Morning Report: median earnings rising slower than average earnings

Vital Statistics:

Last Change
S&P futures 2808 -2.5
Eurostoxx index 386.74 1.76
Oil (WTI) 67.62 -0.46
10 Year Government Bond Yield 2.85%
30 Year fixed rate mortgage 4.51%

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

Mortgage Applications fell 2.5% last week as purchases fell 5% and refis rose 2%. The refi share rose to 36.5%.

Housing starts hit their lowest level since September last year, falling to 1.17 million annualized. This is a huge drop from the strong May print of 1.33 million. The Midwest and the South explain the declines, which was both in single family and multi. June weather was generally good, so that isn’t the explanation. Building Permits fell as well, although not as dramatically. They came in at 1.27 million. The Midwest accounted for most of the decline in permits. Housing starts tend to be volatile, but the moving average is turning down, which is worrisome.

Despite the drop in starts, builder confidence remains strong, at least according to the NAHB. The index was flat at 68, which is an elevated number. Pricing remains strong, but the supply is not there. Rising material costs are becoming an issue as lumber tariffs raise costs. So far builders are able to pass these costs on, but there is a limit, especially if wage inflation remains below house price inflation. The median house price to median income ratio is getting back to extreme levels, and interest rates are not going to come to the rescue this time around.

Jerome Powell begins his second day of testimony on Capitol Hill. There was nothing market-moving yesterday, so expect more of the same. Yesterday, his message was that the US economy has clear sailing ahead with strong growth and moderate inflation. With regard to the potential trade war, Powell downplayed the risks to the economy and said there will be a benefit if it turns out that Trump’s actions lower tariffs overall in the global economy. The US generally has much lower tariffs than its trading partners, and Trump has already made the offer to eliminate all US tariffs if our trading partners eliminate theirs. Separately, Powell said that it would ultimately be better for the US if the GSEs were off the government balance sheet. That is pretty much a universal opinion in DC these days, as the US taxpayer bears the credit risk of the majority of the mortgage market.

Median weekly earnings have not kept pace with the CPI lately, which means workers are losing ground, at least according to the latest survey out of the BLS. It shows that the median weekly wage rose 2% in the second quarter versus an increase in the CPI of 2.7%. Interestingly, the average hourly earnings increase during Q2 was 2.64% in April, 2.74% in May and 2.74% in June. It seems strange that the difference between average wage inflation and median wage inflation would be so stark, which would imply that wages are mainly rising at the high end, not the lower end. Note the other BLS measure of wage inflation, the employment cost index, shows comp growth of 2.9%, which takes into account benefits. For the most part, average hourly earnings have been rising faster than the core PCE index:

AHE vs PCE

New York, Connecticut, New Jersey, and Maryland sued the government yesterday over the state and local tax deduction cap. The lawsuit if probably more for show than anything and doesn’t seem to have much chance of success. Some of the states are looking at workarounds, allowing people to “donate” to charitable funds which go to funding state and local services. Charitable deductions are still deductible. At the end of the day, the biggest issue to states like NY and NJ are the property taxes. NY and NJ have some of the highest property taxes in the country, where people routinely pay $20 – $30k or more. That explains at least partially why you can’t find buyers for luxury properties in the Northeast.

The ECB concludes that QE may have helped the rich, but it helped the poor more. While QE did boost asset prices (housing, bonds, stocks etc) it also boosted growth, which more than offset the increase in asset prices.  “Low short rates do hurt savers via a direct effect, that is a reduction in income on their assets . . . however [low rates] also benefit savers, like all other households, via an indirect effect — that is, the reduction in their unemployment rate and the increase in the labour income,” the paper, called “Monetary policy and household inequality”, said. “The indirect effect dominates . . . The paper also finds that [QE] reduced inequality, mainly through a reduction of the unemployment rate of poorer households.”

Note that this contradicts the observation between median and average earnings. If QE was actually decreasing inequality, you should see median earnings growth close to average earning growth or even slightly higher. Not way below.

Morning Report: Building permits in the Northeast struggle

Vital Statistics:

Last Change
S&P futures 2794 -2.5
Eurostoxx index 383.01 -1.04
Oil (WTI) 68.12 0.06
10 Year Government Bond Yield 2.85%
30 Year fixed rate mortgage 4.51%

Stocks are lower after Netflix (one of the FAANG leaders of the market) missed earnings. Bonds and MBS are flat.

Industrial Production rebounded in June by 0.6% and manufacturing production increased 0.8%. Capacity utilization is 78%.

Jerome Powell heads to Capitol Hill today to begin his semiannual testimony in front of Congress. Expect a lot of questions regarding wage growth, trade wars, and regulation. Overall, he is expected to say that the economy is in good shape overall with above-trend growth and a strong labor market. He will face some questions from Democrats on regulation, especially since the Fed approved Goldman and Morgan Stanley’s capital plans despite the fact they were technically failed their stress tests. The Fed Funds futures continue to move in a hawkish direction, with the Sep futures pricing in a 88% chance of a hike and the Dec futures pricing in a 63% chance of 2 hikes.

Despite trade tensions, the IMF still expects the global economy to grow 3.9% this year and next. Trade remains a threat, however the impact is relatively small: a decrease of 0.5% in global growth by 2020. They forecast the US economy will grow 2.9% this year. Note many strategists took up their Q2 numbers on the strong retail sales print yesterday.

The Fifth Court of Appeals ruled yesterday that the structure of the FHFA is unconstitutional. Not sure how that is going to play out. Separately it also ruled that the FHFA was within its authority to sweep the profit from the GSEs, which is bad news for shareholders. FNMA stock was hit to the tune of 6% after the ruling.

The difference in sentiment between Northeastern real estate markets and the West is night and day. Growth in single family permits was actually negative for the first 5 months of this year. Compare that to the West, where they are up almost 18%.

building permits by geography

The Northeast still has yet to really recover from the Great Recession, although some of that has more to do with secular trends in banking and the securities industry than it does with the real estate bubble. The securities industry has been hit by secular trends (falling commissions, ETFs) that have been great for investors but not great for employment in the industry. 5 cent commissions and 2%/20% hedge fund fees supported a lot of jobs which supported a lot of $1MM + homes. Towns like New Canaan have banned For Sale signs and the only part of the real estate market that is moving is in the sub-$750k segment. Million dollar plus listings languish. It is amazing – we have a housing shortage in the US overall, but you would never know that if you looked at the NYC suburbs.

Morning Report: Bank earnings pour in

Vital Statistics:

Last Change
S&P futures 2797 -1
Eurostoxx index 385.18 0.81
Oil (WTI) 70.6 0.27
10 Year Government Bond Yield 2.84%
30 Year fixed rate mortgage 4.53%

Markets are flat as bank earnings come in. Bonds and MBS are up small. Slow news day.

The US government held a reasonably strong auction yesterday, where primary dealers took down their smallest positions ever. Meanwhile, speculative shorts in Treasuries (one of the biggest trades on the Street) are struggling as rates stay stubbornly low. Some continue to warn that the flattening yield curve is really telling us that a recession is around the corner.

The prepared remarks for Jerome Powell’s semiannual report to Congress should be out today. Probably won’t be market-moving, but you never know.

Import prices fell 0.4% in June as petroleum and food prices fell. For the year, they are up 4.3% however.

Consumer sentiment fell according to the University of Michigan / Reuters survey. The current conditions index drove the fall, which is usually a function of gas prices. Trade fears also weighed on sentiment.

Wells Fargo reported earnings this morning. Earnings were down due to a tax charge. Stripping out the tax charge, they were flat. They had a tough quarter for mortgages like everyone else. Origination for the quarter was $50 billion, which is up seasonally from Q1, but down 11% YOY. The current pipeline of $24 billion is down 26% YOY. Margins were 77 basis points, which is down 17 from the prior quarter and down 47 bps from a year ago. The stock is down 3% pre-open.

JP Morgan had a similar story to Wells. They originated $23.7 billion in mortgages during Q2, which was higher seasonally and down about 10% from a year ago. Mortgage banking revenue (which includes servicing) was down 6% YOY. Margin compression again was the story, especially in correspondent lending. They marked up the MSR book. JPM is flat pre-open.

A bunch of other banks reported this morning and the whole sector is getting hit, with the XLF down about a percent and a half.

Federal Reserve Chairman Jerome Powell made positive comments about the economy, although he is concerned about trade and the effects of a long trade war with China. He is concerned about rising trade tensions, although he notes that Trump’s goal is to get others to lower their tariffs. If he succeeds in that, then the trade tension would be a good thing, not a bad thing. It is important to remember that China’s biggest weapon against the US is not imposing tariffs on US goods – it is ignoring US intellectual property laws. Those sorts of things will not really show up in the balance of trade numbers, but will have huge effects on IP firms, particularly media and software.

Morning Report: Jerome Powell agrees with market on interest rates

Vital Statistic:

Last Change
S&P futures 2667 -3
Eurostoxx index 388.93 -0.56
Oil (WTI) 70.09 -0.62
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.55%

Stocks are lower as we await the Trump Administration’s decision on the Iran deal. Bonds and MBS are down small.

The Administration is set to announce later today whether they intend to stay in the Iranian deal or abandon it. Oil has been rallying on expectations Trump will leave.

Jerome Powell said that market expectations (i.e. the Fed Funds futures) are more or less in alignment with the Fed’s expectations for the future path of interest rates. The December Fed funds futures are predicting about a 10% chance of one more hike this year, a 44% chance of 2 more and a 39% chance of 3 more. Over the past month, the central tendency has become more hawkish.

fed funds probability 2

Small Business Optimism remains strong, according to the NFIB. More businesses are planning on increasing capital expenditures, while hiring remains strong and we are seeing evidence of increased compensation. Profitability increased as well, which indicates that productivity is increasing, and that some of this CAPEX is going towards labor-saving technology. Finding qualified workers continues to be the biggest issue surrounding small business. “There is no question that small business is booming,” said NFIB Chief Economist Bill Dunkelberg. “Consumer spending, the new tax law, and lower regulatory barriers are all supporting the surge in optimism across all small business industry sectors.”

Despite the hurricane-related spike in delinquences, overall DQ rates have been falling, according to CoreLogic. Home price appreciation, in addition to more stringent underwriting standards are the driving force behind it. The foreclosure rate is down from 0.8% to 0.5%, and the 30 day DQ rate is down to 4.8% from 5.0%. As you would expect, TX and FL are experiencing rising DQ rates, but the rest of the nation is down.

Tesla stock has more or less recovered from its conference call induces swoon from last week. The bonds are at the lows however, trading at 88. Note there is a divergence also in NFLX, which has bonds in the low 90s, while the stock is a highflyer.

NYS AG Eric Schneiderman resigned from office after reports came out that he abused 4 women. Schneiderman was an AG cut in the same cloth as Eliot Spitzer, and hated the financial industry about as much as he did (FWIW the feeling was mutual). When Spitzer announced his resignation, cheers went up on the floor of the NYSE.

Freddie Mac is getting into the business of providing lines of credit against MSR portfolios. Nonbank servicers face liquidity issues when loans they are servicing go delinquent. They are required to make the mortgage payment to the ultimate investor of the mortgage until the loan is brought current or foreclosed. Banks generally have no problems with this, but nonbank issuers generally don’t have the balance sheet to withstand heavy advances activity. Fannie Mae only requires 6 months of advances, but Ginnie Mae has no similar relief. Policymakers are concerned about the ability of nonbank servicers to withstand a period of prolonged stress if delinquencies spike.

Homebuyer sentiment hit an all-time high according to the Fannie Mae Home Purchase Sentiment Index. “The latest HPSI reading edged up to a new survey high, showing that consumer attitudes remain resilient going into the spring/summer home buying season,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “High home prices and good economic conditions helped push the share of Americans who think it’s a good time to sell to a fresh record high. However, the upward trend in the good-time-to-sell share seen since last spring has done little to release more for-sale inventory. The tightest supply in decades, combined with rising mortgage rates from historically low levels, will likely remain a hurdle for mobility and a persistent headwind for home sales.”