Morning Report: GSE reform

Vital Statistics:

 

Last Change
S&P futures 2981 9.25
Oil (WTI) 55.12 -1.14
10 year government bond yield 1.57
30 year fixed rate mortgage 3.74%

 

Stocks are higher this morning after the jobs report. Bonds and MBS are flat.

 

Jobs report data dump:

  • Nonfarm payrolls up 130,000, lower than expectations, and the ADP report
  • Unemployment rate 3.7%, unchanged
  • Labor force participation rate 63.2%, unchanged
  • Employment-population ratio 60.9%
  • Average hourly earnings up 0.4% MOM / 3.2% YOY, above expectations

Overall, a disappointing report given the big ADP number, but the ADP generally predicts the final numbers, which means this data probably gets revised upwards. The employment-population ratio continued to edge up, which is good, although we still are nowhere near pre-crisis levels. This indicates that wage growth will remain in a Goldilocks range: enough to beat inflation, but not too hot to worry the Fed.

 

employment population ratio

 

The Trump Administration released its GSE reform plan. The plan states that ” the existing Government support of the secondary market should be explicitly defined, tailored, and paid-for, and the GSEs’ conservatorships should come to an end, subject to the preconditions set forth in this plan.” The government’s guarantee should “stand behind significant first-loss private capital and would be triggered only in exigent circumstances.” “Single-family guarantors should be required to maintain a nationwide cash window through which small lenders can sell loans for cash, and also should be prohibited from offering volume-based pricing discounts or other incentives to their lender clients.” The government support for the GSEs under the preferred stock purchase agreement would be replaced with an explicit, paid for guarantee backed by the US government for paying principal and interest on MBS. The plan would end (or at least modify) the “net worth sweep” which would allow the GSEs to rebuild capital. The GSEs would still have a role to promote affordable housing. FNMA stock is looking down about 6% on the open.

 

Michael Burry, of The Big Short fame, sees a bubble in indexing and passive investment ETFs. Passive investments now account for half of the stock market as more investors pile into these low-fee investment vehicles. “Trillions of dollars in assets globally are indexed to these stocks,” Burry said. “The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.” Certainly the leveraged ETFs – the triple long and triple short types – will become hopelessly illiquid in a market distortion. Burry runs a hedge fund, so he is talking his book a little but like all investment crazes, the more money that goes into the asset class, the more marginal each incremental trade becomes. Eventually, you might see a return to active stock management as they begin to outperform, especially small caps.

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Morning Report: Strong ADP jobs report

Vital Statistics:

 

Last Change
S&P futures 2963 25.25
Oil (WTI) 56.12 0.14
10 year government bond yield 1.53%
30 year fixed rate mortgage 3.7%

 

Stocks are up this morning after China and the US supposedly have scheduled an October meeting. Bonds and MBS are down on the risk-on trade.

 

We have quite a bit of strong data this morning, starting with the ADP jobs report, which came in at 195,000. This was much higher than the 149k the Street was looking for, and the 158k expected for tomorrow’s jobs report. This was the highest number in 4 months. Manufacturing added 8,000 jobs, so we aren’t seeing any sort of trade-driven pull-back in that sector. Construction added 6,000 jobs. Where are jobs shrinking? tech and mining.

 

ADP report

 

Challenger and Gray released their layoffs report, which backed up the ADP report of job cuts in tech. The layoff report is based on press releases, not actual job cuts. US employers announced 53,480 job cuts last month, of which 10,000 were due to trade war issues. That said, most of the job cuts were in retail. “Employers are beginning to feel the effects of the trade war and imposed tariffs by the U.S. and China. In fact, trade difficulties were cited as the reason for over 10,000 job cuts in August,” said Andrew Challenger, Vice President of Challenger, Gray & Christmas, Inc. “We are continuing to see investor concerns shaking confidence in the market, and employers appear to be cutting workers in response to a slowdown in demand for their products and services,” he added.

 

In other economic data, productivity in the second quarter was unchanged at 2.3% and unit labor costs were revised upward to 2.6%. The Street was expecting a downward revision in productivity. Hourly compensation was revised upward to a 4.9% increase. Initial jobless claims came in at 216k.

 

We had a slew of Fed-speak yesterday, with a wide range of opinions, from John Williams of the NY Fed avoiding the dovish bent versus St. Louis President James Bullard advocating for 50 basis points. FWIW, the market is virtually unanimous in its forecast of a 25 basis point cut at the September 17-18 meeting.

 

Despite falling rates and rising home prices, bidding wars for properties hit an 8 year low in August, according to Redfin. “Despite remaining near three-year lows, mortgage rates have failed to bring enough buyers to the market to rev up competition for homes this summer,” said Redfin chief economist Daryl Fairweather. “Recession fears have been enough to spook some would-be buyers from making the big financial commitment of a home purchase. But assuming a recession doesn’t arrive this fall or winter, consumers will likely adjust to the new ‘normal’ of continued volatility in the stock and global markets, and the people who need and want to make a move will take advantage of low mortgage rates. As a result, I still expect homebuying competition to pick back up in the new year.”

Morning Report: Hong Kong extradition bill withdrawn

Vital Statistics:

 

Last Change
S&P futures 2932 23.5
Oil (WTI) 55.12 1.74
10 year government bond yield 1.49%
30 year fixed rate mortgage 3.78%

 

Stocks are higher after the Hong Kong government backed down on its extradition bill that drew massive protests in the Chinese-controlled city. Bonds and MBS are flat.

 

Mortgage applications fell 3.1% last week as purchases increased 4% and refis fell 7%. This was despite the lowest rates since late 2016. MBA Associate Vice President of Economic and Industry Forecasting Joel Kan said “Despite lower borrowing costs, refinances were down from its recent peak two weeks ago, but still remained over 150 percent higher than last August, when rates were almost a percentage point higher.”

 

The trade deficit decreased in July, however the deficit with China increased. Exports rose slightly, while imports were down.

 

The Fed’s balance sheet could be set to increase in size by the end of the year. The NY Fed is forecasting the balance sheet could swell to $4.7 trillion by the end of 2025. They had been edging towards normalcy, however they halted the run off in July when they cut rates by 25 basis points. Note the ECB is probably going to start QE as well, adding fuel to the global sovereign debt bubble.

 

Ray Dalio of Bridgewater lays out his theory about the political and economic landscape and compares it to the Great Depression era.

 

The most important forces that now exist are:

1) The End of the Long-Term Debt Cycle (When Central Banks Are No Longer Effective)

+

2) The Large Wealth Gap and Political Polarity

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3) A Rising Work Power Challenging an Existing World Power

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The Bond Blow-Off, Rising Gold Prices, and the Late 1930s Analogue

In other words now 1) central banks have limited ability to stimulate, 2) there is large wealth and political polarity and 3) there is a conflict between China as a rising power and the U.S. as an existing world power. If/when there is an economic downturn, that will produce serious problems in ways that are analogous to the ways that the confluence of those three influences produced serious problems in the late 1930s.

 

It is an interesting read, and certainly standard gold-bug fodder. I suspect going from an edge-of-deflation environment to hyperinflation is going to take a long time, as in decades. But it is interesting to play through scenarios in this unprecedented government bond bubble.

Morning Report: High frequency traders and mortgage rates

Vital Statistics:

 

Last Change
S&P futures 2907 -16.5
Oil (WTI) 53.33 -1.74
10 year government bond yield 1.50%
30 year fixed rate mortgage 3.78%

 

Stocks are lower this morning on trade issues. Bonds and MBS are flat.

 

The holiday-shortened week ahead looks to be relatively quiet, with the exception of a spate of Fed-speak on Wednesday and the jobs report on Friday. The September Fed Funds futures are pricing in a 100% chance of another 25 basis point cut, and the Fed seems to be in market-following mode, so the data should take a backseat.

 

Manufacturing activity slipped in August, according to the ISM Manufacturing Survey, which came in at 49.1, well below expectations. This was the first contraction in the manufacturing sector since mid-2016. The level for the ISM typically corresponds with 1.8% GDP growth.

 

Separately, construction spending rose 0.1%, which was lower as well, however the previous month’s drop was revised upward from -1.3% to -.7%.

 

Home prices rose .5% MOM / 3.6% YOY in July, according to CoreLogic. Home price appreciation slowed in 2018 as rates rose. That effect will reverse over the next year, and Corelogic expects annual home price appreciation rates to settle in around 5%. Tight supply, especially amongst starter homes will support prices, as well as a robust labor market and a move out of urban areas to the suburbs. About 37% of the US housing stock in the top 100 MSAs is overvalued. This metric is based on wage growth and housing supply.

 

Hurricane Dorian is expected to miss direct landfall, however it is slow-moving and dumping a lot of rain. Coastal areas will be at risk of flooding as the storm parallels the Eastern Seaboard this week.

 

The WSJ has an interesting article this morning about thinning liquidity in the markets. Late summer is often characterized by thinning liquidity, which means fewer active investors are trading, which causes exaggerated market movements when a big buyer or seller wants to execute an order. They mention what has been going on in the Treasury market:

Some analysts point to high-frequency traders. They have dominated the government-bond market, making up a big chunk of trading activity compared with slower counterparts, according to JPMorgan analysts. These traders withdrew last month, the firm said, suggesting that they amplified turbulence. Investors said liquidity worries are even more pronounced in riskier corporate bonds.

“As you go further down the credit spectrum, it starts to get a bit more volatile,” said Gautam Khanna, a fixed-income portfolio manager at Insight Investment. “Liquidity is definitely thinner in this market than it has been.”

This might help explain why mortgage rates have lagged the move in Treasuries. In essence, high frequency traders help establish a liquid market, where it is easier for large investors such as banks, sovereign wealth funds, pension funds, etc to trade large positions. When these high frequency traders withdraw, bid / ask spreads widen, and volatility increases. Here is the issue: MBS investors hate volatility because it makes their portfolios hard to hedge, and adds uncertainty about prepayment speeds. This causes them to be more conservative with respect to the prices they are willing to pay for mortgage backed securities, which flows through to mortgage rates falling less than the move in Treasuries would predict. Below is a chart of 10 year Treasury futures volatility. You can see the spike in the index beginning in August, which corresponds with the dramatic drop in rates, and the exit of high frequency traders from the market.

 

treasury futures volatility

 

 

Morning Report: Personal incomes rise

Vital Statistics:

 

Last Change
S&P futures 2943 16.5
Oil (WTI) 56.33 -0.34
10 year government bond yield 1.51%
30 year fixed rate mortgage 3.77%

 

Stocks are up ahead of the 3 day weekend. Bonds and MBS are flat.

 

No word yet from SIFMA regarding an early close, so assume the bond market is open all day.

 

Personal incomes rose 0.1% in July, which was a deceleration from the previous few months. June was revised upward from 0.4% to 0.5%. Disposable personal income rose 0.3%, and spending rose 0.6%, which came in above expectations. The core PCE index (the Fed’s preferred measure of inflation) rose 0.2% MOM and 1.6% YOY, which is below their 2% target. The headline PCE rose 0.2% / 1.4%.

 

Consumer sentiment fell in August according to the University of Michigan Consumer Sentiment Survey.

 

Pending Home Sales fell 2.5% in July, according to NAR. “Super-low mortgage rates have not yet consistently pulled buyers back into the market,” said Lawrence Yun, NAR chief economist. “Economic uncertainty is no doubt holding back some potential demand, but what is desperately needed is more supply of moderately priced homes.” Regionally, they declined 1.6% in the Northeast and fell 3.4% on the Left Coast.

 

As bond yields have fallen, mortgage rates have not kept up as investors have been sweating prepayment speeds in the MBS market. The biggest issues have been rate volatility, which negatively impacts mortgage backed security pricing, along with fears we are entering a new refinance cycle. Also, many mortgage bankers set their staffing levels for the year back in late 2018, when it looked like we were in a tightening cycle and volumes would be much lower. “Do not expect much, if any of a drop in mortgage rates in the coming weeks,” said Mitch Ohlbaum, president, Macoy Capital Partners in Los Angeles. “It’s not because they shouldn’t, it’s because the lenders are already beyond capacity with refinances and frankly do not want any more volume.” There is probably some truth to that, but that is fixable. The volatility in the Treasury market and convexity risk is killing MBS investors. The classic example of a MBS investor is Annaly, a mortgage REIT, which has gotten clocked this year and cut its dividend.

 

NLY chart

 

PIMCO is advising the Fed to “aggressively cut rates” given the recent economic data suggests a slowdown. Their point is that recent data is “understating” the extent of the slowdown. They raise the point that labor market momentum has decelerated more than forecasters were predicting. Of course, at 3.7% unemployment, we are pretty much at or close to full employment. Wages are generally a lagging indicator, but this morning’s personal income disappointment was partially driven by a decrease in asset income, which probably just reflects falling interest rates.

Morning Report: Q2 GDP comes in at 2%

Vital Statistics:

 

Last Change
S&P futures 2916 26.5
Oil (WTI) 56.17 0.34
10 year government bond yield 1.48%
30 year fixed rate mortgage 3.78%

 

Stocks are up this morning after China said it wouldn’t immediately retaliate on tariffs set to take effect this weekend. Bonds and MBS are down.

 

The second revision to Q2 GDP was unchanged at 2.0%. Consumption drove the increase in GDP as durable goods consumption was up 13% and non-durables were up 7%. Core PCE inflation was unchanged at 1.7%. Despite the chronic housing shortage, residential investment was down again for the sixth straight quarter. Investment and trade made negative contributions to the index.

 

GDP

 

Initial Jobless Claims came in at 215,000 right in line with expectations.

 

The MBA reported that net gains per loan increased to $1,675, compared to $285 in the first quarter. This was the best number since the third quarter of 2016. “With anticipated increases in prepayment activity, we saw hits to servicing profitability resulting from mortgage servicing right markdowns and amortization,” Walsh said. “Nonetheless, the profitability on the production side of the business generally outweighed servicing losses.” Average pretax production profit rose to 64 basis points, while secondary marketing income fell to 287 basis points, down from 308 in the first quarter.

 

Treasury is looking at the idea of ultra-long term government bonds, with 50 or 100 year terms. “If the conditions are right, then I would anticipate we’ll take advantage of long-term borrowing and execute on that,” Mnuchin said in the Bloomberg News interview on Wednesday.

Morning Report: Global yields head lower

Vital Statistics:

 

Last Change
S&P futures 2862 -3.5
Oil (WTI) 56.05 1.14
10 year government bond yield 1.45%
30 year fixed rate mortgage 3.82%

 

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

 

Global bond yields continue to head lower, and a larger percentage of the world’s sovereign yields are negative. Note that Germany has passed negative 70 basis points on the Bund, and France is not too far behind at negative 44 basis points. Japan is at negative 27 basis points. Even some of the ne’er-do-wells of Europe – Italy and Spain – have lower yields than we do. It is important to keep this chart in mind when you hear the business press push the “inverting yield curve means a recession is imminent” narrative. They inevitably ignore the fact that US bonds don’t trade in a vacuum and investors will sell negative yielding bonds to buy something positive.

 

global bond yields

 

Mortgage applications fell 6.2% last week as purchases fell 4% and refis fell 8%. Rates increased about 4 basis points for a 30 year conforming loan. Mortgage rates continue to lag the moves in the overall bond market. “U.S. Treasury yields were volatile over the course of the week, as the ongoing trade dispute between the U.S. and China continued to generate uncertainty among investors,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Rates increased for the first time since the week of July 12, but were still 80 basis points lower than the beginning of the year. With rates edging higher, refinances and purchase applications fell, at 8 percent and 6 percent, respectively.”

 

Consumer confidence remains elevated and close to record highs, according to the Conference Board. We are at levels last seen during the stock market bubble days of the late 90s, and the late 60s when we landed on the moon. Given the retail sales data, this could be one of the best holiday shopping periods in a long time.

 

consumer confidence