell backward again last month, as declines in the West negatively impacted overall activity,” he said. “The greatest decline occurred in the West region where prices have shot up significantly, which clearly indicates that affordability is hindering buyers and those affordability issues come from lack of inventory, particularly in moderate price points.”

Morning Report: Fed Decision Day

Vital statistics:

Last Change
S&P futures 2924.75 3.5
Eurostoxx index 384.06 0.14
Oil (WTI) 71.82 -0.45
10 Year Government Bond Yield 3.08%
30 Year fixed rate mortgage 4.79%

Stocks are up small as we head into the FOMC decision. Bonds and MBS are flat.

The FOMC decision will be announced at 2:00 pm EST today. Be careful locking around that time. Given how much rates have increased ahead of the decision, the bond market is probably set up for a rally if the statement and / or supporting materials contain a dovish surprise. TBAs (and therefore mortgage rates) will be slower to respond to a sharp move in rates however and take a few days to fully react.

One thing to look for: whether the Fed considers its policy stance to be “accomodative.” There has been debate at the Fed whether that term is outdated. FWIW, sub 3% Fed Funds and a continuing bond purchase program sounds pretty accomodative to me, at least compared to Federal Reserve history.

Mortgage applications rose 3% last week. Both purchases and refis rose by the same amount. This is in spite of a big jump in rates, with the 30 year fixed conforming rate pushing 5%. 5/1 ARMS hit 4.22%, the highest since the survey began.

New home sales increased to an annualized pace of 629k in August, according to Census. This is an increase of 3.5% MOM and 12.7% YOY.  Inventory sits at 6.1 months’ worth.

Housing demand was unchanged in August, according to Redfin. You can see the effect rising rates and home prices have had on demand. Unfortunately the series doesn’t go back far enough to give much of a historical perspective, but it certainly indicates that the last year has had a marked negative effect on buyers. What will change that? Wage inflation.

housing demand

Mark Zandi looks at what expanding the housing trust fund might do to alleviate the supply / demand imbalance. He notes that most of the post-bubble building was at the high end price points (urban apartments and McMansions especially), and that entry-level / affordable housing has been neglected. Whether that is a case of NIMBY-ism or higher regulatory costs is open for debate.  Zandi estimates that increasing the housing trust fund could add an additional 200k units next year.

Morning Report: Homebuilders are either cheap of the recovery is still a ways off

Vital Statistics:

Last Change
S&P futures 2928 -5.7
Eurostoxx index 383.56 -0.73
Oil (WTI) 71.89 1.11
10 Year Government Bond Yield 3.09%
30 Year fixed rate mortgage 4.87%

Stocks are lower this morning as oil rallies and China cancels trade talks. Bonds and MBS are down.

We have a lot of important economic data this week, including housing data, GDP, personal income / spending, and also the FOMC meeting. Given how much rates have jumped over the past month, the markets are set up well for a dovish surprise. In other words, if the Fed’s language isn’t as hawkish as people are fearing, we could see a snapback lower in rates. 2s-10s are trading at 26 bps, up from 21 a week ago.

Several strategists think the Fed is going to slow down the pace of normalization if they see the yield curve invert. While inverted yield curves don’t cause recessions, they tend to forecast them. Overseas weakness will play a part here, with Europe and China potentially slowing down. Of course this time is indeed different, as this is the first time the Fed has owned so much of the market. As I have said before, the signal to noise ratio of the yield curve’s slope is pretty lousy right now, and should be taken with a grain of salt.

Economic activity continued to hum along in August, according to the Chicago Fed National Activity Index. Production-related indicators increased, while employment was flat.

NAR notes that the housing market is becoming more balanced (with respect to leverage) between buyers and sellers, however it is still largely a seller’s market. Inventory is nowhere near a balanced level but, it is showing signs of at least bottoming out. 2015-2017 were years of high single-digit reductions in inventory. Affordability issues driven by rising rates and prices are drawing out more sellers, and making buyers more cautious. We are still nowhere near a balanced market, let alone a buyer’s market, but the imbalance may be reversing.

Ultimately, the key to balance is supply, as in homebuilding. Builders have been able to rely upon rising prices to drive growth, however affordability issues are going to make that a harder slog. Ultimately they will have to build more units to exhibit the growth that investors want to see. The age of homes in the US has been increasing for a long time.

age of homes

Note that JP Morgan just downgraded the whole sector, although valuations are close to peak cycle levels. P/E ratios for the big players are in the 8x – 12x range, which is typically where they bottom. The homebuilding sector is very cyclical, which means they will trade at single digit P/E ratios during the boom cycles, and 30x-50x ratios during down cycles. Generally speaking those valuation levels would normally be associated with housing starts in the 1.5 – 2.0 million unit range. This presents something of a conundrum: either investors are wrong about the homebuilders and they are cheap, or the return to normalcy in terms of housing starts is still years away on the horizon.

Wells announced that they will look to cut the workforce by 5% – 10% over the next 3 years, through attrition and displacements. The mortgage business wasn’t mentioned specifically in the press release. The bank is going through a big restructuring, and making an investment in technology, risk management and compliance. USAA announced job cuts as well. The industry is heading into the dreaded Q4 and Q1 and volumes / margins are lousy.

The FHFA is creating a new index that determines housing affordability. Current affordability indices generally use rules of thumb (house prices versus incomes) and generally create a static model of incomes. FHFA’s index will include a pro-forma analysis of what the mortgage will look like 3 years down the road. It is still a work in progress, but it will be interesting to see what an affordability plot looks like over time. Here is one that looks at the typical mortgage payment as a percentage of income (using 20% down and median home prices / incomes). While home prices are high relative to income, rates are still extremely low compared to the 90s, let alone the 80s.

mortgage payment as a percent of income

Morning Report: The Urban Institute studies manufactured home appreciation

Vital Statistics:

Last Change
S&P futures 2899 3.25
Eurostoxx index 377.35 -0.96
Oil (WTI) 69.63 0.75
10 year government bond yield 3.01%
30 year fixed rate mortgage 4.68%

Stocks are higher after Trump’s proposed tariffs against China were smaller than expected. Bonds and MBS are flat.

Same store sales increased 5.4% last week, continuing a string of strong reports. Consumption data suggests that the fourth quarter is going to be strong, supported by the best holiday shopping season since the recession.

Builder sentiment was unchanged in September, according to the NAHB Housing Market Index. A lack of construction workers and higher construction costs are offsetting a strong seller’s market for new homes.

The credit markets for corporations with speculative credit remains robust. A Blackstone-led investor group raised $13.5 billion for a 55% stake in Reuters data business. Huge leveraged buyouts have been largely absent since the financial crisis, and the covenants are extremely borrower-friendly. Aside from the RMBS shenanigans of the 06-07 era, we saw a lot of reaching on leveraged buyout deals (LBO firms buying non-LBO friendly businesses like semis and retailers). In fact, the first indication of a problem in the credit markets in 06 was when the buy side refused to bite on the paper issued to fund the Alliance Boots transaction (an LBO of a British drug store chain). The banks got stuck with the inventory, and the rest is history.

With LBO credit widely available, you would think the private label MBS market would be coming back. So far, it is a shadow of its former self, with a number of issues (prepays, conflicts) preventing it from returning in any size. If it can’t do so in this environment, it almost makes you wonder if it ever will.

A UBS strategist is out with a bold call that the Fed will take a break after September and skip tightening at the December meeting. He believes that trade war fears will keep the Fed cautious, and will not be as inflationary as feared.

new study by the Urban Institute finds that contrary to popular belief, manufactured homes appreciate in value, although at a smaller rate (3.4% annually versus 3.8% for tradition homes). They suggest that geographical differences could explain the difference – mannies are concentrated in slower growth states and are underrepresented in pricey markets like the California. Currently the government only finances mannies when the land is part of the deal, and since this study uses the FHFA House Price Index, they are excluding structure-only chattel loans, which are something like 80% of the market. Note that mannies are overall more volatile that site-built homes, which means more risk for the lender all things being equal and therefore justifies the LLPAs.

A couple of economists think they have found a profitable trading strategy around the Fed. The idea is to buy or sell the market after the Fed makes a surprisingly dovish or hawkish monetary announcement and then unwind the trade 15 days later. The trade provides a higher return without increasing risk (higher Sharpe ratio). Something to think about ahead of next week’s FOMC announcement. If the dot plot comes out a bit more dovish than expected, supposedly you can make some money buying some SPYs and unwinding the trade mid-October. Full disclosure, not recommending you do that, just saying the study says it should work.

Finally, I plan on retiring this website and will begin posting this content exclusively at https://thedailytearsheet.com/