Morning Report: A look ahead to the regulatory environment for the financial industry

Vital Statistics:

 

Last Change
S&P futures 2996 7.25
Oil (WTI) 53.47 -0.44
10 year government bond yield 1.78%
30 year fixed rate mortgage 3.97%

 

Stocks are higher this morning on expectations of an orderly Brexit and optimism on trade. Bonds and MBS are down.

 

Not a lot of market-moving data this week, although we will get a lot of housing indicators, with existing home sales, new home sales, and house prices. Note the FOMC meets next week, and it is looking like a lock that they will cut rates. The Fed funds futures are now handicapping a 91% chance of a cut.

 

The Index of Leading Economic Indicators declined in September, as trade concerns and manufacturing offset strength in other areas. “The US LEI declined in September because of weaknesses in the manufacturing sector and the interest rate spread which were only partially offset by rising stock prices and a positive contribution from the Leading Credit Index,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The LEI reflects uncertainty in the outlook and falling business expectations, brought on by the downturn in the industrial sector and trade disputes. Looking ahead, the LEI is consistent with an economy that is still growing, albeit more slowly, through the end of the year and into 2020.”

 

It looks like the structure of the CFPB is going to be decided by the Supreme Court. The issue with the CFPB goes back to its structure, which makes it nearly impossible to remove a director. The idea was to make the CFPB less influenced by politics, however it also makes it completely immune to oversight and accountability. The case will move forward without the support of the government, as CFPB Director Kathy Kraninger doesn’t support the structure of the agency either. If the CFPB’s structure is declared unconstitutional, it wouldn’t mean the end of the agency, it would mean that the single, unfireable director would be replaced by a bipartisan board, which was actually the initial proposal when the CFPB was created during the drafting of Dodd-Frank.

 

Elizabeth Warren threatened to ban fracking if she wins the presidency. “On my first day as president, I will sign an executive order that puts a total moratorium on all new fossil fuel leases for drilling offshore and on public lands. And I will ban fracking—everywhere.” Needless to say, this would be incredibly disruptive to the US economy as natural gas prices would increase to $9.00 to $15 per mBTU, compared to current prices of around $2.00 – $2.50. Since natural gas is the main way we generate electricity, consumers and industry would feel it immediately, and this would cause uncertainty on steroids, and make Trump’s trade concerns look like a minor annoyance. She would be able to implement many changes via executive order, and she intends to use it. Given that Joe Biden is having trouble fundraising, it is looking more like a lock that she gets the nomination. Even some left-leaning pundits are worried.

 

What would that mean for the mortgage banking business? Regulations will undoubtedly be tightened, but they probably will affect the bigger banks more than the independent operators. She says she wants to re-implement Glass-Steagall, which is really a solution in search of a problem. However, if she succeeds in raising taxes and energy prices as much as she intends, it would almost certainly be the final nail in the longest running expansion ever, and that means the Fed Funds rate is probably heading back to zero. A return to ZIRP almost certainly means the 10 year will breach the 1.47% low set in 2012, which will would create another refi wave similar to the years immediately after the financial crisis. So, perversely a Warren presidency could be great for the mortgage banking business, as the industry feasts on easy refinances.

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Morning Report: Housing starts disappoint again

Vital Statistics:

 

Last Change
S&P futures 2999 -1.25
Oil (WTI) 54.47 0.44
10 year government bond yield 1.75%
30 year fixed rate mortgage 3.97%

 

Stocks are lower this morning on weak overseas growth. Bonds and MBS are flat.

 

Housing starts disappointed again, falling 9.4% from an upwardly revised August number to 1.26 million units. This is up slightly on a YOY basis. Building Permits came in at 1.387 million units, higher than expected but still down 2.4% on a MOM basis. Compared to last year, they are up 9.4%.

 

Despite the disappointing starts, builder confidence hit an 20 month high. “The second half of 2019 has seen steady gains in single-family construction, and this is mirrored by the gradual uptick in builder sentiment over the past few months,” said NAHB Chief Economist Robert Dietz. “However, builders continue to remain cautious due to ongoing supply side constraints and concerns about a slowing economy.”

 

Industrial production fell 0.4% in September, and manufacturing production was down 0.5%. August’s numbers were revised higher. Capacity Utilization fell to 77.5%. Tariffs are attributed to the slowdown, but overseas growth in general is weakening. Note China had the lowest GDP growth since the early 1990s. The global slowdown has increased the odds of another rate cut in two weeks, which is up to 87% compared to 28% a month ago.

 

fed funds futures

Morning Report: Manufacturing contracts

Vital Statistics:

 

Last Change
S&P futures 2924 -14.25
Oil (WTI) 53.85 0.24
10 year government bond yield 1.64%
30 year fixed rate mortgage 3.89%

 

Stocks are lower this morning on overseas weakness. Bonds and MBS are up small.

 

Manufacturing contracted for the second month in a row, according to the ISM Manufacturing Survey. New orders, production, and employment all fell. Some of this is due to the trade wars, however overseas economic weakness is probably the dominant driver. Historically, this number on the ISM would correlate with GDP growth of 1.5%. In other words, the number isn’t signalling a recession, but it is pointing to a slowdown.

 

Mortgage Applications increased 8.1% last week as purchases increased 1% and refis increased 14%. “Mortgage rates mostly decreased last week, with the 30-year fixed rate dropping below 4 percent for the sixth time in the past nine weeks. Borrowers responded to these lower rates, leading to a 14 percent increase in refinance applications,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Although refinance activity slowed in September compared to August, the months together were the strongest since October 2016. The slight changes in rates are still causing large swings in refinance volume, and we expect this sensitivity to persist.”

 

Despite the issues in the manufacturing sector, Freddie Mac expects housing to to remain strong. Overall, government spending and business investment are probably going to decelerate, but this will be offset by a strong labor market and robust consumer spending. Note the uptick in originations. Freddie was initially anticipating this year would be more like $1.6 trillion.

 

Freddie Mac forecasts

 

Freddie is forecasting 1.9% GDP growth in Q3 and 1.8% in Q4. What is the risk to these numbers? To the downside, slowing global growth and perhaps political uncertainty – though the markets seem pretty blase about the impeachment drama. To the upside? Homebuilding. Note the strength in the homebuilder ETF (XHB), which has been on a tear. We are approaching the bubble highs, and as the Millennial Generation begins to start families and head to the suburbs, the builders will be busy addressing the dire shortage of starter homes. The post-bubble “new normal” of 1.3 million housing starts a year is anything but normal and we probably need 2 million just to satisfy pent-up and incremental demand.

 

XHB

 

ADP reported 135,000 jobs were created in September, which matches the estimate for Friday’s jobs report. Construction reported an increase, while mining and natural resources declined. The service sector continued to add jobs as well.

Morning Report: Personal Incomes rise more than expected

Vital Statistics:

 

Last Change
S&P futures 2989 8.25
Oil (WTI) 55.35 -1.24
10 year government bond yield 1.70%
30 year fixed rate mortgage 3.95%

 

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

 

Personal incomes rose 0.4% in August, while personal consumption rose 0.1%. Income surprised to the upside, while spending disappointed. Inflation remains within the Fed’s target, with the core PCE index rising 0.1% MOM and 1.8% YOY. The headline PCE, which includes food and energy, was flat MOM and up 1.4% YOY. Wages and salaries were up 0.6% MOM and up 4.8% YOY. Given that inflation is running below 2%, we are seeing real wage growth.

 

Durable goods orders rose as well, increasing 0.2%, while the Street was looking for a decrease of 1%. Ex-transportation they were up 0.5%, again above expectations. Business capital expenditures disappointed, however falling 0.2%.

 

Pending home sales rose 1.6% in August, according to NAR. “It is very encouraging that buyers are responding to exceptionally low interest rates,” said Lawrence Yun, NAR chief economist. “The notable sales slump in the West region over recent years appears to be over. Rising demand will reaccelerate home price appreciation in the absence of more supply.” The Western region was up 8% YOY as falling mortgage rates are improving affordability.

 

Millennials are continuing to leave the big cities, as they head to the suburbs to raise families (and also get priced out). New York City lost almost 38,000 young adults last year, which was twice the decline it had seen in the previous few years. When the Millennials were younger, urban walkable environments were all the rage and many in the industry thought this time was different. It wasn’t. The Millennial generation is getting married later and having kids later, but it seems like they are going for the same thing every generation prior to them wanted: space, good schools, etc. This is good news for the builders at the lower price points. Take a look at PulteGroup’s chart below.

 

pulte

 

The IPO market is still broken. Peloton was the most recent IPO to break price on the open. “Break Price” means to trade below the IPO price. It opened around $27 versus an IPO price of $29. This won’t help We Work’s IPO which is looking like an absolute dumpster fire as the price keeps getting cut. Historically, IPOs would trade at substantial premiums to their offering price, but those days are over. This represents the change in who pays the bills for investment banks, from the buy side to issuers.

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: The impeachment process begins

Vital Statistics:

 

Last Change
S&P futures 2968 -2.25
Oil (WTI) 56.35 -0.64
10 year government bond yield 1.65%
30 year fixed rate mortgage 3.91%

 

Stocks are flattish this morning despite overseas weakness and Trump Impeachment news. Bonds and MBS are flat.

 

The news that Nancy Pelosi was opening an impeachment inquiry over the Trump / Ukraine situation was a non-event market-wise. Stocks and bonds didn’t budge. Supposedly Trump will release the transcript of the call today, and will make the whistleblower available to Congress. We will see where this goes, but market-wise it will take a while to play out. Check out the chart of the S&P 500 during 1998 when the whole Bill Clinton impeachment situation was played out:

 

clinton

 

Here is a chart of the bond market during the same time period (10 year yield). Looks like we saw a drop in the 10 year of about 160 basis points peak to trough during the whole process. Note that this is a classic example of the old market saw “buy the rumor, sell the fact.” The market priced in impeachment before the votes even took place. If you got short on the votes, you got your head handed to you. If you bought the Treasury flight to safety in late summer of 98, when the whole thing was coming to a head, you were too late, and were on the wrong side of the trade by that point.

 

clinton bond

 

There was some slight movement in the Fed Funds futures for December, with the current odds at 22% no cut, 52%, a 25 basis point cut, and 26% chance of 50 basis points. Note that the repo market issues has been taken by the Fed that they don’t have as much leeway to shrink the balance sheet as they had anticipated.

 

Mortgage applications fell by 10% last week as purchases fell 3% and refis fell 15%. Rates were more or less flat at 4.01% last week, so the refi number is a surprise. That said, mortgage rates had risen about 20 basis points over the past few weeks, so maybe this was a catch-up phenomenon. Despite the back up in rates, the MBA estimates that 2019 will be the best year since 2016, with originations expected to hit $1.9 trillion.

 

Consumer confidence fell in September on trade fears and darkening expectations. The present conditions index fell but it was mainly future expectations that drove the decline.

Morning Report: Fannie and Freddie are told to level the playing field.

Vital Statistics:

 

Last Change
S&P futures 3005 7.25
Oil (WTI) 57.95 -0.64
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.96%

 

Stocks are higher this morning after China made some agricultural trade concessions to the US. Bonds and MBS are flat.

 

House prices rose 0.4% MOM and 5% YOY in July, according to the FHFA House Price Index. Home price appreciation has slowed across the board compared to 2018’s numbers. This is despite a meaningful drop in rates. Separately, the Case-Shiller index was more or less flat on a MOM basis and up a couple of percent annually.

 

FHFA regional

 

One of the best predictors of rising wages is the quits rate, which has been inching up slowly since the economy bottomed out in 2009. The latest reading had it at 2.6%. We are seeing an uptick in the quits rate for the bottom income brackets, with 12% of all lower income households switching jobs during the spring and early summer. For all the concern about income inequality, this is a welcome sign.  Separately, another 1.3 million workers will qualify for overtime pay due to a new Labor Department directive.

 

The FHFA has issued a directive to Fannie Mae and Freddie Mac to end guarantee fee discounts for high volume lenders. “We trying to make sure Fannie and Freddie aren’t driving consolidation in the market, but instead they’re providing a level playing field, and that’s really something we’re focused on,” Calabria said Monday at a National Association of Federally Insured Credit Unions conference. “One of the things that really concerned me before the crisis was that it wasn’t unusual where the big guys like Countrywide would come in and they pay G-fees down here and you come in and pay G-fees up here.” The ruling would level the playing field for smaller lenders, and apply the principle of “same rate of return for the same risks, regardless of size.”

 

What will be the implications of this change? Until we have a better grasp of how Fannie will make changes, it is hard to tell. It will probably push the redevelopment of the private label securities market. If other insurers can compete for the big aggregators, then we might see a more competitive marketplace, and will reduce the taxpayer’s footprint in the mortgage market.