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.

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Morning Report: Rates heading lower

Vital Statistics:

 

Last Change
S&P futures 2788 -17
Oil (WTI) 57.53 -1.78
10 year government bond yield 2.23%
30 year fixed rate mortgage 4.31%

 

Stocks are lower this morning as bond yields continue to fall worldwide. Bonds and MBS are up.

 

Mortgage applications fell 3% last week as purchases declined 1% and refis declined 6%. This is despite a 6 basis point drop in mortgage rates.

 

Bond yields are down worldwide, with Japan, Australia, and Germany all hitting lows or close to it. This is not being driven by trade concerns – it is being driven by economic malaise in Europe. The German Bund, which is the European benchmark, is yielding -17 basis points (which means you have to pay to lend to the German government). Japanese government bonds yield -10 basis points. All of this will pull down US bond yields as investors swap out of negative yielding assets into positive yielding ones. Even if investors need to bear the foreign exchange risk to buy a US Treasury, many of them figure a possible loss is a better deal than a certain one.

 

Expect the narrative of the business press to evolve as this goes on, from worrying about trade issues to worrying about an inverting yield curve. The business press is going to jump at the narrative that the yield curve is predicting an impending recession, especially as we head into the 2020 elections. Be careful with that interpretation. Historically an inverted yield curve has been a signal of a recession, that much is true. That was before the days of extensive central bank intervention in the bond markets, which has diluted the economic messages being sent by rates. The signal-to-noise ratio of the yield curve is at a historical low, and has been for the past 10 years.

 

Instead of signalling a recession, lower long-term rates are more likely to be good news for the US economy in general. Slower global growth will keep a lid on inflation, which will give the US economy more leeway to grow without building inflationary pressures. This has been a theme for the the past 30 years – emerging economies exporting deflation, and that allows the US economy to run hotter than it ordinarily would. And, unlike the late 90s or the mid 00s, we don’t have a stock / residential real estate bubble to worry about. Note that consumer confidence is back towards 18 year highs as well.

 

Quicken CEO Dan Gilbert had a stroke over the weekend. We all wish him a speedy recovery.

Morning Report: US bond yields anchored by creeping Eurosclerosis.

Vital Statistics:

 

Last Change
S&P futures 2859 -7
Oil (WTI) 62.65 -0.48
10 year government bond yield 2.43%
30 year fixed rate mortgage 4.41%

 

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

 

The MBA Secondary Conference was held in NYC on Monday and Tuesday, and it seemed (at least to me) to be much more sparsely attended than in prior years. The most obvious example was the HUB or the conference floor, where there were about half the number of booths. You could see it in the major sessions, where the seats were maybe 25% taken. Of course the secondary conference is largely an off-site event where people go to the various hotels around Times Square for meetings, but it definitely looks like traffic was down this year.

 

The big topic was growth and how to achieve it. Generally speaking most originators were focusing on non-QM as well as renovation loans as the best way to drive growth. Mergers were also mentioned as a way to increase volume. Mohammed El-Arian forecasted that rates will go nowhere in the near future, anchored by negative rates in Europe. The German Bund is trading at a negative yield of 8 basis points (in other words you have to pay for the privilege of lending to the German government), and many money managers prefer to invest in positive-yielding US Treasuries and roll the dice on the currency risk than to lock in a sure loss in German Bunds. He also doesn’t see any sort of recession for at least the next two years unless a massive trade war breaks out internationally.  You can see the creeping Eurosclerosis in the chart of the Bund yield below:

 

german bund

 

The Trump Administration is vetting Judy Shelton to fill a seat on the Federal Reserve Board. She is currently on the European Bank for Reconstruction and Development, which means she has already been through part of the confirmation process. She is in favor of keeping interest rates low, and has criticized the Fed’s methodology for setting the Fed Funds rate.

 

Existing home sales fell in April, according to NAR. They were down 4.4% from a year ago to a seasonally adjusted annual rate of 5.19 million. The median home price rose to 267,300 which is a 3.6% increase from a year ago. Inventory rose as well, to 1.83 million units, which represents a 4.2 month supply. Historically, 6 months would have been considered a balanced market, and we also have a mismatch between price points, where there is a glut of luxury properties and a shortage of entry-level homes. Days on market declined however to 24 days. “I think the market had a bit of a slow start in the Fall, but Realtors® all over the country have been telling me that April was a nice rebound. We’re hopeful and expect that this will continue heading into the summer,” said NAR President John Smaby, a second-generation Realtor® from Edina, Minnesota and broker at Edina Realty. “Homes over the last month sold quickly, which is not only a win-win for buyers and sellers, but it’s also great for the real estate industry.”

 

The mismatch between supply and demand is translating into more boomer empty-nesters staying in their homes. Trulia believes this is a matter of choice, but it may simply be the fact that there is not much demand for those 3,500 square foot homes. The demand is at the lower sizes and price points.

 

Mortgage applications rose 2.4% last week as purchases fell 2.4% and refis rose 8.3%. The average contract interest rate fell 7 basis points to 4.33%.

Morning Report: The Trump Administration pushes for lower rates.

Vital Statistics:

 

Last Change
S&P futures 2893 -2.75
Eurostoxx index 388.4 0.22
Oil (WTI) 63.35 0.27
10 year government bond yield 2.50%
30 year fixed rate mortgage 4.17%

 

Stocks are flattish this morning as the Trump Administration and China get closer to a trade deal. Bonds and MBS are up.

 

This week will be relatively data-light, although we will get inflation data on Wednesday and Thursday. Fed Head Jerome Powell will speak to Democrats at their annual retreat. I doubt there will be anything market-moving in Powell’s speech, but you never know.

 

Lennar is making a big bet on entry-level homebuyers, launching new communities with prices in the mid $100,000s. The homes range from 1200 – 2200 square feet and are on 40 foot lots. Prices range from $162,000 – $200,000.

 

Former Kansas City Fed Chief and restaurateur Herman Cain is currently being vetted by the Trump Administration for a Fed post. He has some allegations of sexual misconduct, and so far most Republicans are in wait and see mode during the process. Over the weekend, Larry Kudlow and Mick Mulvaney stressed that the two nominations were “on track.”

 

Donald Trump said the economy would “take off like a rocket ship” if the Fed cut rates. He also criticized the “quantitative tightening” – i.e. reducing the Fed’s balance sheet. His feelings about monetary policy are natural – there isn’t a politician alive who doesn’t prefer lower rates to higher rates, but his constant criticism is something new. That said, there is a partisan bent to monetary policy. Republicans fret about monetary policy being too loose when Democrats are in charge, and Democrats are less dovish when Republicans are in charge. Both sides want the economy to be weak when their rivals are in charge.

 

Did the Fed overshoot? It is hard to say, since this was really one of the first times the Fed started tightening without a real inflation problem. The point of tightening was advertised as a preventative move to prevent inflationary pressures from building, but the real reason was to get off the zero bound. 0% interest rates are an emergency measure, and emergency measures aren’t meant to be permanent. Interest rates at the zero bound also cause all sorts of distortions in the markets, and build risks into the system. Given that the economy was strengthening, the Fed took advantage of the opportunity to get back closer to normalcy. Would the economy be faster if the Fed wasn’t tightening? Probably. However some of that is going to be determined by global growth, and Europe is not doing well.

 

Monetary policy acts with about a year’s lag, so the June, September, and December hikes from last year still have yet to be felt. Nobody is predicting a recession, but the 2018 hikes are going to sap growth a little this year. I would be surprised if it slowed down the economy enough to prod the Fed to cut rates. Note that the NY Fed raised its Q2 growth estimate to 2% from 1.6%.

 

Finally, even if the Fed raises rates, overall long-term interest rates can stay low for a long, long time. Interest rates went below 4% during the Hoover Administration and didn’t get back above that level until the Kennedy Administration. So, it could be a long time before we ever see a 4% 10 year yield.

 

100 years of interest rates

 

 

Morning Report: Sea change in market expectations

Vital Statistics:

 

Last Change
S&P futures 2815.75 -7.25
Eurostoxx index 375.78 -1.45
Oil (WTI) 59.49 -0.45
10 year government bond yield 2.38%
30 year fixed rate mortgage 4.08%

 

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

 

Independent mortgage banks reported a loss of $200 per loan on average in the fourth quarter of 2018, according to the MBA. This is a drop from the $480 per loan they earned in the third quarter. This works out to be about an 11 basis point production loss per loan. In the fourth quarter of 2017, independent mortgage banks earned 20 basis points. This 11 basis point loss is the lowest since the MBA began keeping tabs on this about 10 years ago. Declining secondary marketing income was met with increasing production costs. The first quarter this year probably looks just as bad, and servicing portfolios are going to be taking a mark-to-market hit as interest rates have unexpectedly fallen. Many banks use their MSR portfolio as a natural hedge for their core business, but there will be a lag so Q1 looks to be similar to Q4.

 

That said, we did see a spike in applications last week, as they rose 8.9%. Purchases rose 6% and refis rose 12% as rates fell.

 

Donald Trump’s nominee to the Federal Reserve Board Steve Moore has called for the Fed to cut rates 50 basis points immediately. He came under criticism (and apologized) for calling for Jerome Powell’s resignation after the Fed hiked rates again in December. FWIW, left econ is pretty bent out of shape over his nomination (the Washington Post penned 2 editorials against him yesterday), mainly for his support of tax cuts, deregulation, and free markets. In an interview with the New York Times, he said “I was really angry” about the December increase, Mr. Moore said. “I was furious — and Trump was furious, too. I just thought that the December rate increase was inexplicable. Commodity prices were already falling dramatically.” Remember Trump criticized the cuts (and was beaten about the head and shoulders in the business press over it). That said, back in December, the markets thought the Fed would raise rates twice this year. They are now predicting at least 1 cut this year. Take a look at what the Fed Funds futures are saying below. Just one month ago, the market was assigning a 81% chance that the Fed would do nothing this year. Now, there is roughly a 75% chance of at least one rate cut. The swing in sentiment is pretty dramatic.

 

fed funds futures dec 19

 

Note that the yield curve has inverted, although that is mainly due to the high 3 month rate. 2s – 10s is still positive.

 

While we have seen a marked deceleration in home price appreciation according to Case-Shiller, the FHFA House Price index still shows decent growth. It increased 5.6% annually in January.  Since the FHFA index only looks at homes with conforming mortgage, it ignores the jumbo space, and that is where we are really seeing the weakness in home prices. Regionally, the West and Mountain states have really slowed down, and the lagging markets in the Mid Atlantic area (especially the NYC area) are finally showing signs of life. You can see the dispersion between 2017 (blue) and 2018 (red) has really decreased as the correlation tightens.

 

FHFA regional

Morning Report: Weak housing starts number

Vital Statistics:

 

Last Change
S&P futures 2821.25 14.5
Eurostoxx index 376.34 2.01
Oil (WTI) 59.65 0.83
10 year government bond yield 2.45%
30 year fixed rate mortgage 4.08%

 

Stocks are higher this morning on overseas strength. Bonds and MBS are up.

 

Lots of housing data to chew through. Let’s start with existing home sales, which increased 11.8%, according to NAR. While this month-over-month print of 5.51 million sounds impressive, we are still down on a YOY basis. Lower rates are helping, and we are beginning this season with a little more inventory to work with. We had 1.63 existing homes for sale, which represents a 3.6 month supply. A balanced market needs something like 6 months. Prices are still rising – the median house price rose by 3.6% – but the rate of appreciation has slowed. The median home price came in at $249,500, and that puts the median house price to median income ratio just over 4. Historically that is a high number, but lower interest rates help the affordability issue. The first time homebuyer represented 32% of home sales, an increase from last year but still below the historical average of around 40%.

 

Housing starts fell 8.7% to 1.16 million, a disappointing number. We saw a huge decrease in single family construction – from an annualized pace of 970k to 805k. Last February, the number was 900k so this is a big drop. One note of caution – the margin for error on these numbers is huge (around 17%), so there is a good chance this gets revised upward in subsequent releases. Building permits were a little better – falling only 2% to 1.3 million. Housing construction has largely been absent from this recovery, and could provide a huge boost to the economy if it ever gets back to normalcy (around 1.5 million units a year).

 

housing starts

 

More evidence that home price appreciation is slowing: the Case-Shiller home price index rose 4.3% in January, the slowest pace since 2015. In general, 2018 was a year to forget for the mortgage industry as rates rose 100 basis points. They have now given back most of those gains, so perhaps 2019 will be a bit brighter, although if you have been counting on MSR unrealized gains to paper over weakness in lending, the Q1 mark is going to be harsh.

 

The economy seems to be slowing, according to the Chicago Fed National Activity Index. It edged downward to -.29 in February, and the 3 month moving average is negative as well. The CFNAI is a meta-index of 85 different economic indicators, of which many are leading as well as lagging. While it is too early to start declaring 2019 a slow-growth year, the first quarter is looking weak.

 

The FHA is backing away from a 2016 decision to loosen credit – it is now tightening standards and flagging more loans as “high risk.” The biggest effect will be for the first time homebuyer, and FHA estimates that 40,000 loans or so might be affected. At the heart of the issue is a 2016 decision to no longer require a manual underwrite for FHA loans with FICOs below 620 and DTIs above 43. FHA was largely a backwater pre-crisis, and most of these types of loans were subprime. As the subprime market disappeared, FHA stepped in to fill the void. Home Ready and Home Possible have emerged as low downpayment competitors, and FHA has suffered from negative selection bias. While FHA permits very low credit scores, most lenders don’t go as low as FHA permits in the first place.

 

Trump nominates free-marketer Steven Moore to the Federal Reserve Board and Paul Krugman isn’t taking it well. For a little economics inside-baseball, this resembles the Spacely Sprockets / Cogswell Cogs rivalry in the economics profession. Since most of the free-market caucus comes from the University of Chicago, they are called “fresh water economists” and Krugman comes from Ivy / Coastal academia (Princeton) so his school is called “salt water” economists. In terms of ideological bent, the fresh water economists are much more non-interventionist than the salt water economists, who support direct government intervention in the markets and economy. Steven Moore is a true believer in the free market approach, and to be honest, most of the Fed and academia are not. A little diversity of opinion is not a bad thing….

 

 

Morning Report: Job openings, and the Fed.

Vital Statistics:

 

Last Change
S&P futures 2833.5 3
Eurostoxx index 381.78 0.68
Oil (WTI) 48.46 -0.14
10 year government bond yield 2.60%
30 year fixed rate mortgage 4.27%

 

Stocks are higher this morning on overseas strength. Bonds and MBS are up.

 

The big event this week will be the FOMC meeting on Tuesday and Wednesday. No changes are expected in interest rates, and the Street will be focused primarily on the dot plot and whether it is catching up with what the Fed Funds futures are saying. The December 2018 dot plot predicted that the end of 2019 Fed Funds rate would be in the 2.75% – 3% range, in other words two more rate hikes in 2019. A Reuters poll of economists forecasts 1 more hike this year. On the other hand, the markets are predicting a Fed Funds rate in the 2.25% – 2.5% range – in other words no change. To be fair, there has been a major change in market sentiment since December, but one of the two (the experts or the markets) has clearly got it wrong. In December, only 2 out of the 17 forecasts expected the Fed to not hike this year, and nobody was looking for a rate cut. The futures on the other hand are handicapping a 75% chance of no hike and about a 25% chance of a rate cut. This is a massive expectations gap.

 

Other than the FOMC meeting, there isn’t much in the way of important economic data. We will get leading economic indicators on Thursday, and existing home sales on Friday.

 

There were 7.58 million job openings at the end of January, which is close to the record set back in November. The 2018 data series was also revised upward, with about 353,000 additional job openings on average. The quits rate was 2.3%, which is where it has been for most of 2013 after that series was revised. The quits rate describes the number of people who are leaving their current job to get another, so it tends to lead increases in wage growth.

 

job openings

 

The housing industry is driven at least partially by new home construction, and there is a noted labor shortage in that sector. The problem is most acute in skilled trades, like electricians and plumbers, but unskilled supply is still an issue. The job opening rate for construction was 3.9% last month, as opposed to 3.3% a year ago. The quits rate edged up for the sector as well, rising to 2.5%.