Morning Report: The US yield curve inverts

Vital Statistics:

 

Last Change
S&P futures 2890 -41.5
Oil (WTI) 55.49 -1.64
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.88%

 

Stocks are lower after disappointing overseas economic data. Bonds and MBS are up on the flight to safety.

 

Overnight, the US yield curve officially inverted with 2s/10s trading at negative 1.7 basis points.  This has historically been considered a recession indicator. You can see the chart below, which plots the difference between the 10 year bond yield and the 2 year bond yield, and not that the shaded grey bars (which represent recessions) have historically followed after the line goes to zero. One caveat to keep in mind however: In the past, we didn’t have the sort of activism out of central banks that we have now. Quantitative easing (where the central bank tries to directly influence long term rates) are a new phenomenon, and therefore investors should take that signal with a grain of salt. Still, it does speak to a global slowdown, and that will inevitably pass through to the US.

 

2s10s

 

The German Bund yields negative 64 basis points, which is a record low. Their economy contracted by 0.1% last quarter. This is what is driving stocks lower and bonds higher. The trade war is being blamed on their economic weakness. China reported the slowest industrial growth since 2002.

 

The FHA announced they will widen the credit box for condos, in an attempt to revive the entry-level condo market and help the first time homebuyer. “This is set to really expand homeownership,” said Ben Carson, secretary of the Department of Housing and Urban Development, which oversees the FHA. FHA will now begin insuring loans in unapproved buildings, provided no more than 10% of the units have a FHA loan.

 

Mortgage applications increased 21.7% last week as purchases increased 2% and refis increased 37%. The average contract interest rate fell from 4.01% to 3.93%, and has dropped about 80 basis points this year. The government refi index is at the highest level since 2013, driven by VA refis.

Advertisements

Morning Report: Trump tries to talk down the dollar

Vital Statistics:

 

Last Change
S&P futures 2905 -14.5
Oil (WTI) 54.68 0.64
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.86%

 

Stocks are lower after a bunch of non-US political headlines over the weekend. Bonds and MBS are up.

 

Overseas, currencies and bond yields are focusing on elections in Italy and Argentina, as well as protests in Hong Kong. Protestors shut down the Hong Kong airport over the weekend.

 

The week ahead will have a few important data points, but nothing likely to be market-moving. We will get inflation at the consumer level tomorrow, retail sales / productivity / industrial production on Thursday, and housing starts on Friday. There doesn’t appear to be any Fed-speak this week, so things should be quiet absent overseas political developments. Congress is on vacation until Labor Day, so things should be quiet in DC as well.

 

Building materials prices rose 0.7% (NSA) in July, but are down overall year-over-year. Despite tariffs, softwood lumber prices are down 20% over the past year, while other products like gypsum are down less. Roofing materials (tar / asphalt) were flattish-to-down as well. Rising home costs are due more to labor, land, and regulatory costs than they are due to sticks and bricks.

 

After rising for a decade, average new home sizes are falling as builders pivot away from luxury buyers to first time homebuyers. In 2018, the average size of a single family dwelling was 2,588 square feet, down from 2,631 the year before. Builders had largely decided to relegate the first time homebuyer to the resale market and focused on McMansions and luxury urban apartments during the immediate aftermath of the housing crash. Townhomes are also increasing in popularity, with 69,000 sales last year, the most since 2007. This is the sector growing the fastest.

 

Prepay speeds were released on Friday, and we saw some eye-popping CPRs on the government side: 2018 FHA had a CPR of 30.7%, while VA was almost 50%. People who loaded up the boat on MSRs in 2017 and 2018 have been killed.

 

The Fed is looking at the idea of a countercyclical capital buffer as a way to mitigate the credit cycle. The idea would be to have the banks hold more capital (i.e. lend less) when the economy shows signs of overheating and then allow them to hold less (i.e. lend more) when the economy goes into a down cycle. This would only apply to the Citis and JP Morgans of the world – banks with more than 250 billion in assets. “The idea of putting it in place so you can cut it, that’s something some other jurisdictions have done, and it’s worth considering,” Fed Chairman Jerome Powell said at a late July press conference. It is an interesting idea, although reserves are typically sovereign debt, and this sounds a bit like adding buying pressure to a market that certainly does not need it.

 

Trump tweeted about the dollar, arguing that it should be weaker. Note this is a yuge departure from the strong dollar policy that every other president has supported. “As your President, one would think that I would be thrilled with our very strong dollar,” he tweeted. “I am not! The Fed’s high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field. With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition. We have the greatest companies in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?”

 

The strength in the dollar is more due to the relative strength of the US economy versus its trading partners, along with various carry trades. A carry trade is where you borrow money in a low yielding currency like the Japanese yen and invest the proceeds in a high-yielding government bond like the US Treasury. The net effect of a strong dollar is to make our exports more expensive to foreign buyers, make imports cheaper for US consumers and to lower interest rates in the US. The problem is that the ones who benefit from a weaker dollar (exporters) are loud and visible, while the beneficiaries (everyone else) aren’t even aware they are benefiting from it. Note that as the US has pivoted from a manufacturing-based economy to a service / IP based economy, the currency has a smaller and smaller impact on things.

 

Chart US dollar index (1989 – Present):

 

dollar

Morning Report: Trump calls China a currency manipulator

Vital Statistics:

 

Last Change
S&P futures 2853 24.5
Oil (WTI) 54.76 -.04
10 year government bond yield 1.75%
30 year fixed rate mortgage 3.92%

 

Stocks are higher after China stopped the devaluation of the yuan and fixed it at a higher than expected rate. Bonds and MBS are flat.

 

Treasury officially called China a “currency manipulator” yesterday for the first time since 1994. This is a specific term used when the country in question intervenes in the currency markets and has a large trade surpluses. That said, it is also largely symbolic in that it doesn’t have any real consequences. It brings the IMF into the loop and that is about it. In essence it is a political move.

 

The 10 year bond was up something like 24 ticks yesterday, but we did not see much movement in MBS, particularly up in the rate stack. If you were looking for big improvements in the 4%+ note rate range, you were disappointed. As a general rule, MBS will lag the moves in Treasuries, especially large ones. If the 10 year seems to find a level around these prices, then eventually mortgage rates will follow. But it generally seems like mortgage rates take a “wait and see” posture after big moves. If we get some sort of trade detente with China, it is likely we will give back a big chunk of this rally and mortgages seem to be wary of this.

 

Home prices rose 0.4% MOM and 3.4% YOY according to CoreLogic. This is despite lower rates from a year ago. Prices are rising at the lower price points and languishing at the higher price points. That said, incomes are rising and that should push prices higher, especially combined with lower rates.

 

Grandpa, tell me again about when people paid to lend money? We know all about negative yields in the sovereign debt markets, with investors paying over 50 basis points per year for the privilege of lending to the German government. We have seen some corporate bonds trade at negative yields, so why not mortgages, too? Jyske Bank in Denmark is offering 10 year mortgage bonds with a negative coupon. Nordea Bank may be following suit as well, by offering 30 year mortgage bonds with negative coupons. Denmark’s government bond yields -50 basis points already, and some banks in Denmark are offering 30 year mortgages with rates as low as 50 basis points. Home prices are up 24% over the past 2 years in Denmark.

 

You have to wonder what the Fed is thinking here – no matter what they do, it seems long term rates globally are being drawn into a vortex of negative rates. Mohammed-El Arian talked about this at the MBA secondary conference in May – the 10 year yield is going to be pulled down by global rates no matter what the Fed does. The US has to feel like the Rodney Dangerfield of government bonds: of the major players, only Greece, Russia, Mexico, Brazil, Indonesia, China, and India have higher yields.

 

The service economy cooled in July, according to the ISM non-manufacturing PMI. It fell from 55.1 to 53.7, which means the sector grew, just at a slower rate than June. That said, this is the lowest reading since August of 2016, which is a concern. The report usually has some anecdotes and I thought this was interesting: “Tariffs continue to push costs higher, and customers are looking for more discounts due to mortgage-rate fluctuations.” (Construction). We have a housing shortage and builders are experiencing softening prices?

 

Black Knight Financial Services said that July home affordability is at an 18 month high. Falling interest rates have translated into a 15% increase in buying power. The share of median income needed to make principal and interest payments on the average home fell from 23.3% to 21.3% in November 2018. In the early 80s, when mortgage rates were double digit, this percentage was closer to 40%.

Morning Report: 10 yield hits a 3 year low.

Vital Statistics:

 

Last Change
S&P futures 2886 -44.5
Oil (WTI) 54.43 -.84
10 year government bond yield 1.77%
30 year fixed rate mortgage 3.91%

 

Stocks are lower this morning on more trade war fears. Bonds and MBS are up.

 

Bond yields worldwide are down this morning, and many traders are watching the yuan / dollar exchange rate. Weakening the yuan is one of the arrows in China’s quiver to combat tariffs. A weaker yuan will make Chinese imports cheaper, which can offset the effect of tariffs. Globally, we see the German Bund with a negative 50 basis point handle, and the Japanese government bond pushing negative 20 basis points. If this continues, I think we are looking at another 25 basis point cut in September.

 

Trump tweeted about the yuan exchange rate this morning and called it “currency manipulation.” This is not an idle term – Treasury Secretary Steve Mnuchin has resisted calling China a currency manipulator, because it is a weighty accusation. Trump also asked if the Fed was “listening.” The Fed is not in the currency business – that is Treasury’s job – but he is putting additional pressure on the Fed to cut rates. If there is a silver lining in all this, it is that it means lower rates and that is good for the mortgage market. It also looks like some of the more expensive real estate markets on the West Coast are re-thinking their zoning laws, which could add some much-needed supply.

 

The week after the jobs report is invariably data-light, and this week is no exception. The biggest reports will be job openings on Tuesday and producer prices on Friday. Since we are no longer in a tightening cycle, the inflation data will not be a market mover. Note that the disappointing construction spending number is pulling down Q3 GDP estimates to the 1.6% – 1.9% range.

 

 

Morning Report: Trump’s tariff tweet send bond yields lower

Vital Statistics:

 

Last Change
S&P futures 2941 -11.5
Oil (WTI) 55.51 1.04
10 year government bond yield 1.90%
30 year fixed rate mortgage 3.96%

 

Stocks are lower after yesterday’s Trump Trade Tweet. Bonds and MBS are up.

 

Donald Trump sent bonds higher yesterday afternoon with this tweet saying that trade talks had broken down between the US and China, and he was therefore imposing an additional 10% tariff on $300 billion in goods from China. This sent stocks reeling, and the 10 year bond yield down about 10 basis points. MBS were slow to react, however we did have some reprices late in the day. If you look at the box scores above, you’ll see we finally have a 3 handle on the 30 year fixed rate mortgage. Commodities were also slammed, with oil down 8%.

 

The escalation in the tariff wars caused some strategists to bump up their probabilities of a September rate cut. Goldman’s Jan Hatzius sees a 70% chance of 25bps, 10% of 50, and 20% of no change at the FOMC meeting next month. This was mirrored in the Fed funds futures market, however the 50 basis point cut looks unlikely. They Sep futures are pricing in an 85% chance of another 25 bps. They were pricing in a 56% chance of a rate cut before the tweet came out.

 

Some of the rally in bonds yesterday was almost certainly due to convexity-related buying, which means hedge adjustment activity. This sort of buying is invariably violent and temporary, which means mortgage backed securities will probably lag the move for a day or two. That said, the path of least resistance for rates remains down, especially since overseas bond yields followed along. The German Bund now yields negative 48 basis points. In fact, their longest term bond – 29 years – is now negative. Think of it: tying your money up for 29 years to get…. absolutely nothing. This is the fixed-income equivalent of buying Salon.com stock at 1000x pageviews in 1999.

 

bund

 

Jobs report data dump:

  • Nonfarm payrolls up 164k (in line with expectations)
  • Unemployment rate 3.%
  • Average hourly earnings up 0.3% MOM / 3.2% YOY (better than expectations)
  • Labor force participation rate 63%
  • Employment / population ratio 60.7%

Overall a good report, and now stock bullish given the Fed’s new posture. Wage growth is picking up and average hourly earnings keep trending upward despite PCE inflation that is stuck in the high teens.

 

average hourly earnings

Morning Report: The CFPB eyes the GSE patch

Vital Statistics:

 

Last Change
S&P futures 3025 1.5
Oil (WTI) 53.61 0.14
10 year government bond yield 2.05%
30 year fixed rate mortgage 4.07%

 

Stocks are flattish as we head into FOMC week. Bonds and MBS are up.

 

The FOMC begins its two day meeting on Tuesday, and is expected to cut rates by 25 basis points. We will also get the jobs report on Friday, so this should be a busy week.

 

While the Fed is ostensibly cutting rates to ward off a potential recession, the economic data has been surprisingly robust. Despite trade fears, GDP growth in the second quarter topped 2%, and earnings season has been robust. The “Powell Put” as it has been dubbed, is the expectation that rates are going down and that will support the stock market. That said, the global economy is slowing and that is pushing down interest rates. Note the German 10-year is again pushing negative 40 basis points, and the Chinese are having issues in their banking system. Meanwhile, the US consumer is alive and well as the biggest canary in the coal mine for the US consumer – UPS – reported a 14% increase in quarterly profit.

 

Last Thursday, the CFPB announced that it was willing to let the “GSE patch” expire in 2021. The GSE patch allows loans with DTI ratios above 43 to fit in the QM bucket if they are approved for sale to Fannie Mae or Freddie Mac. “The top line is the patch is going to expire,” [CFPB Director Kathy] Kraninger said in a meeting with reporters. “We are amenable to what a transition would look like.” The CFPB has put out a public request for comment on the new rules, and is working to ensure that there are no disruptions in the mortgage market. This is important given that 1/3 of the Fan and Fred loans have DTIs over 43%. It is possible that FHA will pick up the slack, however FHA has been tightening credit standards as well, requiring FICOs above 620 to go over 43%. Note that a quarter of FHA lending has DTI ratios over 50% (FHA permits up to 57%), but it is more likely that these loans will end up as securitized non-QM loans. There are still many issues to be resolved before the private label market returns to its former glory, but this may force those issues to finally get ironed out. This may be why the government considers this to be a key part of GSE reform – it will shrink the GSE’s footprint in the market, and also increase the credit quality of their loans.

 

The Trump Administration had indicated they wanted to get GSE reform done before the 2020 election, however that is looking like it won’t happen. Mark Calabria, head of the FHFA, think this is more likely to happen within the next 5 years. By far the biggest issue is whether the government will continue to guarantee MBS issued by the GSEs. The government guarantee was never explicit prior to the financial crisis, and the government floated a trial balloon during the crisis about not guaranteeing these securities. Bill Gross of PIMCO threatened to stop buying Fan and Fred MBS if the government did that and that was the end of that discussion. Note Bill had just loaded up the boat in his Total Return Fund with agency MBS and made a killing when the government formally guaranteed them, so he was talking his book so to speak.

 

Housing security is a big issue for seniors. With the end of defined benefit pension plans, most people are living on Social Security and savings. One proposal would allow seniors to use pretax earnings in their IRA or 401k plans to pay off mortgage debt without triggering taxes and penalties.

Morning Report: German bonds set a record streak of negative yields

Vital Statistics:

 

Last Change
S&P futures 3023 1.5
Oil (WTI) 56.79 0.84
10 year government bond yield 2.07%
30 year fixed rate mortgage 4.04%

 

Stocks are flat as we await earnings from market heavyweights like Amazon and Alphabet. Facebook’s numbers beat the street, while Tesla disappointed. Bonds and MBS are down small.

 

New home sales came in weaker than expected, but at least exhibited positive growth. In June, we saw new home sales of 646,000, which was up 7% MOM and 5% YOY. New home inventory 338k units, which represents a 6.3 month supply.

 

Durable Goods orders rose 2% in June, according to Census. Ex-transportation, they rose 1.2%, and ex-transportation and defense they rose 3.1%. Non-defense capital goods orders (ex-aircraft) rose 1.9%, which shows that businesses are expanding capacity.

 

In other economic news, initial jobless claims fell 13k to 206,000.

 

The ECB opened the door to future stimulus this morning, saying they saw rates lower over the next 12 months. The German Bund is slightly stronger, however we are still close to record low yields at negative 37 basis points. The Bund set a record for the longest streak of days in negative territory – now 79. This eclipses the record set in 2016. What exactly does “negative yield” mean? It means the German 0s of ’29 is trading at 103.66. It is a zero coupon bond, meaning it pays no periodic interest. You pay 103.66 and on August 15, 2029, you will get back 100.

 

german bund yield

 

To get an idea of how much things have changed in Europe, remember the PIIGS? The PIIGS were an acronym for Portugal, Italy, Ireland, Greece, and Spain – all high-yielding sovereign debt that had fiscal issues. Where are they now? All yielding less than the US 10 year, with Greece at 1.95%, Portugal at 38 basis points, Ireland at 11 basis points, Italy at 1.48% and Spain at 33 basis points. Don’t forget, a huge swath of the European corporate sector trades with negative yields.

 

Most (if not all) of these countries have debt-to-GDP ratios well over 1, so we are seeing a real-time test of the hypothesis that government debt levels don’t matter. The granddaddy of debt to GDP ratios is Japan, sitting at 2.4x and its 10 year bond yields negative 15 basis points. Who knows how all this ends up, but we have a global sovereign debt bubble of epic proportions.

 

Bill Gross used to call the US the “cleanest dirty shirt” in the world. Indeed. For all the handwringing over debt to GDP ratios, the US debt to GDP ratio sits at just over 1, and a good chunk of that is owned by the Fed. Essentially, the low yields overseas cannot help but act as an anchor for US yields, which means unless the bubble overseas pops, I can’t see an impetus to push rates dramatically higher. And the first rule of bubbles is that they go on longer and go further than anyone expects.