ISM Manufacturing Index – The Daily Tearsheet

Morning Report: Out: NAFTA. In: USMCA.

Vital Statistics:

	Last	Change
S&P futures	2933	14.75
Eurostoxx index	384.63	1.45
Oil (WTI)	73.2	-0.09
10 year government bond yield		3.09%
30 year fixed rate mortgage		4.71%

Stocks are higher this morning after NAFTA was saved over the weekend. Bonds and MBS are down small.

Canada and the US reached an agreement late last night to keep Canada in NAFTA (which will be renamed). The biggest change in NAFTA makes it harder for automakers to build in Mexico, where labor is cheaper. Canada got to keep a trade dispute mechanism. The treaty will go to Congress for approval. “It is a great deal for all three countries, solves the many deficiencies and mistakes in NAFTA, greatly opens markets to our Farmers and Manufacturers, reduce Trade Barriers to the U.S. and will bring all three Great Nations closer together in competition with the rest of the world,” wrote Trump last night. There is a press conference scheduled for 11:00 am.

Manufacturing continues to impress, with the ISM survey coming in at 59.8. New orders decelerated, while production and employment accelerated. Tariffs continue to weigh on manufacturers, and the clarity of having NAFTA (sorry USMCA) off the table should help somewhat, but we still are nowhere near any sort of resolution with China. Still, the market is strong, and labor issues remain. Wages are going to increase. They have to.

The CFPB’s head of fair lending is under fire for blog posts in the past, where hate crimes were discussed. The blog post in question is a mock legal debate – hardly an inflammatory screed – and is largely a thought crime for entertaining the notion that hate crimes are often hoaxes. Still, some of the employees at the CFPB are having issues with it. Ultimately, most of the CFPB staffers are holdovers from the Cordray “push the envelope” days, and they are chafing under the new approach of the CFPB – “enforce the law as written and then stop.”

This should be a big week ahead with the jobs report on Friday and a lot of Fed-speak. The snapback rally in the 10 year appears to be over, and the new NAFTA agreement definitely points to more expensive cars in the future. That could be offset by lower ag prices, but we will see. Don’t know how lumber will be affected either, but building materials are big inputs to inflation, especially housing inflation.

Mortgage rates increased by 3 basis points during September, making this the 10th month in a row where they have increased. This is affecting affordability, and the share of homes selling above their listing price declined. The drop is mainly in the super hot markets on the West Coast, but there is no doubt that home price appreciation is moderating. Either wages have to catch up or home prices are going nowhere for a while. With rates pushing 5%, will we see a slowdown in housing? Probably not – Zillow estimates that 6% is the number to watch.

Construction spending increased by a hair in August, increasing 0.1% MOM. On a YOY basis, we are still up 6.5%. Residential construction fell, and was up only 4.1% YOY. Where was the activity? Office and commercial.

The Atlanta Fed cut their third quarter growth rate estimate to 3.6% from 3.8%. Still think consumption could surprise to the upside for the year, but want to hear what the retailers report for back to school.

Morning Report: Lot sizes and the CRA

Vital Statistics:

	Last	Change
S&P futures	2897	-4.25
Eurostoxx index	379.06	-3.45
Oil (WTI)	71.13	1.33
10 year government bond yield		2.88%
30 year fixed rate mortgage		4.55%

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

The highlight of the upcoming week will be the jobs report on Friday, although we will get a lot of Fed-speak on Wednesday. Productivity and costs on Thursday will be an important report as well.

Construction spending rose 0.1% which was lower than the Street 0.4% expectation. Residential construction rose 0.6% MOM and 6.6% YOY.

Manufacturing expanded in August, according to the ISM PMI Index. The August PMI increased 3.1% to 61.3, driven by increases in production and new orders. Employment rose as well. Many of the participants noted that trade is injecting some uncertainty into their business, especially with respect to price negotiations with suppliers. The reading of 61.3 is unusually strong, and is typically associated with 5.6% GDP growth.

The OCC is asking for input regarding the CRA and modernization. “As a long-time banker, I have seen firsthand the benefit of CRA investment and how it makes communities vibrant. I applaud the effort of community development practitioners and bankers who work together to make an important difference in our nation’s neighborhoods,” said Comptroller of the Currency Joseph M. Otting. “I have also seen how limitations in the current CRA regulation can fail to provide consideration to a bank that wants to lend and invest in a community with a need for capital, including many low- and moderate-income areas. Unfortunately, the operation of the current CRA regulation can result in restricted resources. It is time for a national discussion on how we can make the CRA work better.”

The ANPR solicits comment on a number of questions regarding improvements to the CRA regulations related to

increasing lending and services to people and in areas that need it most, including in LMI areas;
clarifying and expanding the types of activities eligible for CRA consideration;
revisiting how assessment areas are defined and used;
establishing metric-based thresholds for CRA ratings;
making bank CRA performance more transparent;
improving the timeliness of regulatory decisions related to CRA; and
reducing the cost and burden related to evaluating performance under the CRA.

Donald Trump was jawboning Canada over trade and threatening China with $200 million in higher tariffs. I think markets are pretty much shrugging off trade threats any more. Note that Trump will need legislation to carry out some of the changes he wants to make with Canada, which isn’t going to happen.

Home prices increased 0.3% MOM and 6.2% YOY in July, according to CoreLogic. They are forecast to rise about 5% over the upcoming year. We are seeing sellers in the hot markets decide to pull properties off the market to see if they can ride the home price appreciation for a bit longer. This is adding to the supply crunch. CoreLogic’s model always seems to predict a slowdown in home price appreciation that never seems to materialize.

An interesting tidbit – the median lot size fell to 8.560 square feet in 2017 (about 1/5 of an acre). Lot sizes had been trending downward, but climbed during the bubble years as more and more building was done in the exurbs. New England has the largest lot sizes at about 0.4 acres, while the left coast has the smallest (.15 acres). Note this study is only looking at single family spec homes. It looks like this is basically a secular trend, and the the bubble years (building in the exurbs) was largely a blip. It also could be a function of building activity being dominated in regions (like the West Coast), where lots are smaller.

The ultra-high end luxury market has been getting whacked as foreign investors step away. Changes in tax laws might be having an impact, but it could have also been driven by overbuilding at the top end. I suspect it is the latter, since we are seeing softness in states like Florida which benefit from the tax law.

Morning Report: ISM strong, tight labor market, Fed Funds still see a coin toss for 2 hikes this year.

Vital Statistics:

	Last	Change
S&P futures	2737	10
Eurostoxx index	380.51	3.77
Oil (WTI)	75	1.06
10 Year Government Bond Yield		2.87%
30 Year fixed rate mortgage		4.52%

Stocks are up this morning as emerging markets rally overnight. Bonds and MBS are flat.\

Today should be quiet as markets close early ahead of the 4th of July holiday.

Manufacturing continued to plow ahead in June, according to the ISM PMI Index. The responses from the survey participants show that the trade war is having some impact. One food and beverage company mentioned that they were shifting some production to Canada in order to escape Chinese retaliatory tariffs on US products. Inflationary pressures are present in higher commodity prices, and we are seeing secondary pressure from transportation (higher oil prices and driver shortages are pushing up prices here). Pretty much every commodity is seeing price increases, and there are material shortages in aluminum, steel, and electronic components. Overall, this is a strong manufacturing reading, which is usually associated with 5.2% GDP growth. Of course, manufacturing isn’t the driver of the economy it used to be, but it is still a strong reading.

The Fed is going to pay close attention to this report, particularly the part about labor shortages. From their standpoint, inflationary pressures from commodity price inflation are generally considered transitory and therefore temporary. An old saw in the commodity markets is that the cure for high prices is high prices. The potential dampening effect from trade battles will also concern them. IMO, until you start seeing wage inflation pick up in a meaningful way the Fed will consider this a push. Note we will get some insight into this on Thursday when the minutes from the June meeting are released.

The Fed funds futures are still handicapping a 76% chance of a 25 bp hike in September and a 45% chance of one in December as well.

Construction spending rose 0.4% in May, and is up 4.5% on an annualized basis. Residential construction was up 0.8% MOM and 6.6% YOY, as an increase in private resi construction was offset by a drop in public housing spending. Manufacturing construction took a step back, which will be something to watch (could just be noise, but could be trade-related). Meanwhile retail (specifically mall-related construction) is in the doldrums as vacancy rates soar.

Home price appreciation accelerated in May, according to the CoreLogic Home Price index. Prices rose 1.1% MOM and are up 7.1% YOY. The housing shortage is well-documented, and the problem is most acute at the entry-level. Higher rates and low inventory is also preventing some people from moving. CoreLogic estimates that 50% of the mortgage market has a rate of 3.75% or lower. According to CoreLogic’s model which compares home price appreciation to income appreciation, we are seeing large pockets of overvaluation, particularly in Florida, the West Coast, the sand states, and parts of the Eastern Seaboard. The Midwest remains cheap.

Trump is reportedly mulling whether to pick a new Chief of Staff. One of the potential candidates is current CFPB Chairman Mick Mulvaney. Mulvaney is currently doing double duty as OMB and CFPB head, so a change for him would be unlikely, but the possibility is still there. Here are the implications of a change and who might replace him.

Labor shortages continue to be an issue in the Midwest. Companies are now less squeamish about hiring ex-cons. In Elkhart, (where the labor market is so tight it sports a 2% unemployment rate and even the KFC is offering sign-on bonuses), companies are hiring convicted felons (except sex offenders) and are waiving drug tests. It is a back-to-the future scenario, where the labor market is suddenly transported back to 1955.

Morning Report: Where is the private label MBS market?

Vital Statistics:

	Last	Change
S&P futures	2645	-1.75
Eurostoxx index	385.49	0.17
Oil (WTI)	67.92	-0.65
10 Year Government Bond Yield		2.96%
30 Year fixed rate mortgage		4.56%

Stocks are lower as we begin the FOMC meeting. Bonds and MBS are flat.

Construction spending fell 1.7% MOM but is still up 3.6% YOY. Bad weather in the Northeast and Midwest probably drove the decrease. Residential construction was down 3.5% MOM and up 5.3% YOY.

Manufacturing downshifted in April, but is still reasonably strong according to the IS M Manufacturing Report. Steel tariffs were mentioned several times as an issue. A few comments from the piece:

“[The] 232 and 301 tariffs are very concerning. Business planning is at a standstill until they are resolved. Significant amount of manpower [on planning and the like] being expended on these issues.” (Miscellaneous Manufacturing)

“Business is off the charts. This is causing many collateral issues: a tightening supply chain market and longer lead times. Subcontractors are trading capacity up, leading to a bidding war for the marginal capacity. Labor remains tight and getting tighter.” (Transportation Equipment)

The US economic expansion is now the second-longest on record. Low inflation and low interest rates have made that possible. Despite the increase in interest rates, Fed policy is still highly expansionary, so as long as inflation behaves this could go on for a while longer.

House prices rose 1.4% MOM and 7% YOY, according to CoreLogic. About half of the MSAs are now overvalued according to their model.

Acting CFPB Director Mick Mulvaney is looking for ways to save money. Sharing desks and moving to the basement are possibilities. As an aside, this article belongs on the opinion page.

The private label MBS market used to be a $1 trillion market – last year it was only about $70 billion. What is going on? Regulation may appear to be the culprit, but it really isn’t. There are still all sorts of unresolved issues between MBS investors and securitizers. The biggest surround servicing – how do investors get comfort that the loan will be serviced conflict-free, especially if the issuer has a second lien on the property. How do investors get comfort that the issuer won’t solicit their borrower for a refinance? A lack of prepay history is also a problem – it makes these bonds hard to model and price. Many investors also remember the crisis years, when liquidity vanished and investors were unable to sell, sometimes at any price.

Issuers were content for a lot of years to simply feast on easy refi business – rate and term streamlines which were uncomplicated and simple to crank out. Warehouse banks were reticent to fund anything that didn’t fit in the agency / government box, so why not concentrate on the low-hanging fruit? Investors were able to pick and choose from all sorts of distressed seasoned non-agency paper trading in the 60s and 70s. Most of that paper ended up being money good. But in that environment, why would anyone be interested in buying new issues over par? If you are a mortgage REIT, why not buy and lever new agency debt with interest rates at nothing and a central bank that is actively supporting the market?

Now that the easy refi business is gone, will we see a return of this market? Perhaps, but there probably still is a big gulf between what borrowers and investors are willing to accept and the governance issues remain unsolved.