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: Red October ends

Vital Statistics:

 

Last Change
S&P futures 2704 19.25
Eurostoxx index 361.06 5.53
Oil (WTI) 66.46 0.28
10 year government bond yield 3.14%
30 year fixed rate mortgage 4.89%

 

Stocks are recovering as we end the worst month for stocks in a while. Bonds and MBS are down.

 

Facebook reported last night and rose despite a revenue miss. GM is up 10% pre-open on blowout earnings, while GE cut its dividend to a penny. Earnings are generally good this quarter, although if you focused only on the indices you would figure they were terrible.

 

Home prices rose 5.8% in August, according to the Case-Shiller home price index. Las Vegas led the way with 14% growth. San Francisco and Seattle were the other big winners. Underneath the headline number, we are starting to see some month-over-month declines if you look at the seasonally adjusted indices. Ultimately wages need to catch up with the new reality of higher interest rates and higher home prices.

 

Despite what is going on in housing, consumer confidence remains strong, with the consumer sentiment indices just off multi-decade highs. Historically this index has reflected gasoline prices (gas prices up, consumer confidence down), but that has broken down over the past couple of years. This confidence has allowed companies to raise prices for the first time in a decade, with a laundry list of firms from consumer staples to airlines increasing prices in reaction to increased costs, particularly fuel. Some companies are not raising prices, but cutting sizes. Wages are picking up, but they are generally lagging some of these increases in the inflation indices.

 

Freddie Mac sees home sales improving in 2019 despite an uptick in mortgage rates. Originations are expected to be flat at $1.65T while home price appreciation and GDP growth are expected to moderate. The 30 year fixed rate mortgage is expected to average around 5.1% for the year, and then jump an additional 50 basis points in 2020.

 

freddie mac mortgage rates

 

Janet Yellen told a conference that the current deficit track is unsustainable, and that if she had a magic wand, she would raise taxes and cut retirement spending.

 

Part of the inflation puzzle has always been healthcare inflation, especially in prescription drugs. Amazon looks to be entering the Rx business, and CVS is piloting a free delivery subscription program. Health care is a big part of the inflation picture and perhaps these big can take a bite out of inflation via their market strength.

Despite strong labor data, more people are worried about their jobs

Vital Statistics:

Last Change
S&P futures 2859 3.5
Eurostoxx index 389.41 -0.28
Oil (WTI) 67.29 0.35
10 Year Government Bond Yield 2.94%
30 Year fixed rate mortgage 4.58%

Stocks are higher this morning on decent earnings. Bonds and MBS are up.

Very slow news day.

Initial Jobless Claims fell to 213,000 last week, an exceptionally low level. The 4 week average is sitting at 45 year lows.

Inflation at the wholesale level was surprisingly weak in the first of two inflation readings this week. The Producer Price Index was flat MOM and rose 3.3% YOY. Ex-food and energy, it rose 0.1% MOM / 2.7% YOY. Tariffs explain some of it, but freight and packaging costs pushing prices higher too.

Freddie Mac has extended mortgage forbearance measures due to the wildfires in California. Borrowers in FEMA-declared disaster areas may be allowed to suspend mortgage payments without penalty for up to a year. Fannie Mae is expected to do something similar.

Fannie Mae’s Home Purchase Sentiment Index fell in July for the second consecutive month as inventory and affordability issues weighed on homebuyer moods. The net number of respondents who think it is a good time to buy fell by 4 percentage points and the number who think it is a good time to sell fell by 6. Most respondents think mortgage rates and home prices will rise over the next year. One interesting data point: a big jump in the number of people who are worried about their job. The net number of people (% who are concerned less the % who are not concerned) fell by 11 percentage points. This certainly flies in the face of the data out there, and sentiment surveys are usually not very predictive, but it is a surprise.

HPSI job

Morning Report: Home Prices increase 6.8%

Vital Statistics:

Last Change
S&P futures 2856 6
Eurostoxx index 391.01 2.35
Oil (WTI) 69.62 0.61
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.58%

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

There were 6.7 million open jobs in June, according to BLS. The all-important quits rate was unchanged at 2.3%. The quits rate is a leading indicator for wage growth and is a stat the Fed follows closely. The quits rate was highest in the South and Midwest, and lowest in the Northeast. If you look at industry groups, one group stands out with a quits rate that is going nowhere. Financial Services.

quits by industry

Home Prices rose 0.7% MOM in June, according to CoreLogic. They are up 6.8% YOY and forecast to rise another 5% over the coming year. Rising mortgage rates and home prices are affecting sales in the high cost markets. They also surveyed renters and found that affordability is the biggest reason why they aren’t interested in buying a home. For older renters, affordability isn’t the biggest issue – probably convenience is – although a jump in bankruptcy filings in the senior citizen demo is on the rise. We are seeing large pockets of overvaluation on the coasts, but the interior of the country is undervalued.

Corelogic overvalued

Freddie Mac is trying a new program to enhance rental affordability: providing low-interest loans to developers who promise to cap rental inflation. This is certainly a less intrusive way to deal with the affordable housing problem. The West Coast is finding that affordable housing mandates are pushing developers to scrap projects entirely and local governments are being pushed to override zoning restrictions. Freddie’s program is a way to incentivize the private sector into doing something: “Maybe there’s a way we can help change incentives,” said David Brickman, an executive vice president at Freddie Mac and head of its multifamily division. “We can provide an economic basis for private, profit-oriented developers to pursue a strategy where they didn’t raise rents by quite as much. You’re taking some of the opportunity to hit a home run off the table but arguably making it more likely you can hit a single or a double.”

Washington is hoping to address the affordable housing crisis by allowing tax credits for low-income renters who spend more than 30% of their income on rent. Cory Booker’s plan also looks to ease some of the regulatory burden in building new housing as well as introduce a new savings plan for renters.

What is it with tech companies who have a competitive edge wanting to diversify into hyper-competitive low-margin businesses? The latest is Zillow, which has decided it is time to get into the mortgage business. Wall Street panned the move, sending the stock down 20%. Part of the decline was due to lousy earnings, but still….

Morning Report: Trump Admin recommends privatizing the GSEs

Vital Statistics:

Last Change
S&P futures 2767 14
Eurostoxx index 384.04 3.19
Oil (WTI) 67.44 1.9
10 Year Government Bond Yield 2.92%
30 Year fixed rate mortgage 4.57%

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

The Trump administration released a set of principles around privatizing the GSEs. It is more or less the same thing as before – the goal is to lessen the government’s footprint in the mortgage market. The idea would be to have Fannie and Fred issue MBS with a catstrophic government guarantee – in other words, some private mortgage insurer would bear the initial losses and the government would only step in if the losses exceeded that number. That is all well and good, however there are all sorts of issues that remain before private label MBS can do the heavy lifting of the mortgage market.

First and foremost, there is a huge gulf between what the MBS investor market requires as a rate of return and current mortgage rates. In a perfect world, PL MBS would trade at similar levels to Fannie / Freddie MBS, but they won’t. There are huge governance issues that need to be resolved. For just one example, will the servicer (who is probably the issuer, who may also have a second lien) service the loan to benefit the MBS holder or themselves? What about reps and warranties? I went into more depth about this whole issue here. These uncertainties need to be priced in, which means that the bid / ask spread between private label and FNMA MBS is so large that nobody would take out a mortgage at the rate the private label investors require. That is a necessary but not sufficient requirement to bring back private money into the US mortgage market.

Taking the GSEs out of conservatorship is going to require legislation, and to be honest it isn’t a priority for either party. As far as DC is concerned, yes it would be nice if the government could lessen its footprint in the mortgage market, but people are getting loans, and the market is functioning normally. It just isn’t a priority.

The US borrower believes that the 30 year fixed rate mortgage is nothing unusual. In fact, it is a distinctly American phenomenon, where the borrower bears no risk. In the rest of the world, mortgages are adjustable rate, and not guaranteed by the government. In other words, the borrower bears the interest rate risk and the bank bears the credit risk. In the US, the bank bears the interest rate risk and the taxpayer bears the credit risk. Upsetting that apple cart is going to be a tough slog politically.

Finally, the news did nothing for the stocks of Fannie and Fred, which continue to languish. When the government took over Fannie and Fred, they left 20% of the common outstanding. This was an accounting gimmick to prevent the government from having to consolidate Fan and Fred debt on its balance sheet (incidentally, this was the reason why LBJ privatized the GSEs in the first place). The government could not take the GSEs through a bankruptcy without creating chaos in the mortgage market. So they left 20% outstanding and decided to deal with the bankruptcy part later. The stock should be worthless, but it is a litigation lottery ticket.

FNMA chart

A Federal Judge ruled yesterday that the CFPB’s structure is unconstitutional. The PHH case never made it to SCOTUS, but it will be interesting if this one does. At some point, the CFPBs structure will make it to SCOTUS, and the only one with the standing to defend the agency is the government.

Morning Report: Number of job openings equals number of unemployed

Vital Statistics:

Last Change
S&P futures 2747 1.75
Eurostoxx index 388.56 0.45
Oil (WTI) 64.56 -0.19
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.54%

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

Job openings continue to creep upward, hitting 6.7 million in April, which is just about the number of unemployed people in the country. Job openings increased in manufacturing, but fell in finance. The quits rate was flat MOM at 2.3% and is up about 20 bps since last year. The quits rate is a strong predictor of wage inflation, as it measures people leaving jobs to take new, higher paying ones. Below is a chart of the quits rate versus wage growth. Wage inflation is a bit more volatile, but the correlation is pretty tight.

quits rate

The ISM non-manufacturing index rose in May to 58.6. The current level historically corresponds to a GDP growth rate of around 3.5%. Tariffs are weighing on many sectors however.

The House Financial Services Committee will hold a hearing tomorrow to discuss transparency and accountability at the CFPB. This hearing is the result of a memo from Mick Mulvaney, which recommended that the CFPB be subject to Congressional appropriation, that major rules be passed by legislation, that there be an independent Inspector General, and recommended that the agency report to the President.

Home prices rose 1.2% in April, according to CoreLogic. On a YOY basis, they are up 6.9%. They expect home price appreciation to moderate over the next year and increase about 5%. Much of the country’s real estate is becoming overvalued, according to CoreLogic’s model – in fact, over half. The valuation metric is based on incomes, which is why an expensive market like San Francisco may appear fairly valued, while areas on the Gulf Coast may seem overvalued.

Corelogic overvalued

The first time homebuyer accounted for almost half the Freddie Mac purchase market, the highest since 2012, when Freddie first started tracking this statistic. The Bloomberg headline is terrible – the first time homebuyer does not account for almost half of mortgages. 40% are refis and the first time homebuyer is about 32% of existing home sales.

Over the past 2 years, about 4.4 million jobs have been added in the US. How many houses have been built? 2.4 million. Great illustration of just how acute the housing shortage is.

Morning Report: Consumer Credit to hit $4 trillion this year

ital Statistics:

Last Change
S&P futures 2737 4.75
Eurostoxx index 396.69 0.82
Oil (WTI) 72.55 0.31
10 Year Government Bond Yield 3.07%
30 Year fixed rate mortgage 4.66%

Stocks are higher this morning as the trade rhetoric with China cools. Bonds and MBS are up.

China said overnight it would cut its tariff duties on automobiles from 25% to 15%.

Things are looking grim for the origination business, according to people at the MBA Secondary Conference in NYC. A combination of declining volumes and skinnier margins are pushing the smaller originators out of the market. Hard to see what changes things, although an increase in homebuilding would help.

McMansion builder Toll Brothers missed quarterly earnings estimates on higher costs, driven by building materials, land and labor. Gross margins contracted 150 basis points, while revenues increased 17%. The stock is down 7% this morning.

Economic activity accelerated slightly in April, according to the Chicago Fed National Activity Index. Production-related indices accounted for the majority of the index gain, followed by employment indices. The CFNAI is a meta-index of 85 different economic indicators.

Oil continues its strong run on the back of OPEC cuts and supply disruptions out of Venezuela and Iran. Oil is the highest it has been in almost 4 years. The ability to turn on incremental supply quickly and cheaply will help keep a lid on prices, although higher gas prices for the summer driving season are going to dampen sentiment.

JP Morgan might get bigger in FHA loans, according to statements made at the MBS Secondary Conference. Regulatory risk caused the bank to publicly state it was pulling back from that market. Regulatory reform is helping, but the bank says that further fixes will be needed. Chase does do FHA lending, but it is tiny.

The level of consumer debt in the economy has a lot of people talking. Consumer debt is probably going to hit $4 trillion by the end of 2018. Certainly the chart of consumer debt looks worrisome:

consumer credit

Increased student loan debt is a big driver of the increase. That said, does that mean consumers are in over their heads? Can they service that debt? Well, if you look at this chart, it doesn’t appear to be a problem:

debt service ratio

In other words, consumer debt is high, but the amount people are actually paying to service that debt is very low. Higher interest rates will move that debt service ratio up, but it is hard to make an argument that consumers are over-extended, at least by looking at that chart.

Freddie Mac is launching its Borrower of the Future Campaign to take a look at how the industry will have to address the younger homebuyer. “The increase in self-employed and the rise of the sharing economy and digitally-driven lifestyles are having a tremendous impact and leading to shifts in behavioral, economic and societal factors,” said Chris Boyle, Chief Client Officer at Freddie Mac. “Collectively, the industry must now take into account these dynamics as we think about how to effectively help the next generation find the home of their dreams. We’re excited to serve in this important role to help the industry better understand the Borrower of the Future, and then drive the conversation on how to apply these insights to make the mortgage process more efficient and affordable.”

Neel Kashkari discusses how the Fed has beaten the Phillips Curve. The Phillips Curve dates back to the 1950s, and plots a relationship between unemployment and inflation. Kashkari cites the 2009 interventions, which should have caused deflation, but didn’t. We have unemployment below 4% and still no signs of real inflation.