Morning Report: Sea change in market expectations

Vital Statistics:

 

Last Change
S&P futures 2815.75 -7.25
Eurostoxx index 375.78 -1.45
Oil (WTI) 59.49 -0.45
10 year government bond yield 2.38%
30 year fixed rate mortgage 4.08%

 

Stocks are lower on no real news. Bonds and MBS are up again.

 

Independent mortgage banks reported a loss of $200 per loan on average in the fourth quarter of 2018, according to the MBA. This is a drop from the $480 per loan they earned in the third quarter. This works out to be about an 11 basis point production loss per loan. In the fourth quarter of 2017, independent mortgage banks earned 20 basis points. This 11 basis point loss is the lowest since the MBA began keeping tabs on this about 10 years ago. Declining secondary marketing income was met with increasing production costs. The first quarter this year probably looks just as bad, and servicing portfolios are going to be taking a mark-to-market hit as interest rates have unexpectedly fallen. Many banks use their MSR portfolio as a natural hedge for their core business, but there will be a lag so Q1 looks to be similar to Q4.

 

That said, we did see a spike in applications last week, as they rose 8.9%. Purchases rose 6% and refis rose 12% as rates fell.

 

Donald Trump’s nominee to the Federal Reserve Board Steve Moore has called for the Fed to cut rates 50 basis points immediately. He came under criticism (and apologized) for calling for Jerome Powell’s resignation after the Fed hiked rates again in December. FWIW, left econ is pretty bent out of shape over his nomination (the Washington Post penned 2 editorials against him yesterday), mainly for his support of tax cuts, deregulation, and free markets. In an interview with the New York Times, he said “I was really angry” about the December increase, Mr. Moore said. “I was furious — and Trump was furious, too. I just thought that the December rate increase was inexplicable. Commodity prices were already falling dramatically.” Remember Trump criticized the cuts (and was beaten about the head and shoulders in the business press over it). That said, back in December, the markets thought the Fed would raise rates twice this year. They are now predicting at least 1 cut this year. Take a look at what the Fed Funds futures are saying below. Just one month ago, the market was assigning a 81% chance that the Fed would do nothing this year. Now, there is roughly a 75% chance of at least one rate cut. The swing in sentiment is pretty dramatic.

 

fed funds futures dec 19

 

Note that the yield curve has inverted, although that is mainly due to the high 3 month rate. 2s – 10s is still positive.

 

While we have seen a marked deceleration in home price appreciation according to Case-Shiller, the FHFA House Price index still shows decent growth. It increased 5.6% annually in January.  Since the FHFA index only looks at homes with conforming mortgage, it ignores the jumbo space, and that is where we are really seeing the weakness in home prices. Regionally, the West and Mountain states have really slowed down, and the lagging markets in the Mid Atlantic area (especially the NYC area) are finally showing signs of life. You can see the dispersion between 2017 (blue) and 2018 (red) has really decreased as the correlation tightens.

 

FHFA regional

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Morning Report: Job openings, and the Fed.

Vital Statistics:

 

Last Change
S&P futures 2833.5 3
Eurostoxx index 381.78 0.68
Oil (WTI) 48.46 -0.14
10 year government bond yield 2.60%
30 year fixed rate mortgage 4.27%

 

Stocks are higher this morning on overseas strength. Bonds and MBS are up.

 

The big event this week will be the FOMC meeting on Tuesday and Wednesday. No changes are expected in interest rates, and the Street will be focused primarily on the dot plot and whether it is catching up with what the Fed Funds futures are saying. The December 2018 dot plot predicted that the end of 2019 Fed Funds rate would be in the 2.75% – 3% range, in other words two more rate hikes in 2019. A Reuters poll of economists forecasts 1 more hike this year. On the other hand, the markets are predicting a Fed Funds rate in the 2.25% – 2.5% range – in other words no change. To be fair, there has been a major change in market sentiment since December, but one of the two (the experts or the markets) has clearly got it wrong. In December, only 2 out of the 17 forecasts expected the Fed to not hike this year, and nobody was looking for a rate cut. The futures on the other hand are handicapping a 75% chance of no hike and about a 25% chance of a rate cut. This is a massive expectations gap.

 

Other than the FOMC meeting, there isn’t much in the way of important economic data. We will get leading economic indicators on Thursday, and existing home sales on Friday.

 

There were 7.58 million job openings at the end of January, which is close to the record set back in November. The 2018 data series was also revised upward, with about 353,000 additional job openings on average. The quits rate was 2.3%, which is where it has been for most of 2013 after that series was revised. The quits rate describes the number of people who are leaving their current job to get another, so it tends to lead increases in wage growth.

 

job openings

 

The housing industry is driven at least partially by new home construction, and there is a noted labor shortage in that sector. The problem is most acute in skilled trades, like electricians and plumbers, but unskilled supply is still an issue. The job opening rate for construction was 3.9% last month, as opposed to 3.3% a year ago. The quits rate edged up for the sector as well, rising to 2.5%.

 

 

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.

Morning Report: Surprising payroll number

Vital Statistics:

 

Last Change
S&P futures 2729.75 -20
Eurostoxx index 370.51 -3.3
Oil (WTI) 55.07 -1.53
10 year government bond yield 2.63%
30 year fixed rate mortgage 4.35%

 

Stocks are lower this morning after Chinese stocks fell 4.4% overnight. Bonds and MBS are up.

 

Jobs report data dump:

  • Payrolls up 20,000 (huge miss – Street was looking for 180k)
  • Unemployment rate 3.8%
  • Labor force participation rate 63.2%
  • Employment-Population Ratio 60.7%
  • Average hourly earnings up 3.4%

Surprisingly poor payroll number, and a bit of a suprise given the ADP number and all of the other numbers, which indicate strength. I suspect this will get revised upward next month. The average hourly earnings number is the highest in a decade, and probably is a better indicator of the health of the labor market than the payroll number. Still, the first indication of a labor slowdown will be a drop in hiring, so it bears watching.

 

Housing starts rose 1.23 million in January, which was a touch higher than the Street estimate. Building Permits rose 1.35 million, slightly above the 1.29 million estimate. January housing numbers are typically the nadir of the seasonal slowdown, so it is hard to read too much into them.

 

Labor productivity rose 1.9% in the fourth quarter as output increased 3.1% and hours worked increased 1.2%. Productivity is what allows non-inflationary growth and is the biggest input into higher standards of living. Unit Labor costs rose 2%.

 

Initial Jobless Claims fell to 223,000.

 

House Democrats have introduced legislation to prevent any sort of reform of the CFPB. Their big objection is the fact that Mick Mulvaney ended regulation by enforcement action, which was the practice of promulgating intentionally vague rules and then fining companies for violating them without saying what the rules exactly are. Since the government has unlimited resources and most companies don’t, they choose just to pay whatever the agency asks. Mulvaney also required the agency’s lawyers to conduct cost-benefit analyses for proposed regulations, which they also dislike. The bill has zero Republican sponsors, will go nowhere in the Senate, and is really nothing more than a messaging exercise.

 

Rising home prices means rising home equity. In the fourth quarter, homeowners saw their equity increase by 8.1%, or $678 billion, according to CoreLogic. The number of homes with negative equity rose to 2.2 million units, however the amount of the negative equity also fell. Louisiana, Connecticut, and Illinois have the highest percentage of homes with negative equity, while Washington, Oregon, and Utah have the smallest.

 

negative equity

Morning Report: New home sales surprise on the upside

Vital Statistics:

 

Last Change
S&P futures 2786.75 -4
Eurostoxx index 376.51 0.03
Oil (WTI) 56.07 0.4
10 year government bond yield 2.70%
30 year fixed rate mortgage 4.43%

 

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

 

The economy added 183,000 jobs in February, according to the ADP Employment Survey. The Street is looking for about 180,000 additions in Friday’s employment situation report, so the ADP numbers seem to be in line.

 

Mortgage applications decreased 2.5% last week as purchases fell by 2.6% and refis fell 2%. The typical mortgage rate rose by 2 basis point to 4.67%.

 

The ISM non-manufacturing index expanded in February, which means that the services sector is picking up momentum.  The biggest issues seem to be potential trade issues, labor shortages and trucking costs.

 

New Home Sales rose by 621,000 in December. This is up 3.7% from the downward-revised November number, but down 1.5% from a year ago. For the full year, 622,000 homes were sold, which is slightly higher than the 613,000 sold in 2017. The median price was $318,000, while the average price was $377,000. The median sales price has been declining over the past year after peaking in November 2017 at $343,400. This demonstrates the shift from luxury to entry-level home construction to meet demand. This is a reversal of the early years of the crisis, when the luxury end of the market was the only part that was working.

 

Note that new home sales are about where they were during the 60s – 80s. Pretty amazing when you take into account that the US population has increased by close to 60% since 1970.

 

new home sales

 

Here is a copy of the letter that NAR, MBA, and a host of other housing advocates sent to Joseph Otting, Acting Director of the FHFA regarding GSE reform. It urges FHFA to go slow, work to maintain the 30 year fixed rate mortgage, and allow the GSE’s to act as a counter-cyclical buffer.

 

The Fed is catching up to the markets. Boston Fed President Eric Rosengren said it could be “several meetings” before the Fed gets enough clarity on the economy to make a move in interest rates. In many ways, he is acknowledging what the Fed Funds futures have been saying for a while now – that the Fed is going to wait and see how the 2018 hikes affect the economy before making any further moves. Since monetary policy generally acts with a 9 – 15 month lag, it means that the economy still hasn’t factored in the Sep and Dec hikes from last year.

Morning Report: Atlanta Fed predicts Q1 GDP will come in at 0.3%

Vital Statistics:

 

Last Change
S&P futures 2793.25 3.2
Eurostoxx index 374.38 -0.84
Oil (WTI) 56.73 0.14
10 year government bond yield 2.74%
30 year fixed rate mortgage 4.43%

 

Stocks are up on trade hopes. Bonds and MBS are flat.

 

Construction spending fell 0.6% in December, but was up 1.2% on a year-over-year basis. While the government shutdown may have had an effect on public construction spending, private construction spending was down the same amount. Housing continues to punch under its weight class, falling 1.4% MOM and 1.5% YOY. Public housing construction was even worse, falling 5% MOM and 20% YOY.

 

Now that more people are shopping for real estate online at sites like Zillow, Redfin and Realtor.com, the photos you use to show your property take on greater importance. Certainly it pays to have someone who knows what they are doing to photograph your home to put it in the best light, as opposed to simply posting photos from your phone. Now, with photo editing software getting cheaper and cheaper, more people are using edited photos to show their place. Some of this is innocuous: like photoshopping out your personal stuff in the kitchen and some of it is not: adding a pool or removing a wall. Given that 20% of homes are bought sight unseen, this is no longer a trivial, theoretical issue. It takes on even more importance given the move towards computer-generated appraisals.

 

Mortgage rates tend to vary across states. For example, the cheapest state to borrow in is California, where the average rate is 4.74%. The most expensive is NY, where the average rate is 4.96%. The US average is 4.84%. You would think that judicial versus non-judicial foreclosure laws would explain the difference (you can live in your foreclosed house for years in NY), but maybe there is more going on here. Guess what the second-lowest rate state is: New Jersey, which has a pretty similar foreclosure legal structure.

 

Yesterday I mentioned that strategists and the Atlanta Fed are extremely bearish on Q1 GDP growth, figuring that it will come in under 1%. A couple of points: First, Q1 GDP has been weak for the past several years. It might be a measurement issue or something spurious, but that is one reason economists might be cheating down the number a tad. Second, if Q1 GDP comes in around 1%, you can probably forget about any rate hikes this year. For what its worth, the Fed Funds futures are predicting a 94% chance of no hikes this year and a 6% chance of 1 hike.

 

HUD Secretary Ben Carson plans to leave the Administration at the end of Trump’s term, where he will return to the private sector.

Morning Report: Shareholder activism and the banks

Vital Statistics:

 

Last Change
S&P futures 2767 -7
Eurostoxx index 368.05 -1.73
Oil (WTI) 56.06 0.47
10 year government bond yield 2.66%
30 year fixed rate mortgage 4.43%

 

Stocks are lower as investors return from a 3 day weekend. Bonds and MBS are flat.

 

We don’t have much in the way of economic data this week – the highlight will be existing home sales on Thursday and the FOMC minutes on Wednesday. Other than that, it should be a quiet week.

 

Industrial Production in January fell by 0.6%, while manufacturing production fell by 0.9%. Capacity Utilization fell to 78.2%, down from 78.8% the prior month. Volatile vehicle production largely accounted for the decrease. Note that December’s numbers were strong, which means the average for the two months was a modest gain.

 

Due to the government shutdown, Q4 GDP numbers have been delayed until Feb 28. Right now, the consensus seems to be for a high 1% / low 2% print – a definite slowdown from Q3, which would put 2018 annual growth around 2.8%. These forecasts are from Merrill, Goldman, and the NY / Atlanta Fed. Holiday retail sales disappointed, and some of the industrial data showed a slowdown as 2018 ended.

 

Mortgage delinquencies dropped to an 18 year low, according to the MBA. Fourth quarter DQs fell to 4.06%, which is down from 5.17% a year ago. The foreclosure rate ticked up to .25%. “The overall national mortgage delinquency rate in the fourth quarter was at its lowest level since the first quarter of 2000,” said Marina Walsh, MBA’s Vice President of Industry Analysis. “What’s even more noteworthy, the delinquency rate dropped from the previous quarter and on a year-over-year basis across all loan types and stages of delinquency. With the unemployment rate near a 50-year low, wage growth trending higher and household debt levels relative to disposable incomes at a 35-year low, homeowners are in great shape, and mortgage performance is quite strong.”

 

HomeStreet Bank is greatly reducing its footprint in the mortgage business, and has retained Keefe, Bruyette to sell its retail mortgage operations. MountainView will auction off the MSR portfolio. HomeStreet will not exit mortgages entirely, but it will move to more of a traditional mortgage business built around its bank branches. Interestingly, the divestiture comes after pressure from an activist investor. Banks have historically been pretty immune from shareholder pressure – hostile takeovers in the banking sector are rare events. it will be interesting to see if this starts a trend of shareholder activism in the sector. One of the best trades ever was holding onto the pieces of AT&T when it was broken up by the government in the 1980s. With so many banking giants, I wonder what would happen if, say, Bank of America decided to spin off Merrill Lynch and its mortgage business. Could the 3 parts be worth more than the sum? As the banking sector deals with its first secular bond bear market in 40 years, it may turn out that the strategies that worked in the bull market (consolidation) won’t work in a rising interest rate environment. Note that the Elizabeth Warrens of the world would likely push in this direction as well, which makes it conceivable we could see a return of venerable names like Salomon Brothers or Smith Barney, Chemical Bank, or Manufacturers Hanover.