Morning Report: Markets down on travel restrictions

Vital Statistics:


Last Change
S&P futures 2601 -139.25
Oil (WTI) 31.12 -1.89
10 year government bond yield 0.70%
30 year fixed rate mortgage 3.5%


Stocks are lower after Trump announced a 30 day travel ban from Europe. Bonds and MBS are up.


Initial Jobless Claims came in at 211,000 last week, below expectations. If Coronavirus is going to cause a recession, this will be the first place you see it. So far, it looks like companies are hanging on to their workers. This is key to preventing a recession.


Credit spreads are beginning to widen, however. The banks have been crushed YTD, with Wells down something like 40%, JPM down 30%. We are nowhere near 2008 levels (and probably aren’t heading there), but widening credit spreads are the canary in the coal mine.


Speaking of widening spreads, mortgage backed security spreads are widening. The difference between the implied yield of mortgage backed securities and treasuries is about 150 basis points right now. It was about 110 at the end of February. In a nutshell, this means that mortgage rates right now are about the same as they were when the 10 year was yielding 1%.  If all you watch is the 10 year bond yield indicator on CNBC. It isn’t telling the whole story.


We are entering “oh crap” season, where companies that are going to miss their first quarter earnings expectations disclose it to the market. This could be an opportunity for companies to “kitchen sink” a lot of things as Coronavirus provides an opportunity for them to build in cushion for future earnings releases. In other words, if the Street expects you to make $1.16 in your first quarter earnings, and you are going to come in around $1.12 – $1.13, you might disclose that you will make only $1.10 and take the opportunity to write down a whole bunch of assets and doubtful accounts to create some cushion to make sure they make their numbers going forward. Companies aren’t supposed to do this, but they do. Certainly look for airlines, hotels, banks, consumer discretionaries, and energy to warn on Q1.


Inflation at the wholesale level fell 0.6% MOM in February, and is up 1.3% on a YOY basis. Ex-food and energy it is down 0.3% MOM and up 1.4% YOY. Again, inflation no longer matters to the Fed.


The Fed Funds futures are now predicting a 60% chance cut of 75 bps next week and a 40% chance of a 100 bp cut. Note that the CME indicates that the inter-meeting cut has screwed up the probability graphs, but they don’t quantify it. Oh, by the way, the CME is suspending all open-outcry trading until further notice starting Friday.


Fed funds futures Mar 20




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.