quantitative easing – The Daily Tearsheet

Morning Report: The Fed announces further stimulus measures

Vital Statistics:

	Last	Change
S&P futures	2323	34.4
Oil (WTI)	22.71	0.09
10 year government bond yield		0.76%
30 year fixed rate mortgage		3.84%

Stocks are higher after the Fed announced additional support measures for the markets. Bonds and MBS are up as well.

The NY Fed announced further measures to support the markets this morning. Essentially, the Fed will do whatever it takes to keep the financial market working properly.

Effective March 23, 2020, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to increase the System Open Market Account (SOMA) holdings of Treasury securities and agency mortgage-backed securities (MBS) in the amounts needed to support the smooth functioning of markets for Treasury securities and agency MBS. The FOMC also directed the Desk to purchase agency commercial mortgage-backed securities (CMBS).

The Fed expects to buy $75 billion of Treasuries and $50 billion of MBS every day this week. As of right now (pre-open), TBAs are up, but bid ask spreads are wide.

The chart below (courtesy of Reuters) shows MBS spreads, which is the difference between the yield on the current coupon mortgage backed security and the comparable duration Treasury. This represents the market’s reluctance to bid MBS and that flows through to rate sheets. Yes, the Treasury market yields are lower than February. Yes, the Fed Funds rate is lower than February. No, mortgage rates are not. Once those green bars get back to where they were in February we will be seeing lousy pricing in the primary market. The Fed’s $250 billion purchasing activity in the MBS market should help though.

The Fed is also extending credit to other parts of the economy, specifically the muni market and the corporate credit market. The Fed will start purchasing investment grade corporate loans, it will re-launch the Term Asset-Backed Lending Facility which lent money to investors who buy credit card receivables and other consumer debt. The Fed also plans to roll out a Main Street Business Lending Program which will lend to small businesses.

Late last week, pretty much everyone stopped buying non-QM loans, and it looks like jumbos will end soon as well. The securitization markets are halted. I have heard that some non-QM lenders are even refusing to honor locks they have already extended. Aggregators were also declining to buy MBS with rates below 3% as well.

Lenders are still waiting for guidance out of Fannie Mae regarding verbal verifications of employment and drive-by appraisals. So far, people have been closing loans in parking lots, but loans are getting done. The last thing Fannie needs is for the mortgage finance pipeline to stop, so I assume they’ll find a way to make things work. The FHFA website apparently contains an announcement that it directs the GSEs to grant flexibility for appraisal and employment verification, so something should be forthcoming.

Washington is set to vote on a relief bill today at noon. The Democrats are complaining about executive compensation and stock buybacks, though the bill does contain some limitations on those. Treasury Secretary Steve Mnuchin said the bill could help the Fed direct $4 trillion to the business sector. Companies that take the money will be required to maintain payroll “to the extent practicable.” Supposedly the portion of the loan that goes to maintaining payroll could be forgiven.

Interesting data point: Lennar reported good first quarter earnings, which pretty much was expected. Pre-Coronavirus, homebuilding was set to have the best year in over a decade. Their quarter ends in February, and the company said that orders were up 16% in the first two weeks of this quarter – i.e. the first two weeks in March. In most of their markets construction continues, and with interest rates as low as they are PITI payments are lower than market rents.

The deadline for filing taxes has been extended to July 15.

Existing Home Sales increased 6.5% in February, according to NAR. “February’s sales of over 5 million homes were the strongest since February 2007,” said Lawrence Yun, NAR’s chief economist. “I would attribute that to the incredibly low mortgage rates and the steady release of a sizable pent-up housing demand that was built over recent years.” Social distancing and economic uncertainty is expected to weigh on sales going forward, but the fundamentals of the housing market remain strong, with tremendous pent-up demand.

Morning Report: The Fed cuts to zero

Vital Statistics:

	Last	Change
S&P futures	2555	-128.4
Oil (WTI)	29.01	-2.79
10 year government bond yield		0.76%
30 year fixed rate mortgage		3.71%

Stocks are limit down after the Fed made an emergency cut over the weekend. Bonds and MBS are up.

Yesterday, the Fed cut interest rates to zero and re-initiated QE. The Fed will begin purchasing up to $500 billion in Treasuries and $200 billion in mortgage backed securities over the coming months. For what its worth, stocks are unimpressed. S&P 500 futures went limit down immediately on the Asian open and have been sitting there ever since. The 10 year is trading at 77 basis points pre-open, which is much higher than where it was a week ago.

Mortgage backed securities seem to like the re-introduction of quantitative easing. The current coupon TBA is up about 2 points, but it is early and we could just be seeing some short covering. The NY Fed plans to purchase $80 billion of TBAs over the next month.

Companies have been taking down their lines of credit to maximize cash on the balance sheet. This is another reason for the rate cut. Banks have been getting clobbered in the sell-off, with the XLF down 25% since the start of the Coronavirus contagion. The Fed is watching to make sure we don’t see a repeat of 2008 when businesses were unable to borrow in the commercial paper market. The banks have all suspended their stock buyback as well.

Right now, the immediate concern for the markets is the state of airlines and the energy patch. Oil below $30 a barrel is a problem for almost all of the shale producers. Airline bankruptcies have been a fact of life forever, and many will hit the wall if this drags on. In the meantime the labor market is entering this crisis as strong as it has ever been. Remote working is about to face its biggest test, and if productivity doesn’t take a hit, it could become more mainstream. Certainly for employers it saves money for office space, while improving quality of life for employees. Less commuting is also better for the planet.

Coronavirus is going to put a damper on the Spring Selling Season for real estate. Have to imagine traffic is going to fall, although inventory is so tight we probably won’t see much of an impact on prices. Also, this should be an issue for the builders, so supply is going to remain constrained. Refis will continue to drive the business. FWIW, Redfin took the temperature of the average consumer on how it will impact housing. Roughly 40% think it will be bad, while 50% see no effect. The drop in stock prices isn’t going to help the animal spirits in the real estate market, but I find it hard to imagine any sort of decline in prices, aside from the overheated markets on the West Coast.

We do have quite a bit of data this week. The FOMC meeting on Tuesday and Wednesday will be more about the press conference than anything, with particular emphasis on whether credit spreads are widening and if we are seeing indications of financial stress in the system. Aside from the FOMC meeting, we will get housing starts, home prices, industrial production and existing home sales. Of course none of this will matter to the bond market, which will be driven by headlines.

What does this mean for mortgage rates? The re-introduction of QE will certainly help things, especially if it encourages trading in the lower note rates. Mortgage rates may take a while to adjust. I also suspect that the big money center banks, which drive jumbo pricing are about to increase margins to free up capital to lend to small and medium sized enterprises which are facing cash crunches.

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)

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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.