Morning Report: The fed cuts rates and goes on hold.

Vital Statistics:

 

Last Change
S&P futures 3042 -5.25
Oil (WTI) 54.42 -0.64
10 year government bond yield 1.73%
30 year fixed rate mortgage 4.02%

 

Stocks are lower this morning after the Fed cut rates. Bonds and MBS are up.

 

As expected, the Fed cut rates by 25 basis points yesterday, and Jerome Powell said that “the current stance of policy is expected to remain appropriate” as long as the labor market remains strong and the economy continues to expand moderately. They also removed the language that said the Fed would “act as appropriate” to maintain the current expansion. This was the “pause” language that the markets were looking for. The vote was 8-2, with two members voting to maintain the current Fed Funds target. For some reason, the pause language put some starch in the bond market, which has sent rates lower by about 12 basis points. The December Fed Funds futures are currently handicapping a 20% chance of another 25 basis point cut. FWIW, Morgan Stanley is out with a call saying the Fed is on hold through 2020. As a general rule, the Fed tries to stay out of the picture as much as it can during an election year, so that call may end up being correct.

 

Personal Incomes and spending increased 0.3% and 0.2% respectively, which was lower than August’s torrid pace. On an annual basis, incomes rose 3.8% and consumption increased 4.4%, both strong numbers and well ahead of the weaker-than-expected inflation readings. The PCE price index (which is the Fed’s preferred inflation measure) was flat in September, and up 1.3% YOY. Ex-food and energy the PCE index was flat and up 1.7% annually. Separately, the employment cost index rose 0.7% in the third quarter and was up 2.8% YOY. Note that wages increased 0.9%, which is a quite strong number.

 

The Urban Institute has panned the Administration’s plan to reduce the GSE footprint in the mortgage market. Their point is that the government guarantee for Fannie MBS is so important that it will be hard for other entities to compete, unless the guarantee fee is set higher than the credit risk dictates. They also claim that it will reduce credit and slow down the economy.

 

The overall share of GDP attributable to housing increased to 14.6% in yesterday’s GDP report. Residential fixed investment (homebuilding, remodeling, etc) increased to 3.11%, while housing services, which is mainly rent, was about 11.5% of the economy. Historically, residential fixed investment has been closer to 5% and rent has been closer to 12% – 13%. In other words, housing is still punching below its weight economically, although it may be turning around. This represents a huge potential boost to GDP once things return to normalcy.

 

housing GDP

 

 

Morning Report: Third quarter GDP comes in stronger than expected

Vital Statistics:

 

Last Change
S&P futures 3036 0.25
Oil (WTI) 55.32 -0.24
10 year government bond yield 1.84%
30 year fixed rate mortgage 4.03%

 

Stocks are flat as we await the FOMC decisions and earnings from Facebook and Apple after the bell. Bonds and MBS are flat.

 

The FOMC decision is set for 2:00 pm. The big tariff-related slowdown that has been widely predicted doesn’t seem to be materializing. This means that the language of the FOMC statement and the press conference will take on more weight and we could see some volatility in the bond market as everyone reassesses the lay of the land. Be careful locking around then.

 

The advance estimate of third quarter GDP came in better than expected, at 1.9%, versus street expectations of 1.6%. Personal consumption expenditures drove the increase, rising 2.9%, while investment fell 1.5%. Residential fixed investment broke a 6 quarter losing streak, increasing 5.1% in the quarter. Inflation remains under control, with the headline PCE number rising 1.5%, and the core rising 2.2%.

 

GDP

 

ADP estimated that payrolls increased by 125,000 in October, which was above expectations. September’s estimate was revised downward however to below 100k. Note the 125,000 number is well above the Street estimate for Friday’s jobs report, which is forecasting an increase of only 85,000.

 

Mortgage applications increased by 0.6% in the latest MBA survey. Purchases increased 2% and refis fell 1%. “The 10-year Treasury rate rose slightly last week, as markets expected more progress toward a trade deal between the U.S. and China,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Mortgage rates increased for the second straight week as a result, with the 30-year fixed rate climbing to 4.05 percent–the highest level since the end of July. Mortgage applications were mostly unchanged, with purchase activity rising 2 percent and refinances decreasing less than 1 percent. Purchase applications continued to run at a stronger pace than last year, finishing a robust 10 percent higher than a year ago. Considering how much lower rates are compared to the end of 2018, purchase applications should continue showing solid year-over-year gains.”

 

The MBA forecasts that 2019 will be the best year for origination since 2007, at $2.06 trillion, although they expect 2020 to slip to $1.89 trillion. Although they forecast rates will remain low, they anticipate that refis will dry up in the second half and the margin pressure that bedeviled lenders in 2018 will reappear.

 

Pending home sales rose 1.5% in September, according to NAR. “Even though home prices are rising faster than income, national buying power has increased by 6% because of better interest rates,” he [NAR Chief Economist Lawrence Yun] said. “Furthermore, we’ve seen increased foot traffic as more buyers are evidently eager searching to become homeowners.” The foot traffic comment is interesting since we should be seeing a drop-off heading into the seasonally slow period.

 

The homeownership rate ticked up to 64.8% in the third quarter. This is an increase of 70 basis points from the second quarter and an increase of 40 bps from a year ago.

Morning Report: Whistleblower complaint released

Vital Statistics:

 

Last Change
S&P futures 2988 1.25
Oil (WTI) 56.05 -0.64
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.93%

 

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

 

The House Intelligence Committee released the whistleblower complaint. This is a developing story and I have not read the complaint carefully, but it seems to be all hearsay. In other words, the whistleblower is recounting things he heard from other people and did not hear directly. My guess is that the issue is going have a similar fate to the Russian Collusion story – it will fall down along partisan lines again, and the markets will largely ignore the story. At the margin, it should mean lower stock prices and lower interest rates, but it probably won’t be meaningful.

 

New Home Sales came in at 713,000, which was up 7.1% MOM and 18% YOY. The standard deviations on new home sales is always huge, so take it with a grain of salt. The South and the West experienced the biggest gains. Note that housing has been a drag on the economy for six consecutive quarters, and it appears that it will finally contribute to GDP.

 

Speaking of GDP, the third revision to second quarter GDP is out. Growth came in at 2%, and the inflation numbers were tweaked upward. The core PCE index rose 1.9%, up from the 1.7% previous estimate and the headline number was bumped up 0.2% to 2.4%. The uptick inflation doesn’t appear to have had any impact to the Fed Funds futures.

Morning Report: Q2 GDP comes in at 2%

Vital Statistics:

 

Last Change
S&P futures 2916 26.5
Oil (WTI) 56.17 0.34
10 year government bond yield 1.48%
30 year fixed rate mortgage 3.78%

 

Stocks are up this morning after China said it wouldn’t immediately retaliate on tariffs set to take effect this weekend. Bonds and MBS are down.

 

The second revision to Q2 GDP was unchanged at 2.0%. Consumption drove the increase in GDP as durable goods consumption was up 13% and non-durables were up 7%. Core PCE inflation was unchanged at 1.7%. Despite the chronic housing shortage, residential investment was down again for the sixth straight quarter. Investment and trade made negative contributions to the index.

 

GDP

 

Initial Jobless Claims came in at 215,000 right in line with expectations.

 

The MBA reported that net gains per loan increased to $1,675, compared to $285 in the first quarter. This was the best number since the third quarter of 2016. “With anticipated increases in prepayment activity, we saw hits to servicing profitability resulting from mortgage servicing right markdowns and amortization,” Walsh said. “Nonetheless, the profitability on the production side of the business generally outweighed servicing losses.” Average pretax production profit rose to 64 basis points, while secondary marketing income fell to 287 basis points, down from 308 in the first quarter.

 

Treasury is looking at the idea of ultra-long term government bonds, with 50 or 100 year terms. “If the conditions are right, then I would anticipate we’ll take advantage of long-term borrowing and execute on that,” Mnuchin said in the Bloomberg News interview on Wednesday.

Morning Report; GDP comes in better than expected

Vital Statistics:

 

Last Change
S&P futures 3014 7.5
Oil (WTI) 56.51 0.84
10 year government bond yield 2.08%
30 year fixed rate mortgage 4.05%

 

Stocks are higher this morning after good numbers from Google, sorry Alphabet, and Q1 GDP came in better than expectations. Bonds and MBS are flat.

 

The US economy grew at 2.1% in the second quarter, a deceleration from the 3.1% recorded in the first quarter, but higher than the Street estimate of 1.8%. Note that the Atlanta Fed’s GDP Now model was predicting only 1.3% growth as of yesterday, which is a big miss, so perhaps this number will eventually get revised down.

 

In terms of the internals, consumption rebounded rising 4.3%, compared to only 1.1% in the first quarter. Inflation rose 2.3% on the headline number, while the core PCE rose 1.8%. Disposable income rose 4.4%, or 2.5% after inflation and the savings rate fell from 8.5% to 8.1%. Trade was a drag on growth, with exports falling 5.2% and imports flat. Investment was disappointing, falling 5.5% however the first quarter was revised upward from 1% to 3.1%. The economy’s old bugaboo, housing, fell 1.5%. It is strange to think we have a such pent-up demand for housing yet it remains a headwind but here we are. Inventories fell as well.

 

GDP

 

The Fed Funds futures moved slightly. A rate cut next week is more or less a sure thing, and the futures are predicting an 80% chance of a 25 bp cut and a 20% chance of a 50 bp cut. This is realistically the last data point before the Fed meets next week, although consumption and PCE will be released on the day the meeting begins.

 

The homeownership rate fell in the second quarter, falling to 64.1% from 64.2% in the previous quarter. This rate of 64% was more or less the norm prior to the big homeownership push from the government in the mid 90s. It topped 69% during the bubble years and then fell below 63% during the bust. The rental vacancy rate was flat at 6.8%, which again is consistent with historical norms. It is an interesting series the vacancy rate was quite low during the high interest rate 1970s and quite high during the bubble years.

 

vacancy rate

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: Surprisingly strong GDP report

Vital Statistics:

 

Last Change
S&P futures 2939 -3.25
Eurostoxx index 390.26 -0.72
Oil (WTI) 63.11 -0.18
10 year government bond yield 2.51%
30 year fixed rate mortgage 4.23%

 

Stocks are flattish as we end the month of April. Bonds and MBS are flat.

 

We have a decent amount of data this week, along with a Fed meeting. The biggest news will be the jobs report on Friday, although we will get income / spending data and the ISM.

 

Q1 GDP came in at a much higher than expected 3.2% versus the 2.3% growth that was expected. Even better, the inflation rate came in much lower than expected, which should mean the Fed is out of the way. The 10 year bond yield traded below 2.5% for the first time in 2 months, despite having the strongest Q1 growth in 4 years. Note that consumption didn’t drive the increase in growth (it only came in at 1.2%) – the growth was driven by exports  – which at a minimum should end the talking point that Trump’s trade wars are alienating our trading partners.

 

GDP

 

The immediate market reaction was subdued. The 10 year bond yield drifted lower, stocks were flat, and the Fed Funds futures didn’t change all that much – still predicting a 1/3 chance of no moves this year and a 2/3 chance of a rate cut.

 

In terms of the individual components, the trade numbers were affected by both an increase in exports (3.7%) and a drop in imports (-3.7%). Durable goods consumption fell 5.3%, which is probably related. Residential continues to be a persistent weak spot (-2.8%), and a bit of a head-scratcher given the sheer lack of inventory. Increased investment was driven by an increase in intellectual property (8.6%), which offset a decrease in building (-0.8%).

 

Housing’s contribution to GDP has been shrinking since the late 80s. The financial crisis caused it to fall from about 18% to 15%, and in the past decade it has been more or less stuck there. It looks like housing is again beginning to decline as a percent of GDP, and it is now below 15%. If housing can get back to at least normalcy, that should provide a good bump for GDP growth.

 

housing GDP

 

Personal Incomes rose 0.1% in March, which was below expectations. Consumption surprised to the upside. Inflation remains tame, with the headline PCE number up .1% MOM / 1.5% YOY and the core up 0.2% / 1.6% YOY.

 

New FHFA Director Mark Calabria has an ambitious agenda for housing reform, including solving problems with servicing, fixing the QM patch, and eventually releasing the GSEs from conservatorship. He is emphatic that he does not want to see the mortgage market return to the pre-2008 days.