Morning Report: Two new Fed nominees, weak payroll growth

Vital Statistics:

 

Last Change
S&P futures 2986.25 6.4
Oil (WTI) 56.75 0.9
10 year government bond yield 1.96%
30 year fixed rate mortgage 4.06%

 

Stocks are higher this morning as we are approaching detente in the US-China trade spat. Bonds and MBS are higher.

 

Bonds are rallying globally, with the German Bund yield hitting a record low of -39 basis points. Ex-IMF Chair Christine Lagarde is in the running to replace Mario Draghi as the head of the ECB. She is considered to be more of a politician, so the markets are interpreting her nomination to be bond-bullish. US rates will be influenced by overseas bond markets, so that means lower rates here at least at the margin.

 

Christopher Waller and Judy Shelton are the latest Trump picks to join the Federal Reserve Board. Judy Shelton has been vocal in criticizing the Fed’s practice of paying interest on excess reserves, and has questioned the effectiveness of the current regime of floating exchange rates versus the gold standard and the gold exchange standards of yesteryear. While there is a 0% chance we go back to some sort of hard-asset backed currency, between the serial bubbles of the past 40 years and the hyper-inflation of the 1970s, the economic record of post-Bretton Woods era (basically from when Nixon closed the gold window) has been mixed.

 

Construction spending fell 0.8% MOM and 2.3% YOY in May. Residential construction continues to be an issue, falling 0.6% MOM and 11.2% YOY.

 

Manufacturing expanded in June, according to the ISM Manufacturing report. That said, it decelerated compared to May. Tariffs remain the largest concern. New Orders were flat, while employment and production increased.

 

Mortgage Applications were more or less flat last week, as purchases increased 1% and refis fell 1%. Mortgage rates were unchanged-to-slightly lower, depending on the product. We have left the tightening-driven doldrums of 2016-2018 and approaching more normal levels. Here is the MBA Mortgage Index going back 20 years to give some perspective:

 

MBA application index

 

Private payrolls increased by 102,000, according to the ADP Employment Report. This is the second weak-ish reading in a row. Jobs were created in education and health as well as professional and business, while the construction sector lost jobs. Note the Street is looking for 160,000 new payrolls in Friday’s jobs report. Separately, initial jobless claims fell to 221k last week. You can see the drop-off in hiring in the ADP chart below:

 

ADP report

 

 

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Morning Report: The Fed prepares the markets for a rate cut

Vital Statistics:

 

Last Change
S&P futures 2957.5 24.1
Oil (WTI) 55.54 1.78
10 year government bond yield 2.01%
30 year fixed rate mortgage 4.10%

 

Stocks are higher this morning as interest rates fall globally. Bonds and MBS are up.

 

The Fed maintained interest rates at current levels, but signaled the willingness to cut rates if necessary:

“The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”

The dot plot showed a 30 basis point decline in the fed funds expectations. You can see the plots side by side below. The central tendency for 2019 fell by 32 basis points to 2.17%

 

Jun Mar dot plot

 

FWIW, the Fed upped their forecast for GDP, and cut their forecast for unemployment and inflation. Why that would be consistent with a potential rate cut is beyond me, but such is life in our era of Calvinball monetary policy. The decision was nearly unanimous, with only Bullard dissenting, preferring to see a 25 basis point cut. The Fed funds futures are pricing in 100% chance of a rate cut at the July meeting.

 

Bonds rallied on the announcement, although mortgage backed securities were slow to follow. We did see some reprices for the better late in the day, but nothing too dramatic. Expect mortgage rates to lag the move in bonds, as usual.

 

Initial Jobless Claims fell from 220,000 to 216,000 last week.

 

Home prices rose 3.6% YOY, the strongest acceleration in 7 months, according to Redfin. Interestingly, the only areas that dropped were the markets that rallied the most over the past few years: San Jose, New York, Los Angeles, where inventory is up smartly. Where was the fastest growth? Knoxville TN at 15%, Milwaukee WI at 15% and Camden NJ at 11%.

 

Judy Shelton is the latest potential nominee to the Fed. She is an advocate for much lower interest rates. She also favors ending the Fed’s policy of paying interest on excess reserves, which encourages banks to park money at the Fed versus lending it out.

 

Fannie and Fred are trying to do more to increase lending for manufactured homes.

Morning Report: Why mortgage rates don’t exactly mirror Treasury rates

Vital Statistics:

 

Last Change
S&P futures 2788 7
Oil (WTI) 59.1 0.1
10 year government bond yield 2.26%
30 year fixed rate mortgage 4.24%

 

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

 

First quarter GDP was revised downward from 3.2% to 3.1%. Increased exports offset a downward revision in residential fixed investment (homebuilding). The inflation number was also revised downward and is well below the Fed’s 2% target. The Fed funds futures are now forecasting a more than 80% chance of a rate cut this year.

 

Initial Jobless Claims ticked up to 215k from 212k the prior week.

 

In market environments like yesterday, I always seem to get the following question: “Brent, the 10 year is down from 2.4% to 2.25% over the past two weeks. I just ran a scenario and only saw a small improvement in pricing. How come?” The short answer to that question is that mortgage rates are tied to the prices of mortgage backed securities which are influenced, but not determined by the 10 year. (This is why my opening statement always talks about bonds and MBS – they are different animals and will behave differently to changing market conditions)

 

To make things even more complicated, mortgage backed securities will behave differently depending on the coupon. Take a look below at what a typical MBS screen looks like. This lists the TBAs (stands for to-be-announced) mortgage backed securities that correspond to Fannie Mae loans. If you do a Fannie Mae loan, it is probably going to go into one of these securities. You can see that there is a different security for each month of delivery and note rate. On the far left hand side you can see the coupon groupings. It starts at 3%, then goes to 3.5%, then to 4% and so on. The delivery months are also listed: June, July, and August. Note that the price falls as you go out in the future. This is why a 45 day lock costs more money than a 15 day lock.

 

During the day, mortgage backed securities will trade and prices will be updated pretty frequently. So, if the 10 year bond rate falls by, say 5 basis points, you could see the implied yield of the Fannie 4% of August drop by 5 basis point, 2 basis points, whatever. It will be a function of the supply and demand for that mortgage backed security. Since these prices are the inputs to the rate sheets you see every day, this is the security that really matters, not the 10 year.

 

MBS

 

If you take a look at the 4% coupon, you’ll see them trading at just under 103. An investor who buys a mortgage backed security is paying 103 for a bond that will pay 100 at some time in the future. Why would a rational investor do that? The answer lies in the interest. The 4% interest payment is higher than the corresponding rate you would get on the benchmark Treasury, which is 2.375%. That difference is the compensation for paying more than par. The investor is betting that they will get that extra interest for a long enough period to cover the extra 3 points they paid. If the mortgages pay off earlier than expected, then the investor is out of luck. This is why early refinancings are a no-no and why Ginnie Mae is taking action to prevent early refinancings of VA loans.

 

So, when interest rates fall, like we have seen over the past couple of days, the rates on mortgages don’t fall in lockstep. MBS investors will re-evaluate their prepayment models and figure out the right price to pay given the fact that the period they will get that extra interest has changed. Before, they might have expected to get it for, say 7 years. Now they expect to get it for 6 years. When they crunch the numbers, they come up with a right price to pay for that 4% mortgage backed security. And the price for that mortgage backed security will then be used for everyone’s rate sheets. To make things even more complicated, the change in price for a 3% security will differ from a 4% security. The name for this whole phenomenon is called convexity, and it gets into some gnarly bond math. But the punch line about convexity is that mortgage backed securities have a lot of it, which causes them to behave differently than the 10 year. So, when you see on CNBC that the 10 year bond yield fell 10 basis points, you can’t expect to see a corresponding 10 basis point improvement in mortgage rates. It just doesn’t work that way.

Morning Report: 35% of the top 100 metros are overvalued

Vital Statistics:

 

Last Change
S&P futures 2821 26
Oil (WTI) 61.65 0.61
10 year government bond yield 2.42%
30 year fixed rate mortgage 4.17%

 

Stocks are higher this morning as overseas stocks rebound. Bonds and MBS are down.

 

Small Business Optimism increased in April, according to the NFIB. Pretty much every component of the index increased, with only capital expenditure plans unchanged from March. “The ‘real’ economy is doing very well versus what we see in financial market volatility. Many jobs were created, and GDP produced with no substantive inflation pressure. The pace of economic growth has accelerated, and consumers and small businesses are an important part of the improvement in sales,” said NFIB’s Chief Economist Bill Dunkelberg.

 

What will global warming do to Florida real estate values? According to one environmentalist, lending for 30 year for Florida property is insane. “No one should be lending for 30 years in most of Florida,” [Woods Hole senior fellow Spencer Glendon] said at an investment conference in New York last week. “During that time frame, insurance will disappear and terminal values” — future resale income — “will shrink. I tell my parents that it’s fine to rent in Florida, but it’s insane to own or to lend.” Note that the US flood insurance is heavily subsidized and will probably have to be cut back if the more extreme forecasts end up being borne out.

 

Stocks had a bit of a rebound yesterday after Steve Mnuchin assured that the trade talks with China are still ongoing. Uber had another rough day, with the stock closing at $37.10 a share, down 18% from the IPO price on Friday.

 

30 day DQs are down 80 basis points from 4.8% to 4% according to CoreLogic. DQs fell in every bucket, and the foreclosure rate fell from 0.6% to 0.4%. Separately, home prices rose 3.7% YOY in February. 35% of cities have overvalued housing stock, while 26% are undervalued and 39% are fairly valued.

 

Corelogic overvalued

Morning Report: Wages and interest rates

Vital Statistics:

 

Last Change
S&P futures 2851 -35
Oil (WTI) 62.46 0.8
10 year government bond yield 2.43%
30 year fixed rate mortgage 4.15%

 

Stocks are lower this morning after rhetoric between the US and China hardened over the weekend. Bonds and MBS are up.

 

The rhetoric over trade intensified over the weekend, with both China and the US blaming each other for the impasse. As promised, the US hiked tariffs on $200 billion worth of Chinese goods on Friday and blamed China for reneging on its deal. In response, China said it would never surrender, and has raised tariffs on about $60 billion worth of US goods starting on June 1. FWIW, the issue with China is not so much tariff-related, it is intellectual property related.

 

This week is relatively data-light, at least as far as market-moving data is concerned. We will get housing starts and the NAHB Housing Market Index, along with a lot of Fed-speak.

 

Uber priced its IPO on Friday at $45 a share, and the stock ended up opening at $42. It never broke above the IPO price for the entire day. The record for IPOs has been downright awful and they have gone from being an almost sure thing to a greatest fool tournament. Historically, bankers would underprice IPOs by about 10% – 20%, so that investors would get a nice bump on the first day. Of course this means the company left some money on the table, but everyone was generally happy with that arrangement. Today, all the value is extracted in the pre-IPO funding rounds, so by the time it hits the public stock exchanges the companies are fully valued (if not overvalued). I have to imagine the big institutional investors are going to start turning these things down.

 

The share of 43%+ DTI loans going to Fannie and Freddie has almost doubled over the past couple of years from 15% to 30%. This is triggering more debate over the “QM patch” that allows safe harbor for loans with DTIs over 43% as long as they are GSE loans. This provision is slated to expire in 2021, but affordable housing advocates are pushing for it to be extended. Interestingly, the Urban Institute says that while default rates for 45+ DTI loans were higher prior to the crisis, that is no longer the case. Urban Institute has an agenda to push, so counterintuitive findings like that might be the result of some statistical jiggery-pokery and further examination is warranted.

 

Neel Kashkari is making the argument that rates should stay low due to income inequality. This is not necessarily a new argument – Janet Yellen said she was willing to let the labor market “run hot” for a while to wring all of the slack out of the labor market. Historically, the Fed has shied away from political footballs like income inequality, fiscal policy, etc given the fact that the Fed handles banking regulation and the Fed Funds rate – tools that aren’t suited to tackle either issue. In fact, you could make the argument that loose monetary policy increases inequality due to the fact that it pushes up asset prices. Here is another issue: if low rates increase the cost of shelter more than it helps increase wages, it could in fact be a negative for those that rent. Note that he isn’t arguing that the Fed should cut rates, but he is in favor of waiting to see if inflation returns.

 

That said, wage growth has been strong over the past couple of years as the labor market has strengthened. If you compare the yield on the 10 year bond to wage growth, historically they have correlated reasonably well. Over the past couple of years, the 10 year yield has fallen while average hourly earnings have increased. Given that labor’s share of GDP is still around historical lows, wages have to rise further to reach historical averages.

 

wage growth versus interest rates

Morning Report: The Fed catches up with the markets

Vital Statistics:

 

Last Change
S&P futures 2817 -10
Eurostoxx index 380.22 -0.62
Oil (WTI) 60.12 1.09
10 year government bond yield 2.51%
30 year fixed rate mortgage 4.22%

 

Stocks are lower after the Fed cut interest rates. Bonds and MBS are up.

 

As expected, the Fed maintained the Fed Funds rate at current levels and took down their forecast for the end of year. The December dot plot showed a central tendency in the 2.72% (using the lower bound of the range) and the March plot showed a central tendency of 2.37%. The forecast for 2019 GDP was lowered from 2.3% to 2.1%, while the unemployment rate was increased from 3.5% to 3.7%. PCE inflation was more or less unchanged at 2%.  The Fed Funds futures increased their probability of a 2019 rate cut from about 25% to about 40%.

 

dot plot

 

The Fed also tweaked their balance sheet runoff plan, increasing the amount they reinvest each month by $15 billion. This only affects Treasuries – MBS will continue to run off.

 

Stocks initially rallied on the Fed announcement, but then sold off on fears the Fed sees something the markets don’t. Bonds rallied on the Fed announcement, with the 10 year yield falling to 2.53%. MBS were slow to follow, but we did see some reprices towards the end of the day. With rates even lower this morning, expect to see a big move down in mortgage rates. FWIW, Fannie Mae has taken down their prediction for the 30 year fixed rate mortgage from 4.8% to 4.4%.

 

What does some of this mean for mortgage bankers? 2019 won’t necessarily be as bad as people feared for origination, and if you have been aggressively marking your servicing portfolio in order to paper over a price war, you might have a problem.

 

Banks that refocused their mortgage lending towards high-end buyers in the aftermath of the financial crisis are seeing the winds shift. Jumbo origination has been falling as prices at the high end have been peaking out and tax reform has limited the value of the mortgage interest deduction. Many non-banks focused on the first time and moderate income buyer. Many banks were offering amazing jumbo terms, presumably in an attempt to cross sell the more lucrative asset management business.

 

 

Morning Report: No revelations in Humphrey Hawkins testimony

Vital Statistics:

 

Last Change
S&P futures 2785.75 -5
Eurostoxx index 372.14 -1.55
Oil (WTI) 56.64 1.06
10 year government bond yield 2.63%
30 year fixed rate mortgage 4.34%

 

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

 

Jerome Powell’s Humphrey-Hawkins testimony didn’t really reveal much in the way of new information. Here are his prepared remarks.  The Fed will be patient as it evaluates incoming data: “With our policy rate in the range of neutral, with muted inflation pressures and with some of the downside risks we’ve talked about, this is a good time to be patient and watch and wait and see how the situation evolves.” He didn’t volunteer too much information regarding balance sheet runoff other than to say the Fed is evaluating the timing. For the most part, the bond market didn’t really react much to the testimony other than to rally somewhat on his view that he doesn’t see much in the way of wage-push inflation. The message to the bond market: don’t freak out if you start seeing wage growth with a 3 handle.

 

Home prices rose 1.1% in the fourth quarter, according to the FHFA House Price Index. December was up 0.3% from November. The hot markets of 2017, especially the West Coast markets, have cooled substantially and are now experiencing appreciation more in line with the rest of the country. This chart probably understates the deceleration in the hotter markets, as the index only looks at loans with a conforming mortgage, which means it is only measuring the lower price points, which is where the strength lies. The jumbo market has been struggling.

 

FHFA regional

 

Mortgage Applications increased 5.3% last week as purchases rose 6% and refis rose 5%. Mortgage rates were little changed last week, but as we anticipated, homebuyers are responding favorably to this more stable rate environment,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “Purchase applications for both conventional and government loans rose last week, with the government gain led by a 14 percent increase in applications for VA purchase loans.”

 

A Senate Panel voted to advance Mark Calabria to a full vote on the Senate floor. The vote was 13-12, straight along party lines. The industry applauded the appointment.

 

Both Zillow and Redfin have models to value homes – which one is more accurate? It turns out that if you look at listed homes, Redfin is the winner, with an error rate of 1.8%. However, for homes off the market, it rises to 6%. Zillow, who doesn’t break out on the market / off the market for its error estimates comes in around 4%. FWIW, appraisers consider an error range of 4% about accurate. Note though that these are median error rates. In newer subdivisions, where square footage and lot sizes are similar, the estimates will be pretty predictive of final sales prices. As the properties become more diverse the error ranges increase. Note that in MSAs like Chicago, the median error is 4%, but over 40% of all home sales are not within 5% of the final sales price.