Mick Mulvaney – The Daily Tearsheet

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: Awaiting the Fed

Vital Statistics:

	Last	Change
S&P futures	2652	0.25
Eurostoxx index	387.17	2.14
Oil (WTI)	67.45	0.19
10 Year Government Bond Yield		2.99%
30 Year fixed rate mortgage		4.55%

Stocks are flat as we await the FOMC decision. Bonds and MBS are down small.

Mortgage Applications fell 2.5% last week as purchases fell 2% and refis fell 4%.

The economy added 204,000 jobs last month according to the ADP Employment Report. This was higher than expectations and is above the Street estimate for Friday’s jobs report. Medium sized firms (50-500 employees) added the most jobs, and Professional and Business Services sector had the most growth. Construction added a lot of jobs as well.

ADP by sector

The FOMC announcement is scheduled for 2:00 pm EST today. No changes in rates are expected, but investors will be looking to see if the Fed changes its language about inflation running below target. The latest PCE index came in at 2%, which is the Fed’s target. The second-order question will be to see whether the Fed changes their 2% rate from a symmetric target to a ceiling. The most likely outcome will be a “steady as she goes” statement and any changes will be communicated at the June meeting with a fresh set of economic forecasts. Today’s announcement should be a nonevent.

The Fed Funds futures are predicting a 6% chance of a hike at the May meeting and a 94% chance of a 25 basis point hike at the June meeting.

The labor shortage is so acute in the Rust Belt that some towns are paying people to move there. Most of these small towns have a major demographic problem – younger workers moved to the cities in response to the Great Recession, leaving only the older workers who are now retiring. The fear is that labor shortages will prompt employers to leave, which will create a downward spiral.

Consumer advocates worry that Mick Mulvaney is not going to blow up the CFPB, but will neuter it with a thousand cuts. That said, the rhetoric from the left is a bit overblown. Mick Mulvaney said: “When I took over, we had roughly 26 lawsuits ongoing,” he told the House Appropriations Committee on April 18. “I dismissed one, because the other 25 I thought were pretty good lawsuits.”

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.

Morning Report: Stocks sell off as 10 year breaches 3% level

Vital Statistics:

	Last	Change
S&P futures	2626.5	-9
Eurostoxx index	379.58	-3.53
Oil (WTI)	67.53	-0.22
10 Year Government Bond Yield		3.02%
30 Year fixed rate mortgage		4.59%

Stocks are lower this morning after yesterday’s interest rate-driven sell-off. Bonds and MBS are down.

The 10 year breached the 3% mark yesterday, which served as a catalyst for a substantial stock market sell-off. Of course 3% is just a round number, but it is the highest rate since 2014. Some pros are looking for a global slowdown in the economy, which could make some corporate borrowers vulnerable. We certainly appear to be in the late stages of a credit cycle. Junk-rated bond issuance has been on a tear over the past few years, reaching $3 trillion as yield-starved investors have had to reach into the lower credits to make their return bogeys. That said, corporate bond spreads are still at historical lows, (investment grade spreads are still half of what they were as recently as early 2016. Let’s also not forget that much of the bond issuance over the past 8 years went to refinance old debt at higher interest rates – in other words it was a net positive for these companies.

We are now going to see just how much of the huge rally in financial assets over the last decade was due to the inordinate amount of stimulus coming out of the Fed. As stocks now have to compete with Treasuries, some changes in asset allocations are to be expected and the riskier assets are going to bear the brunt of the selling. Keep things in perspective, however. Interest rate cycles are measured in generations.

One of the benefits of QE has been to goose asset prices (which was kind of the whole point). Increasing people’s net worth would increase spending and therefore increase GDP. It probably worked, however that hasn’t been costless. One of the problems with increasing real estate prices is that it shuts people out from places where there is opportunity (California in particular). If you already own property in CA and have been experiencing torrid home price appreciation, you can move since your increased home equity can be used to purchase another expensive property. But if you live in the Midwest were home price appreciation has been less, you might not be able to take that job in San Francisco since you can’t afford to live there. That said, negative equity was probably a bigger problem and home price appreciation did mitigate that issue.

Mortgage Applications fell 0.2% last week as purchases were flat and refis were down 0.3%. Conforming rates increased 6 basis points, while government rates increased 1. ARMs decreased to 6% of total applications. A flattening yield curve makes ARMs less and less attractive relative to 30 year fixed mortgages.

Acting CFPB Director Mick Mulvaney has made some changes at the Bureau. First, he is ending the pursuit of auto lenders, which Dodd-Frank prohibited. The Cordray CFPB did an end-around by going after the big banks behind some of the auto financing, and that will end. Second, Mulvaney will no longer make public the complaint database against financial services companies, saying that “I don’t see anything in here that I have to run a Yelp for financial services sponsored by the federal government.” Finally, he plans to change the name from the CFPB to the BCFP. All of this is in keeping with Mulvaney’s commitment to follow the law and go no further.