Morning Report: Inflation is tame, gas is not

Vital Statistics:

 

Last Change
S&P futures 2708 9.25
Eurostoxx index 360.56 -1.71
Oil (WTI) 56.32 0.07
10 year government bond yield 3.11%
30 year fixed rate mortgage 4.94%

 

Stocks are higher as oil stabilizes. Bonds and MBS are up. The 10 year is trading at 3.11%, quite the drop from the 3.27% levels of last week.

 

Inflation remains largely under control according to the Consumer Price index. The CPI in October rose 0.3% MOM and 2.5% YOY, right in line with street forecasts. Ex food and energy, it was up 0.2% MOM and 2.1% YOY.

 

A couple of trade groups wrote letters of support for Kathy Kraninger as head of the CFPB. The agency has been led by Mick Mulvaney, who also head OMB, as Acting Director. Kraninger is the supposed replacement. If she isn’t confirmed by the Senate in the lame duck session, the nomination returns to the President and Mick Mulvaney stays in charge for another 210 days. Kraninger promises to reform the CFPB in the same way Mick Mulvaney is, by ending “regulation by enforcement” and being more transparent about what the rules actually are.

 

It usually pays to keep tabs on markets unrelated to your own. While people have been focusing on the oil market, and the bear market in oil, we are seeing the opposite effect in natural gas. Oil has lost about 24% over the past month. Natural gas gained more than that this week. Seriously. Natural gas closed last Friday at around $3.70 a contract and closed yesterday at around $4.70 a contract. Many commodities, especially natgas, is extremely sensitive to weather forecasts – if you go to the New York Stock Exchange, you’ll see CNBC on the trading floor. If you go to the a commodity exchange like the Chicago Mercantile Exchange, they have on the Weather Channel. So, if you get a forecast for an extra-cold winter, the price can skyrocket. As the link above explains, while we are the Saudi Arabia of natural gas, supply is not the driver here, storage is. And if we have an unusually cold winter, the amount of gas in storage can fall to dangerously low levels, which means higher prices. There are rumors going around of a hedge fund that is short Natgas and in trouble, but who knows? Regardless, it is something to watch.

 

natural gas

 

Speaking of keeping tabs on other markets, watch the corporate bond markets. General Electric has issues. While everyone is aware of what is going on the stock price, the bonds are down about 15 points since early October. In bond market terms, for a household name like GE, that is a lot. Bonds trading in the low 80s aren’t necessarily distressed, but this is GE we’re talking about. If this snowballs, we should see a tightening of credit overall. It probably won’t affect the MBS market and mortgage pricing, but it will almost inevitably act as a drag on interest rates overall, and it could keep the Fed at bay.

 

Chart: Financial Stress Index:

 

financial stress index

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 CFPB wants to define the term “abusive.”

Vital Statistics:

 

Last Change
S&P futures 2810 2.75
Eurostoxx index 364.61 -0.6
Oil (WTI) 71.52 -0.5
10 year government bond yield 3.18%
30 year fixed rate mortgage 4.95%

 

Stocks are flattish this morning after yesterday’s huge rally. Bonds and MBS are down.

 

We will get the minutes of the September FOMC meeting today at 2:00 pm. Be careful locking around that period. They usually aren’t market-moving, but you never know.

 

Lots of people are returning from the MBA conference in Washington, DC, so let’s catch up on the economic data from the past couple of days.

 

Job openings hit a record (going back to 2000) last month as 7.1 million positions went unfilled. The quits rate was unchanged at 2.4%. The quits rate has been steadily inching upward and we are back to early 2001 levels. The quits rate is generally considered to be a predictor of wage inflation.

 

quits rate

 

Retail sales for September disappointed at the headline level, rising only 0.1%. The control group, which strips out autos, gas stations, and building materials rose 0.5%, which was towards the higher end of expectations. Department Stores were especially weak, which isn’t surprising given that Sears just filed for bankruptcy. Overall, consumption for the third quarter looks to have been strong, which will support a good GDP number.

 

Industrial production rose 0.3% last month, and manufacturing production rose 0.2%. Capacity Utilization was steady at 78.1%. Manufacturing was up about 3.5% YOY, which is an inflation-adjusted number. If you add back 2.5% inflation, we are looking at 6% nominal growth, which is a very respectable number. Suffice it to say that whatever trade wars seem to be occurring have yet to show up in the numbers. Also, with capacity utilization stuck below 80%, we don’t have inflationary pressure from more marginal (and costly) production being used.

 

Mortgage applications fell 7% last week as purchases fell 6% and refis fell 9%. Seasonal adjustments are primarily responsible; unadjusted applications were more or less flat, which is kind of impressive given that rates rose about 16 basis points in the previous two weeks.

 

CFPB Chairman Mick Mulvaney told the MBA conference that regulation by enforcement is dead. Regulation by enforcement was a prime tactic of the Cordray regime, which was characterized by intentionally vague rules. Dodd-Frank inserted the term “abusive” into the vernacular, and while words like “fair” and “unfair” have been litigated over the past century such that we all have a pretty good legal idea of what they mean, “abusive” is still pretty much a blank canvas. The CFPB is working on a definition of what the term actually means.

 

“We know what ‘unfair’ is,” Mulvaney said. “We know what ‘deceptive is; I’m not sure we know how to define ‘abusive.’ This is an example of how we are looking at issues….”We are still Elizabeth Warren’s child, for better or worse. We’re not the FDIC; we’re not the SEC…I want the Bureau to get there, to where we are associated with other regulators and not controversial because of its partisan circumstances, which colors what half of Americans think of it.”

 

“Partisan” is a good description of how the agency was initially staffed. Here is one lawyer’s description of how things went. The agency ensured that only Democrats who were inherently hostile to the financial industry were hired to staff out the agency. Mulvaney may have different goals than Richard Cordray, but the rank-and-file of the agency do not.

 

Trulia noted that price reductions at the high end of the market accelerated in July and August. Over 17% of US listings had a price cut during August. Between tax reform, higher rates, and higher prices it was only a matter of time before we started seeing an impact at the higher price points. Don’t forget that in the aftermath of the crisis, luxury real estate was about the only sector that was working for homebuilders. While the West Coast has been able to absorb that inventory, the East Coast definitely has not. Indeed, tony NYC suburbs are swollen with $1 million + properties for sale, and some have gone as far as to ban “for sale” signs.

 

Trump continued to jawbone the Fed, calling it his “biggest threat.” FWIW, there isn’t a politician on the planet that actually likes tightening cycles, but most have the common sense not to say anything about.

Morning Report: James Bullard says no further rate hikes are warranted

Vital Statistics:

Last Change
S&P futures 2722 3.75
Eurostoxx index 392.17 0.2
Oil (WTI) 71.3 -0.06
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.56%

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

Import prices rose 0.3% MOM and 3.3% YOY, driven by oil. Ex-energy import prices were flat.

St. Louis Federal Reserve Head James Bullard said that interest rates may already be at the level where they are no longer stimulating the economy. There are “reasons for caution in raising the policy rate further given current macroeconomic conditions” he said in his prepared remarks. Bullard has generally been considered a dove, so this is not much of a surprise. He is also a non-voter. He believes that there is little in the inflationary pressures being signaled in the market.

With respect to inflation signalling, he has a point. The spread between the 30 year bond and the 5 year bond is now the narrowest since 2007. Note that the yield curve generally flattens during tightening phases and is probably not signifying the type of deflationary period that 2007 did. Given all of the QE over the past decade, the signals from the bond markets are heavily distorted and should be taken with a grain of salt. Note short Treasuries is one of the biggest hedge fund trades on the Street.

flat yield curve

Are the homebuilders set to outperform going forward? They have suffered more than the market during the recent declines, but the environment should be favorable for the sector going forward. With a shortage of housing, high demand and rising prices, the sector should be in good shape. The problem for investors? The sector is highly cyclical, and the stock behavior reflects that. In other words, earnings will rise and fall, and the multiple will expand and contract, dampening the effect. So, if the average multiple is typically mid-teens, don’t be surprised if P/E ratios fall to the high single digits during boom times.

Q2 GDP is currently tracking at 3.7%.

Sen Pat Toomey says that the Trump Administration doesn’t have the authority to pull out of NAFTA, since it was passed by Congress. On the other hand, the Admin does have the authority to pull out of the Iran Deal, as well as the Paris Accords because they were only deals with the Obama Administration and not the US – never ratified by Congress.

Morning Report: Number of unemployed equals number of job openings

Vital Statistics:

Last Change
S&P futures 2680 9.75
Eurostoxx index 390.81 0.81
Oil (WTI) 70.9 1.84
10 Year Government Bond Yield 3.00%
30 Year fixed rate mortgage 4.63%

Stocks are higher this morning after the US pulled out of the Iran deal. Bonds and MBS are down, with the 10 year trading over 3% again.

The Iran deal was never ratified by the Senate, so it never reached the level of “treaty.” It was basically a deal with the Obama Admin and Iran.

Oil had a volatile day yesterday and is rallying again. China is the biggest customer of Iranian oil, so in theory it shouldn’t affect the US all that much, but WTI will follow Brent on the relative value trade. Note that a sustained oil price over $70 is estimated to be about a 0.7% drag on GDP growth.

Inflation at the wholesale level moderated last month, with the producer price index rising 0.1% MOM and 2.6% YOY. Ex-food and energy, the index rose 0.1% / 2.3% and the core rate rose 0.1% / 2.5%.

Job openings hit 6.6 million last month, which is a new record for the index, which goes back to early 2000. The quits rate increased to 2.3%. The quits rate has been stuck in a 2.2% – 2.3% range for what seems like forever. Fun fact: The number of job openings has hit the number of unemployed for the first time.

JOLTs vs unemployed

The labor shortage is particularly acute in construction, which is part of the reason why housing starts have been short of demand. This shortage has extended to home remodeling as well.

While everyone seems to focus on the CPI / PPI / PCE inflation measures and imagines that a single point estimate accurately reflects the cost of living, it doesn’t. First the relative weights of different goods and services differ. For example, PCE and CPI will weight healthcare differently, as well as owner-equivalent rent. The St. Louis Fed notes that the differences in inflation between regions of the US can be substantial as well.

Mortgage Applications fell 0.4% last week as purchases fell 0.2% and refis fell 1%. Tough times for the smaller originators.

Despite the slim pickings out there, mortgage credit has contracted a bit this year. Overall, it was a mixed bag, as government credit contracted on less streamlines while conventional increased as jumbos rose. Government credit has been tightening since early 2017, when the government began to crack down on serial VA IRRRL shops.

How have things changed at the CFPB or the (BCFP) under Mick Mulvaney? Despite the ululating in the press, not that much. One of the panelists warned industry lawyers not to advise their clients that the CFPB is relaxing its enforcement activities. So far, the biggest change we have seen is that the name has been changed back to the Bureau of Consumer Financial Protection, which was the way it was written into Dodd-Frank.

Fair Housing groups are suing HUD over Ben Carson’s delay of the Obama-era re-interpretation of AFFH – affirmatively furthering fair housing. Their complaint is that HUD didn’t provide advance notice before suspending the rule,. which would have required communities to “examine and address barriers to racial integration and to draft plans to desegregate their communities.” HUD delayed the compliance deadline until 2024. In practice, this means that HUD wants communities to change or eliminate their zoning ordinances to include more multi-family housing in wealthier neighborhoods.

Morning Report: Goldilocks moment with unemployment and inflation

Vital Statistics:

Last Change
S&P futures 2670 6.9
Eurostoxx index 388.46 1.44
Oil (WTI) 70.62 0.89
10 Year Government Bond Yield 2.94%
30 Year fixed rate mortgage 4.54%

Stocks are higher this morning as oil tops $70 a barrel. Bonds and MBS are flat.

Jobs report data dump:

  • Nonfarm payrolls 164,000 (lower than estimates)
  • Unemployment rate 3.9%
  • Average hourly earnings +.1% MOM / 2.6% YOY
  • Labor force participation rate 62.8%

This was the second month in a row where the labor force participation rate fell. The labor force fell by 236k, while the population increased by 175k. Wage inflation remains present, however it is still unlikely to drive higher inflation in the overall economy. The unemployment rate fell to the lowest since early 2000. This report takes some pressure off the bond market, and makes another run at 3% for the 10 year less likely.

unemployment rate

The drop in the unemployment rate along with moderate wage growth is somewhat of a Goldilocks moment for the Fed. The Philps Curve is an older economic model which suggests that inflation should rise as unemployment falls, which makes sense: Unemployment falls -> workers become scarce -> wages rise -> those costs get passed on to consumers. In reality, the relationship between unemployment and inflation has been weak (R^2 = .27). The low r-squared gives away the weakness of the model – it is too simplistic, plus the unemployment rate might not be the best measure of employment strength since it ignores the long term unemployed. However, if you look at the plot below, you can see we are at a very “Goldilocks” point, which is denoted by the yellow star.

Phillps Curve

The upcoming week will have the consumer price index and the producer price index, but that should be the only market-moving data. We will have some Fed-speak as well today and Wednesday.

Donald Trump has until May 12 to renew the Iran deal. Israel calls the deal fatally flawed, while Iran says the US will regret not renewing it. West Texas Intermediate is trading over $70 on fears the deal will not be renewed.

Doctors tend to have difficulties getting a mortgage early in their careers – they usually have a high level of student loan debt, no savings and the earnings early on can be low. Mortgages that carry a higher interest rate but don’t require downpayments are becoming more popular for this market. These loans can carry an interest rate 25 -100 basis points over prevailing rates. although they usually don’t require PMI. One catch – the prepay speeds on these mortgage will almost certainly be high.

The CFPB dodged a bullet – PHH will not appeal the DC Circuit’s ruling that rejected their claim that the single-director structure is unconstitutional. There are other cases in the process that also use that claim, so it is possible the question may come to SCOTUS. If one of these cases makes it to SCOTUS, the only one with standing to defend the agency is the Administration, who probably won’t defend it.

Merger news: Mutual of Omaha is buying Synergy One. Synergy One will be a wholly-owned subsidiary and will continue to operate out of San Diego.