Morning Report: The Fed’s balance sheet will probably never return to pre-crisis levels.

Vital Statistics:

 

Last Change
S&P futures 2896 -2.5
Eurostoxx index 388.12 0.58
Oil (WTI) 64.46 0.06
10 year government bond yield 2.52%
30 year fixed rate mortgage 4.16%

 

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

 

Factory Orders fell 0.5% in February, while January was revised downward to no change. Core Capital Goods Orders (which is a proxy for business capital expenditures) fell 0.1% after unusually strong readings in January and December.

 

Small Business Optimism increased in March, according to the NFIB Small Business Optimism Survey. Hiring indicators improved (companies added .5 workers on average), the earnings outlook brightened, and capital expenditures were steady. The only negative was an inventory build.

 

House flipping is back to pre-crisis levels. Profit margins are much higher however, which should provide a bit of a cushion if home price appreciation tails off. The type of property is generally older – a fix and flip – which is dominated by professionals, not neophytes. Those were the type who would purchase rights to buy a new construction condo and then hope to sell the right at a profit.

 

Margin compression and lower volumes has meant job losses in the nonbank mortgage sector. Nonbank lenders employed 320,000 people in February, which is a drop of about 20,000 jobs from August.

 

30+ day delinquencies fell to 4% in January, which is a drop from 4.9% in January of 2018. The foreclosures rate fell to 0.4% from 0.6%. Delinquency rates fell across the entire spectrum of buckets, and are at the lowest levels in 20 years. Interestingly, DQ rates for student loans and auto loans are up.

 

Good explainer on quantitative easing and why the Fed doesn’t want to return to pre-crisis levels for its balance sheet. Changes in the way banks manage their reserves, along with rising global demand for dollars has made a larger Fed balance sheet a necessity. The mechanics of rate setting involve setting the interest they pay on bank reserves, and in order to do that, they need a large level of reserves in the banking system. These reserves are the Fed’s liabilitites, and if the liabilities need to increase, the assets will have to move up in lockstep. Hence the need to maintain a bigger balance sheet.

 

Note that the equity value of the Fed’s balance sheet is largely unchanged, which means the Fed is vulnerable to a fast uptick in interest rates. This is because rising interest rates will negatively affect the value of its bond portfolio (bond values fall as rates rise). The Fed has about $3.9 billion in assets, supported by $39 billion in equity. In other words, a 1% drop in their asset portfolio would wipe out their equity. While that is a distinct possibility for their long-term bond holdings, it is highly unlikely for their short term bond holdings. That said, the Fed does operate with a 100:1 leverage ratio and historically that level has been deadly for institutions that don’t own a printing press.

 

Federal Reserve Assets

 

 

 

 

Morning Report: Disappointing ADP print

Vital Statistics:

 

Last Change
S&P futures 2883 13.25
Eurostoxx index 384.71 1.04
Oil (WTI) 62.04 0.65
10 year government bond yield 2.51%
30 year fixed rate mortgage 4.17%

 

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

 

ADP reported that the private sector created 129,000 jobs in March. Education and health reported the biggest increase, while the financial sector and the construction sector cut jobs. The Street is looking for 170,000 new jobs in Friday’s employment situation report. The Street will look at the payroll number, but the more important one is the average hourly earnings number. The Street is forecasting a 0.3% MOM and 3.4% YOY gain.

 

Construction spending rose 1% in January, and is up 1% on an annual basis. Residential construction rose 1% on a MOM basis, but is down 3.6% YOY. Construction spending was probably affected at least somewhat by the partial government shutdown at the end of last year / beginning of this year.

 

The manufacturing sector continues to do well, with the ISM Manufacturing Index hitting 55.3 in March. New Orders, Production, and Employment were the drivers of the increase. I found this comment interesting: “Business remains very strong amid rumors of a slowdown, but forecasts do not indicate this. Electronics are at tight capacity from manufacturers, with no [change] in the near future.” (Transportation Equipment) The transportation sector touches most parts of the economy, so it has always been the equivalent of the canary in a coal mine. But overall, this report isn’t showing any signs of economic weakness.

 

Durable Goods orders however did show some weakness. Durable Goods orders fell 1.6% in February, however they were up slightly when you strip out the volatile transportation sector. Core Capital Goods (a proxy for business capital expenditures) fell slightly. January’s numbers were revised upward, so the report isn’t as bad as it initially appears.

 

Ron Wyden wants your unrealized capital gains to be taxed every year. This is more or less an Overton Window widening exercise and has a less than zero percent chance of gaining mainstream Democratic support, let alone Republican support. He would also increase the capital gains tax to 37%. It would be like the government assessing you every year on the increase Zillow reports for your home and sending you a bill for 37% of it. The final plan will probably exempt your primary residence, but still – it would force you to sell investments you may not want to sell in order to pay the tax.

 

Further, in the political space, Elizabeth Warren is taking a victory lap after Wells Fargo CEO Tim Sloan’s retirement. She is pushing for laws to make it easier for the government to prosecute corporate executives who don’t have firsthand knowledge of crimes their subordinates are doing.

 

That was quick: After a big open on Friday, Lyft is now trading below its IPO price. The big gains seem to be reaped pre-IPO anymore, when the company is revalued at each funding round. By the time it hits the IPO phase, it is priced for perfection. Remember, Blue Apron, which went public at $10 a share during the summer of 2017? It is now a drill bit.

 

 

Morning Report: Friday’s jobs report in perspective

Vital Statistics:

 

Last Change
S&P futures 2756 0.4
Eurostoxx index 371.87 1.24
Oil (WTI) 56.47 0.4
10 year government bond yield 2.65%
30 year fixed rate mortgage 4.32%

 

Stocks are flattish on no real news. Bonds and MBS are flat.

 

The upcoming week has a lot of economic data, however most of it is not housing related, and probably won’t be market-moving either. The biggest housing-related number will be new home sales and construction spending. We will also get inflation data and industrial production.

 

Friday’s payroll number was a definite downward surprise, and the question is whether this indicates a slowing labor market? Extremely low job prints happen occasionally we had sub-20k months in Sep 2017 and May 2016. Both prints ended up being a blip, and there is a good chance this gets revised upward in next month’s number. The number to take away from the jobs report is the increase in average hourly earnings. Average hourly earnings are a notoriously non-volatile series, and this one keeps inexorably increasing by larger and larger amounts.

 

average hourly earnings

 

Just because the US economy is doing relatively well, that doesn’t mean things are rosy overseas. China has had some bad days in the stock market, and the cracks are starting to appear in the economy. In Europe, the German Bund yield (The European benchmark) is about to go negative. Growth estimates have been slashed from 1.7% to 1.1%. So there is a bit of a global slowdown, and it means that we will probably take some shrapnel in the form of lower rates.

 

CFPB Chair Kathy Kraninger appeared before the House Financial Services Committee last week, and the commentary broke down along partisan lines. Democrats, pining for the Cordray days, had a laundry list of complaints, ranging from a de-emphasis on payday lenders to kvetching about changes in internal reporting lines. Republicans generally supported her and the agency’s end of regulation by enforcement. Kraninger reaffirmed the Agency’s commitment to chasing bad financial actors.