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%.

 

 

Morning Report: No revelations in Humphrey Hawkins testimony

Vital Statistics:

 

Last Change
S&P futures 2785.75 -5
Eurostoxx index 372.14 -1.55
Oil (WTI) 56.64 1.06
10 year government bond yield 2.63%
30 year fixed rate mortgage 4.34%

 

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

 

Jerome Powell’s Humphrey-Hawkins testimony didn’t really reveal much in the way of new information. Here are his prepared remarks.  The Fed will be patient as it evaluates incoming data: “With our policy rate in the range of neutral, with muted inflation pressures and with some of the downside risks we’ve talked about, this is a good time to be patient and watch and wait and see how the situation evolves.” He didn’t volunteer too much information regarding balance sheet runoff other than to say the Fed is evaluating the timing. For the most part, the bond market didn’t really react much to the testimony other than to rally somewhat on his view that he doesn’t see much in the way of wage-push inflation. The message to the bond market: don’t freak out if you start seeing wage growth with a 3 handle.

 

Home prices rose 1.1% in the fourth quarter, according to the FHFA House Price Index. December was up 0.3% from November. The hot markets of 2017, especially the West Coast markets, have cooled substantially and are now experiencing appreciation more in line with the rest of the country. This chart probably understates the deceleration in the hotter markets, as the index only looks at loans with a conforming mortgage, which means it is only measuring the lower price points, which is where the strength lies. The jumbo market has been struggling.

 

FHFA regional

 

Mortgage Applications increased 5.3% last week as purchases rose 6% and refis rose 5%. Mortgage rates were little changed last week, but as we anticipated, homebuyers are responding favorably to this more stable rate environment,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “Purchase applications for both conventional and government loans rose last week, with the government gain led by a 14 percent increase in applications for VA purchase loans.”

 

A Senate Panel voted to advance Mark Calabria to a full vote on the Senate floor. The vote was 13-12, straight along party lines. The industry applauded the appointment.

 

Both Zillow and Redfin have models to value homes – which one is more accurate? It turns out that if you look at listed homes, Redfin is the winner, with an error rate of 1.8%. However, for homes off the market, it rises to 6%. Zillow, who doesn’t break out on the market / off the market for its error estimates comes in around 4%. FWIW, appraisers consider an error range of 4% about accurate. Note though that these are median error rates. In newer subdivisions, where square footage and lot sizes are similar, the estimates will be pretty predictive of final sales prices. As the properties become more diverse the error ranges increase. Note that in MSAs like Chicago, the median error is 4%, but over 40% of all home sales are not within 5% of the final sales price.

Morning Report: Shareholder activism and the banks

Vital Statistics:

 

Last Change
S&P futures 2767 -7
Eurostoxx index 368.05 -1.73
Oil (WTI) 56.06 0.47
10 year government bond yield 2.66%
30 year fixed rate mortgage 4.43%

 

Stocks are lower as investors return from a 3 day weekend. Bonds and MBS are flat.

 

We don’t have much in the way of economic data this week – the highlight will be existing home sales on Thursday and the FOMC minutes on Wednesday. Other than that, it should be a quiet week.

 

Industrial Production in January fell by 0.6%, while manufacturing production fell by 0.9%. Capacity Utilization fell to 78.2%, down from 78.8% the prior month. Volatile vehicle production largely accounted for the decrease. Note that December’s numbers were strong, which means the average for the two months was a modest gain.

 

Due to the government shutdown, Q4 GDP numbers have been delayed until Feb 28. Right now, the consensus seems to be for a high 1% / low 2% print – a definite slowdown from Q3, which would put 2018 annual growth around 2.8%. These forecasts are from Merrill, Goldman, and the NY / Atlanta Fed. Holiday retail sales disappointed, and some of the industrial data showed a slowdown as 2018 ended.

 

Mortgage delinquencies dropped to an 18 year low, according to the MBA. Fourth quarter DQs fell to 4.06%, which is down from 5.17% a year ago. The foreclosure rate ticked up to .25%. “The overall national mortgage delinquency rate in the fourth quarter was at its lowest level since the first quarter of 2000,” said Marina Walsh, MBA’s Vice President of Industry Analysis. “What’s even more noteworthy, the delinquency rate dropped from the previous quarter and on a year-over-year basis across all loan types and stages of delinquency. With the unemployment rate near a 50-year low, wage growth trending higher and household debt levels relative to disposable incomes at a 35-year low, homeowners are in great shape, and mortgage performance is quite strong.”

 

HomeStreet Bank is greatly reducing its footprint in the mortgage business, and has retained Keefe, Bruyette to sell its retail mortgage operations. MountainView will auction off the MSR portfolio. HomeStreet will not exit mortgages entirely, but it will move to more of a traditional mortgage business built around its bank branches. Interestingly, the divestiture comes after pressure from an activist investor. Banks have historically been pretty immune from shareholder pressure – hostile takeovers in the banking sector are rare events. it will be interesting to see if this starts a trend of shareholder activism in the sector. One of the best trades ever was holding onto the pieces of AT&T when it was broken up by the government in the 1980s. With so many banking giants, I wonder what would happen if, say, Bank of America decided to spin off Merrill Lynch and its mortgage business. Could the 3 parts be worth more than the sum? As the banking sector deals with its first secular bond bear market in 40 years, it may turn out that the strategies that worked in the bull market (consolidation) won’t work in a rising interest rate environment. Note that the Elizabeth Warrens of the world would likely push in this direction as well, which makes it conceivable we could see a return of venerable names like Salomon Brothers or Smith Barney, Chemical Bank, or Manufacturers Hanover.

Morning Report: Lots of labor data

Vital Statistics:

 

Last Change
S&P futures 2723 12.25
Eurostoxx index 364.42 2.24
Oil (WTI) 64.81 -0.46
10 year government bond yield 3.16%
30 year fixed rate mortgage 4.89%

 

Stocks are higher this morning after yesterday’s end of month window dressing. Bonds and MBS are down again.

 

The ADP report showed the US economy added 227,000 jobs in October, which is well ahead of the Street estimate for Friday’s BLS report. There was a big (typically seasonal) increase in transportation and retail, although professional / business services was strong as well. Mark Zandi, chief economist of Moody’s Analytics, said, “The job market bounced back strongly last month despite being hit by back-to-back hurricanes. Testimonial to the robust employment picture is the broad-based gains in jobs across industries. The only blemish is the struggles small businesses are having filling open job positions.” Large and medium sized employers (50 employees +) accounted for the lion’s share of new jobs.

 

ADP jobs report

 

With added employees comes added employee cost. The Employment Cost Index rose 0.8% QOQ and 2.8% YOY. The wage component of employment costs rose 2.9% while the benefit portion rose 2.4%. The drop in healthcare costs is helping wages as higher healthcare costs of consumed a lot of employee raises. Your cost of healthcare ate your cost of living raise.

 

Mortgage Applications decreased 2.5% last week as purchases fell 2% and refis fell 4%. Rates held steady. “The 30-year fixed-rate mortgage held steady over the week, but total applications decreased overall. Purchase applications inched backward from the previous week, as well as compared to one year ago – the first year-over-year decline in purchase activity since August,” said Joel Kan, AVP of economic and industry forecasts. “Purchase applications may have been adversely impacted by the recent uptick in rates and the significant stock market volatility we have seen the past couple of weeks. Additionally, the ARM share of applications increased to its highest level since 2017, but since this is a compositional measure, it was driven by a greater decrease in applications for fixed-term loans relative to the decrease in ARM applications.”

 

The Challenger and Gray job cut report rose last month, but it is a third-tier employment data point. It focuses on job cut announcements, which may or may not happen.

 

The homeownership rate rose 64.4% according to the Census Bureau. This was up 0.1% from the second quarter and 0.4% from a year ago. The homeownership rate has been ticking up, although the big jump in homeownership from 1994 to 2005 was partially driven by aggressive social engineering out of Washington and probably was artificially high.

 

homeownership rate NAD