Morning Report: A look ahead to the regulatory environment for the financial industry

Vital Statistics:

 

Last Change
S&P futures 2996 7.25
Oil (WTI) 53.47 -0.44
10 year government bond yield 1.78%
30 year fixed rate mortgage 3.97%

 

Stocks are higher this morning on expectations of an orderly Brexit and optimism on trade. Bonds and MBS are down.

 

Not a lot of market-moving data this week, although we will get a lot of housing indicators, with existing home sales, new home sales, and house prices. Note the FOMC meets next week, and it is looking like a lock that they will cut rates. The Fed funds futures are now handicapping a 91% chance of a cut.

 

The Index of Leading Economic Indicators declined in September, as trade concerns and manufacturing offset strength in other areas. “The US LEI declined in September because of weaknesses in the manufacturing sector and the interest rate spread which were only partially offset by rising stock prices and a positive contribution from the Leading Credit Index,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The LEI reflects uncertainty in the outlook and falling business expectations, brought on by the downturn in the industrial sector and trade disputes. Looking ahead, the LEI is consistent with an economy that is still growing, albeit more slowly, through the end of the year and into 2020.”

 

It looks like the structure of the CFPB is going to be decided by the Supreme Court. The issue with the CFPB goes back to its structure, which makes it nearly impossible to remove a director. The idea was to make the CFPB less influenced by politics, however it also makes it completely immune to oversight and accountability. The case will move forward without the support of the government, as CFPB Director Kathy Kraninger doesn’t support the structure of the agency either. If the CFPB’s structure is declared unconstitutional, it wouldn’t mean the end of the agency, it would mean that the single, unfireable director would be replaced by a bipartisan board, which was actually the initial proposal when the CFPB was created during the drafting of Dodd-Frank.

 

Elizabeth Warren threatened to ban fracking if she wins the presidency. “On my first day as president, I will sign an executive order that puts a total moratorium on all new fossil fuel leases for drilling offshore and on public lands. And I will ban fracking—everywhere.” Needless to say, this would be incredibly disruptive to the US economy as natural gas prices would increase to $9.00 to $15 per mBTU, compared to current prices of around $2.00 – $2.50. Since natural gas is the main way we generate electricity, consumers and industry would feel it immediately, and this would cause uncertainty on steroids, and make Trump’s trade concerns look like a minor annoyance. She would be able to implement many changes via executive order, and she intends to use it. Given that Joe Biden is having trouble fundraising, it is looking more like a lock that she gets the nomination. Even some left-leaning pundits are worried.

 

What would that mean for the mortgage banking business? Regulations will undoubtedly be tightened, but they probably will affect the bigger banks more than the independent operators. She says she wants to re-implement Glass-Steagall, which is really a solution in search of a problem. However, if she succeeds in raising taxes and energy prices as much as she intends, it would almost certainly be the final nail in the longest running expansion ever, and that means the Fed Funds rate is probably heading back to zero. A return to ZIRP almost certainly means the 10 year will breach the 1.47% low set in 2012, which will would create another refi wave similar to the years immediately after the financial crisis. So, perversely a Warren presidency could be great for the mortgage banking business, as the industry feasts on easy refinances.

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Morning Report: Housing starts disappoint again

Vital Statistics:

 

Last Change
S&P futures 2999 -1.25
Oil (WTI) 54.47 0.44
10 year government bond yield 1.75%
30 year fixed rate mortgage 3.97%

 

Stocks are lower this morning on weak overseas growth. Bonds and MBS are flat.

 

Housing starts disappointed again, falling 9.4% from an upwardly revised August number to 1.26 million units. This is up slightly on a YOY basis. Building Permits came in at 1.387 million units, higher than expected but still down 2.4% on a MOM basis. Compared to last year, they are up 9.4%.

 

Despite the disappointing starts, builder confidence hit an 20 month high. “The second half of 2019 has seen steady gains in single-family construction, and this is mirrored by the gradual uptick in builder sentiment over the past few months,” said NAHB Chief Economist Robert Dietz. “However, builders continue to remain cautious due to ongoing supply side constraints and concerns about a slowing economy.”

 

Industrial production fell 0.4% in September, and manufacturing production was down 0.5%. August’s numbers were revised higher. Capacity Utilization fell to 77.5%. Tariffs are attributed to the slowdown, but overseas growth in general is weakening. Note China had the lowest GDP growth since the early 1990s. The global slowdown has increased the odds of another rate cut in two weeks, which is up to 87% compared to 28% a month ago.

 

fed funds futures

Morning Report: Bank earnings looking strong

Vital Statistics:

 

Last Change
S&P futures 2991 -6.25
Oil (WTI) 52.97 0.14
10 year government bond yield 1.74%
30 year fixed rate mortgage 3.97%

 

Stocks are lower this morning as bank earnings come in. Bonds and MBS are down.

 

Retail Sales disappointed, falling 0.3%, which was lower than expected. Ex autos and gas, they were flat, although August numbers were revised upward across the board. The control group was flat, and sales rose 4.1% YOY.

 

Mortgage Applications rose 0.5% last week as purchases fell 4% and refis rose 4%. “The ongoing interest rate volatility is impacting a borrowers’ ability to lock in the lowest rate possible. Despite a slight rise in mortgage rates last week, refinance applications increased 4 percent and were 199 percent higher than a year ago,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Purchase applications slowed for the second week in a row. While near term economic uncertainty is still a factor, other fundamental issues, such as a lack of housing inventory in many markets, is preventing purchase activity from meaningfully rising. However, purchase applications were still much higher than a year ago. This is a reminder that the purchase environment in 2019 continues to be stronger than in 2018.”

 

Bank earnings are generally looking good, and mortgage backed securities trading desks are doing well as rates have fallen and volumes have picked up. The other side of the coin is that the drop in rates have negatively affected the values of mortgage servicing rights. Wells is a good example: despite a $127 million increase in origination revenue, total mortgage banking revenue fell by $292 million as their servicing book took a $419 million mark-to-market loss.

Morning Report: Mortgage rates and the 10 year.

Vital Statistics:

 

Last Change
S&P futures 2915 -6.25
Oil (WTI) 53.07 0.54
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.84%

 

Stocks are down this morning on no real news. Bonds and MBS are down as well.

 

Consumer inflation was flat in September, and is up 1.7% YOY. The core rate, which excludes some volatile commodities, rose 0.1% MOM and 2.4% YOY. Inflation continues to sit right in the range it has been historically.

 

Job openings fell from a downward-revised 7.17 million to 7.05 million, while initial jobless claims ticked up to 214k.

 

Mortgage Applications rose 5.2% last week as purchases fell 1% and refis rose 10%. The rate on a 30 year fixed conforming loan fell 9 basis points to 3.9%. Weaker-than-expected economic data drove the decrease.

 

Good news for the financial community: Trump is planning to sign a couple of executive orders, which will bring more sunlight on rulemaking, and will permit more public input in the federal guidance. Much of this guidance had been “rulemaking in secret” and this will give companies more of a head’s up when the regulatory agencies plan major changes in guidance. The CFPB sprung a nasty surprise on auto lenders during the Obama Administration, where they determined that any lenders who provide auto loans through dealerships are responsible for “discriminatory pricing.” It is this sort of the thing the order intends to limit.

 

“CNBC is saying the 10 year bond yield is way lower, but I just ran a scenario and my borrower still has to pay a point and a half. What is going on?” This is a common observation these days, and it can be frustrating for both loan officers and borrowers. As the Wall Street Journal notes, that the difference between the typical mortgage rate and the 10 year bond is at a 7 year high. What is going on? First, and most important, mortgage rates are not determined by the 10 year. They are determined by mortgage backed securities, which have entirely different financial characteristics than a government bond. When rates are volatile (i.e. changing a lot in a short time period) mortgage backed security pricing will be negatively affected. In practical terms, it means that when the 10 year bond yield abruptly moves lower, it will take a few days for mortgage rates to catch up, while the time it takes to adjust to big upward moves in Treasury rates is often shorter. It also explains why it can be hard to get par pricing when you have a lot of loan level hits from Fannie (i.e. investment property, cash out refinancing, etc). The “rate stack” gets compressed and MBS investors are wary of buying high coupon securities. Bond geeks have a term for this – negative convexity – but in practical terms it means that moves in the 10 year don’t directly carry over to mortgage rates.

 

primary market spreads

Morning Report: Reassuring jobs report.

Vital Statistics:

 

Last Change
S&P futures 2915 4.25
Oil (WTI) 52.60 0.14
10 year government bond yield 1.53%
30 year fixed rate mortgage 3.84%

 

Stocks are higher after the jobs report. Bonds and MBS are down.

 

The economy added 136,000 jobs in September, versus Street expectations of 145,000. August’s number was revised upward by 38,000 to 168,000. The unemployment rate fell to 3.5%, which is the lowest in 50 years. The labor force participation rate was flat at 63.2% and the employment-population ratio ticked up to 61%. Average hourly earnings were flat on a MOM basis and up 2.9% YOY.

 

Overall, it confirmed that we are seeing a bit of a deceleration in the economy, although we are nowhere near a recession. The Fed Funds futures are handicapping a 75% chance of a 25 bp rate cut at the October meeting at the end of the month.

 

If the unemployment rate is at a 50 year low, we can pretty much dismiss the recession talk as the press generating alarmism to capture eyeballs, right? Not necessarily. We have had recessions in the past with unemployment rates this low. Take a look at the chart below. It plots the unemployment rate and the Fed funds rate. The vertical shaded areas are recessions. You can see that we hit 3.5% unemployment in 1969 and entered a recession soon thereafter. You can see the cause of that recession however in the Fed Funds rate, which went from 4% to 9% in the two years leading up to it. Similarly, we had a recession in 1973 – 75 even though unemployment was in the mid 4% range immediately prior. That one was caused by the Arab Oil Embargo. That said, you can see that most recessions are preceded by a tightening cycle out of the Fed, and that explains why the Fed is now cutting rates – they worry they might have overshot.

 

unemployment vs fed funds

 

As home prices increase, many homeowners are considering renovation loans (like 203k or HomeStyle) to increase the value of their house. What are the best renovations, in terms of return on investment? Hint: not a swimming pool. It is a new roof. What about kitchen renovations? Homeowners can expect to recoup about 50% – 60% of the cost in increased home value. Same with bathroom upgrades and master bedrooms. It turns out that mundane upgrades (wood flooring, insulation, roofing) provide more bang for the buck than the more dramatic ones.

 

 

Morning Report: Personal Incomes rise more than expected

Vital Statistics:

 

Last Change
S&P futures 2989 8.25
Oil (WTI) 55.35 -1.24
10 year government bond yield 1.70%
30 year fixed rate mortgage 3.95%

 

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

 

Personal incomes rose 0.4% in August, while personal consumption rose 0.1%. Income surprised to the upside, while spending disappointed. Inflation remains within the Fed’s target, with the core PCE index rising 0.1% MOM and 1.8% YOY. The headline PCE, which includes food and energy, was flat MOM and up 1.4% YOY. Wages and salaries were up 0.6% MOM and up 4.8% YOY. Given that inflation is running below 2%, we are seeing real wage growth.

 

Durable goods orders rose as well, increasing 0.2%, while the Street was looking for a decrease of 1%. Ex-transportation they were up 0.5%, again above expectations. Business capital expenditures disappointed, however falling 0.2%.

 

Pending home sales rose 1.6% in August, according to NAR. “It is very encouraging that buyers are responding to exceptionally low interest rates,” said Lawrence Yun, NAR chief economist. “The notable sales slump in the West region over recent years appears to be over. Rising demand will reaccelerate home price appreciation in the absence of more supply.” The Western region was up 8% YOY as falling mortgage rates are improving affordability.

 

Millennials are continuing to leave the big cities, as they head to the suburbs to raise families (and also get priced out). New York City lost almost 38,000 young adults last year, which was twice the decline it had seen in the previous few years. When the Millennials were younger, urban walkable environments were all the rage and many in the industry thought this time was different. It wasn’t. The Millennial generation is getting married later and having kids later, but it seems like they are going for the same thing every generation prior to them wanted: space, good schools, etc. This is good news for the builders at the lower price points. Take a look at PulteGroup’s chart below.

 

pulte

 

The IPO market is still broken. Peloton was the most recent IPO to break price on the open. “Break Price” means to trade below the IPO price. It opened around $27 versus an IPO price of $29. This won’t help We Work’s IPO which is looking like an absolute dumpster fire as the price keeps getting cut. Historically, IPOs would trade at substantial premiums to their offering price, but those days are over. This represents the change in who pays the bills for investment banks, from the buy side to issuers.

Morning Report: The impeachment process begins

Vital Statistics:

 

Last Change
S&P futures 2968 -2.25
Oil (WTI) 56.35 -0.64
10 year government bond yield 1.65%
30 year fixed rate mortgage 3.91%

 

Stocks are flattish this morning despite overseas weakness and Trump Impeachment news. Bonds and MBS are flat.

 

The news that Nancy Pelosi was opening an impeachment inquiry over the Trump / Ukraine situation was a non-event market-wise. Stocks and bonds didn’t budge. Supposedly Trump will release the transcript of the call today, and will make the whistleblower available to Congress. We will see where this goes, but market-wise it will take a while to play out. Check out the chart of the S&P 500 during 1998 when the whole Bill Clinton impeachment situation was played out:

 

clinton

 

Here is a chart of the bond market during the same time period (10 year yield). Looks like we saw a drop in the 10 year of about 160 basis points peak to trough during the whole process. Note that this is a classic example of the old market saw “buy the rumor, sell the fact.” The market priced in impeachment before the votes even took place. If you got short on the votes, you got your head handed to you. If you bought the Treasury flight to safety in late summer of 98, when the whole thing was coming to a head, you were too late, and were on the wrong side of the trade by that point.

 

clinton bond

 

There was some slight movement in the Fed Funds futures for December, with the current odds at 22% no cut, 52%, a 25 basis point cut, and 26% chance of 50 basis points. Note that the repo market issues has been taken by the Fed that they don’t have as much leeway to shrink the balance sheet as they had anticipated.

 

Mortgage applications fell by 10% last week as purchases fell 3% and refis fell 15%. Rates were more or less flat at 4.01% last week, so the refi number is a surprise. That said, mortgage rates had risen about 20 basis points over the past few weeks, so maybe this was a catch-up phenomenon. Despite the back up in rates, the MBA estimates that 2019 will be the best year since 2016, with originations expected to hit $1.9 trillion.

 

Consumer confidence fell in September on trade fears and darkening expectations. The present conditions index fell but it was mainly future expectations that drove the decline.