Morning Report: Strong retail sales

Vital Statistics:

 

Last Change
S&P futures 2857 14.5
Oil (WTI) 54.92 -0.64
10 year government bond yield 1.59%
30 year fixed rate mortgage 3.84%

 

Stocks are up after strong retail sales numbers. Bonds and MBS are flat. The German Bund hit a new low this morning, trading at negative 66 basis points.

 

Strong retail sales numbers out this morning. The headline number was up 0.7%, well above the Street expectations of 0.4%. The control group, which strips out volatile gas and autos, was up 1.0% MOM, exceeding the Street estimate by 0.7%. Note that Trump’s delay of Chinese tariffs means they won’t hit until mid-December, or after the holiday shopping season. These numbers bode well for the back-to-school shopping season, which is the second most important of the year. Note that Walmart also reported strong numbers this morning, another bellwether for the retail sector. Expect strategists to take up their GDP estimates on these figures.

 

In other economic news, initial jobless claims rose to 220,000 last week, while industrial production fell 0.2% MOM and rose half a percent YOY. Capacity Utilization fell to 77.5%. The industrial and manufacturing numbers are probably influenced by trade.

 

Productivity rose 2.3% in the second quarter, way more than expectations as output rose 1.9%, hours worked fell 0.4% and compensation rose 4.8%. The biggest surprise however came in the revisions, where compensation in the first quarter was revised upward from -1.5% to +5.5%! These are inflation-adjusted numbers, so we had real compensation growth of 5.2% in the first half of the year. Where was the growth strongest? Manufacturing.

 

With the inversion of the yield curve, the business press is chattering about an imminent recession. Don’t buy it. Most of them are talking their partisan book and are sticking with their preferred narrative: (Trump’s trade war is causing a recession!). It helps that it is the most convenient and easy to explain scenario, and let’s face it: it is hard to talk about overseas interest rates when most journalists wouldn’t know a Bund if it bit them in the begonias. Reality check: you generally don’t get recessions with a dovish Fed, unemployment at 50 year lows, strong consumer spending and accelerating wage growth. In fact, the bullish case is that with strong wage growth, overseas deflation keeping inflation in check, and a dovish Fed, you could see what a scenario similar to the mid / late 90s. Food for thought.

 

The new FHA guidance for condos is available in its unpublished form here. The new rule will become effective 60 days after publication in the Federal Register (which should be any day now) and will make more condos eligible for FHA insurance.

 

Home prices rose 3% in July, according to Redfin. “July home prices and sales were weaker than I had expected, especially given that falling mortgage rates have been luring homebuyers back to the market since early spring,” said Redfin chief economist Daryl Fairweather. “Even though we’ve seen increased interest from homebuyers—especially compared to a year ago when mortgage rates were climbing—uncertainties in the overall economy and talk of a looming recession have people feeling jittery about making a huge purchase and investment. But I think the odds are that we won’t see a recession within the next year. If rates stay low and the economy continues to grow, we’ll see more homebuyers come back in a serious way in 2020, and the market will be much more competitive.” Home sales were down 3.4%, while supply fell by the same amount. In terms of price, the previously hot markets of San Jose and Seattle fell, while many of the laggards (like Cleveland and Rochester) rose.

 

Redfin price chart

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Morning Report: Reprieve from volatility

Vital Statistics:

 

Last Change
S&P futures 2891 10.5
Oil (WTI) 52.40 1.34
10 year government bond yield 1.75%
30 year fixed rate mortgage 3.83%

 

Markets are stronger this morning after China fixed the yuan stronger than expected. Bonds and MBS are down.

 

Mortgage credit availability decreased in July, according to the MBA’s Mortgage Credit Availability Index. Conventional credit increased by 0.1%, while government credit decreased. Credit increased primarily in the jumbo space. The drop in government credit availability was seen primarily in the high balance and streamline buckets.

 

Foreclosures filings are down 18% in the first six months of the year, according to ATTOM. Most MSAs fell, and it looks like any increases were concentrated in Florida. 177k properties entered the foreclosures process in the first 6 months of the year, down from 1.07 million in the first 6 months of 2009, which was the peak.

 

One strategist is out with a call for a “Lehman-like” sell off in the stock market, beginning as early as this month. Note this is a call based on market technicals, not fundamentals, which means it is looking at sentiment indicators and volatility. Note that the crash of 1987 happened in a similar environment, with trade and currency tensions between the US and Japan. Note another technical analyst is out with a call saying the US 10 year yield will eclipse the prior low of 1.36%. It is important to keep in mind that the US economy is not driving the action right now, nor is trade. This is being driven by overseas bond markets, and the actions of foreign central banks. The Fed is following the markets, not driving them.

 

Initial Jobless Claims fell to 209k last week, while consumer credit fell in June.

 

 

Morning Report: Fed day

Vital Statistics:

 

Last Change
S&P futures 3017 5.5
Oil (WTI) 58.51 0.54
10 year government bond yield 2.05%
30 year fixed rate mortgage 4.07%

 

Stocks are higher this morning after good numbers from Apple. Bonds and MBS are flat.

 

The FOMC announcement is scheduled for 2:00 pm EST. A Bloomberg piece from Ex NY Fed President William Dudley was making the rounds yesterday, which poured cold water on the idea that the Fed is entering a new easing cycle.

“All told, the case for lowering rates is less compelling now than it was when the Federal Open Market Committee last met in June. This doesn’t necessarily mean that an interest-rate decrease this week would be a mistake. But it does mean that market participants — who are expecting a series of cuts over the next year or so — might be in for an unpleasant surprise, because the Fed’s future moves will be more dependent on incoming economic data than they think. There’s a good chance that, after this week’s meeting, the central bank will be “one and done.”

If Dudley is right, and Powell’s subsequent press conference confirms this, then the Fed Funds futures market is way over its skis with respect to further rate cuts this year. The December Fed Funds futures are handicapping a 88% chance of at least 50 basis points in rate cuts this year. If the Fed disappoints, that doesn’t necessarily mean that long-term rates would increase, since the US 10 year is highly influenced by overseas bond markets. But further rate cuts are already baked in the cake, and the market will be vulnerable to a statement and / or press conference that is insufficiently dovish. Not only that, don’t be surprised if one or two members dissent (in favor of no rate cut). Might want to think about locking before the 2:00 pm release.

 

fed funds futures

 

Mortgage Applications fell 1.4% last week as purchases decreased 3% and refis were down 0.1%. Purchase activity is up 6% from a year ago, however it has been stalling out. Refinance applications for conventional mortgages were up 1.1%, however a 3% drop in government (primarily VA) offset the gain. Conventional 30 year mortgage rates were unchanged at 4.04%.

 

The economy added 156,000 jobs in July, according to the ADP Employment Report. IT and mining fell, while most other buckets increased. The Street is looking for 164,000 nonfarm payrolls this Friday.

 

The employment cost index rose 0.6% in the second quarter. On a YOY basis, they rose 2.7% as wages and salaries rose 2.9% and benefit costs rose 2.3%.

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: 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