tariffs – The Daily Tearsheet

Morning Report: Durable Goods Orders increase

Vital Statistics;

	Last	Change
S&P futures	2836.5	-4.75
Eurostoxx index	388.69	1.55
Oil (WTI)	69.2	-0.1
10 Year Government Bond Yield		2.96%
30 Year fixed rate mortgage		4.62%

Stocks are lower after fAANG leader Facebook reported a slowdown in revenues. The stock is under severe pressure this morning, having traded down 24% last night. Bonds and MBS are flat.

As expected, the ECB kept rates unchanged and reiterated their plan to end QE this year. German Bunds are down in Europe, which is pulling US rates higher as well.

Durable goods orders rose 1%, which was lower than expected. Capital Goods orders rose 0.6%, which is better than expected. May numbers were revised upward as well. Capital Goods Orders are a proxy for business capital expenditures and it looks like we are breaching the $68 billion level where we have historically stalled out.

Initial Jobless Claims rose from a 48 year low to 217,000.

The US and the EU have come to an agreement on trade, where the Europeans will import more soybeans and LNG in exchange for an easing in auto tariffs. Euro automakers are up big this morning. They still have to come to an agreement on steel and aluminum tariffs however. Still it is good news for the markets and takes some of the pressure off.

PulteGroup reported strong earnings that beat consensus estimates. Revenues increased 25% and we saw margin expansion. New orders were only up 3%, however. Despite their strong growth, Pulte sold some land and bought back a lot of stock. Given the deceleration in new orders, it raises the question if they are sensing that the market is slowing down a little. With affordable land hard to come by, selling inventory and buying back stock in lieu of investing more in the business is a cautionary sign.

Maxine Waters (who will lead the House Financial Services Committee if Democrats take the House) said that reforming the GSEs will be a priority Both liberals and conservatives would like to see the government less involved in residential real estate finance, and there is broad agreement on the model they would like to see. The problem is that there doesn’t appear to be the demand from private capital to pick up the slack, at least not yet. The private label securitization market is still a shadow of its former self and there are many governance issues that need to be solved before we see the buy side increase their appetite.

The FHFA announced that it will not make a decision about updating the credit scoring model and instead will continue to come up with new rules. Consumer advocates have complained that FICO scores are preventing some credit-worthy borrowers from accessing mortgages. Separately, Jeb Hensarling sounded like he is being considered to replace Mel Watt.

New rules intended to prevent the serial refinancing of VA IRRRLs are creating problems for some VA loans that were originated prior to the law change. These loans are not eligible for Ginnie Mae multi-issuer pools, which effectively “orphans” them. As a result, these loans are going to be illiquid and will probably trade at scratch and dent levels, exposing some originators to big losses.

Morning Report: New Home Sales fall

Vital Statistics:

	Last	Change
S&P futures	2816	-4
Eurostoxx index	387.12	-1.06
Oil (WTI)	68.52	0
10 Year Government Bond Yield		2.94%
30 Year fixed rate mortgage		4.61%

Stocks are lower this morning after lousy earnings out of the automakers. Bonds and MBS are flat.

Donald Trump tweeted contradictory statements about trade yesterday, both extolling the virtues of tariffs and also telling Europe that he is ready to end all tariffs if they are. He is also planning to use taxpayer money to help offset the negative effects of Chinese retaliatory tariffs on American farmers. This is New Deal type stuff and I have to imagine that Congress is contemplating legislation to take control of tariffs back from the Executive Branch. When tariffs were going down overall worldwide, it may have made sense to allow the President to lower them without involving the legislative branch, but the unintended consequence was that it allows the President to conduct a trade war unilaterally.

New Home Sales fell 5% on a MOM basis, but were up 2% on a YOY basis to a seasonally-adjusted annual level of 631,000. The Street was looking for something around 680,000. New Home Sales is a notoriously volatile estimate so that number could be revised upward next month. For sale inventory came in at 301,000 which represents a 5.7 month supply.

Mortgage Applications fell 0.2% last week as purchases fell 1% and refis rose 1%.

Flagstar reported earnings yesterday. EPS and revenues rose, however there are some acquisition-related effects happening (not Stearns though). Mortgage origination volume fell by 1.5% and gain on sale fell by 6 basis points. Flagstar appears to be taking share, at least judging by those numbers. Most other banks are reporting sizeable volume drops.

With home prices back above peak bubble levels, the question of affordability invariably comes up. CoreLogic crunched the numbers and it turns out that if you adjust for inflation, the median mortgage payment (P&I) on the median house is much lower than the peak years. This is being driven by the drop in rates. Of the top 10 MSAs, only San Francisco and Denver were higher than the peak. Compared to pre-bubble years (2002), they are higher.

Redfin notes that some of the least affordable MSAs are starting to see an increase in inventory. Homes for sale rose 35% in Portland, 12% in San Jose, and 24% in Seattle. Whether that inventory buildup remains enough to slow the double-digit home price appreciation in those markets remains to be seen. We are heading into the seasonally slow period, and as a general rule home prices decline in Fall and Winter. Overall, home prices rose 5.7% which is the smallest increase since late 2016. Inventory levels still declined on a YOY basis.

Chinese investors were net sellers of US commercial property in the second quarter for the first time in a decade. Pressure from Beijing is the catalyst, although China has a real estate bubble of their own to deal with. Chinese money was also behind some of the activity in the big West Coast MSAs, and it will be interesting to see if that dumps some supply on the market to balance it out.

Morning Report: Gen X hit hardest by Great Recession

Vital Statistics:

	Last	Change
S&P futures	2733	19.7
Eurostoxx index	382.97	2.89
Oil (WTI)	74.32	0.2
10 Year Government Bond Yield		2.85%
30 Year fixed rate mortgage		4.54%

Stocks are higher this morning on rumors that the Trump Administration is dialing back its plans for tariffs on European autos. Bonds and MBS are flat.

The minutes from the June FOMC meeting are coming out at 2:00 pm today. Be careful locking around then since they could be market-moving.

The service economy continues to plow ahead, according to the ISM Non-Manufacturing Survey. Higher input prices, tariffs, and labor shortages are the biggest worries. Trucking shortgages are increasing prices, and that has the potential to push up inflation since it touches just about every business, at least indirectly.

The economy added 177,000 jobs last month according to the ADP Survey. This was a touch below street estimates. Note that ADP numbers have generally been higher than the government’s for the past several months. The Street is looking for 191,000 jobs in tomorrow’s payroll report. While the payroll number will be important, for the bond market, it will all come down to the average hourly earnings number.

Initial Jobless Claims ticked up to 231,000 last week. Separately, outplacement firm Challenger, Gray and Christmas noted there were 37,000 announced job cuts in May.

Tariffs on about $34 billion worth of Chinese exports are set to go into effect tomorrow. Beijing has announced it will retaliate with more tariffs the “instant it goes into effect.” Trade fears have been weighing on the stock market, and we are seeing some effects in commodity prices. Today’s minutes will probably discuss the issue at length. On one hand, this trade war is pushing up commodity prices, which is inflationary and should encourage the Fed to lean hawkish, at least at the margin. On the other hand, trade wars are an economic drag, which should encourage more dovishness. The Fed generally considers commodity inflation to be transitory, so on net trade wars should encourage dovishness, at least at the margin.

Oil prices have been a problem for while now, as WTI crude now trades close to $75 a barrel. Oil prices have been rising due to Venezuela issues and pressure on Europe to not buy Iranian oil. Trump tweeted that OPEC should increase production, which caused Saudi Arabia to announce it would increase output and Iran to announce that his pressure on them have added about $10 to the price of oil in the first place. At the end of the day however these issues affect North Sea Brent prices, which really only matter to East Coast refineries. The rest of the country uses US domestic oil. Higher gas prices do make consumers surly and the Administration wants to see them down ahead of midterms this fall.

Here are the hottest real estate markets in June, according to Realtor.com. Note it isn’t the names you would think.

Interesting chart in today’s Journal about which breaks down the labor force participation rate by age cohort. The press keeps harping on the job market for entry level workers (essentially the Millennial Generation) however if you look at the labor force participation rate for that cohort, it is lower than the year 2000, but not by much. Nor is the problem the 55+ cohort (baby boomers). They are close to all-time highs. It is Gen X that is the issue – their cohort peaked around 83% in 2000 and now is closer to 80%. It is this generation that was hit hardest by the Great Recession (nailed right during the peak earnings years) and has yet to recover.

Morning Report: Don’t fret the flattening yield curve

Vital Statistics:

	Last	Change
S&P futures	2701.75	-8
Eurostoxx index	381.94	0.11
Oil (WTI)	69.26	0.79
10 Year Government Bond Yield		2.90%
30 Year fixed rate mortgage		4.44%

Stocks are lower as commodities surge. Bonds and MBS are down.

The US imposed sanctions on Russia’s Rusal, which has sent aluminum prices up 30% and nickel to 3 year highs. This has the potential to spill through to finished products and bump up inflation. As a general rule, commodity push inflation generally isn’t persistent. An old saw in the commodity markets: the cure for high prices is… high prices.

Initial Jobless Claims ticked up to 232,000 last week, still well below historical numbers.

Investors are starting to worry about the inverted yield curve. An inverted yield curve (where short term rates are higher than long term rates) has historically signaled a recession. The spread between the 10 year and the 2 year is around 41 basis points, which is a 10 year low. Is that what the yield curve is telling us now? I would answer this way: the yield curve is so manipulated by central banks at the moment, that the information it is putting out should be taken with a boulder of salt. We are in uncharted territory, where long term rates are no longer set purely by market forces.

Also, take a look at the chart below, where I plotted the last 4 tightening cycles. In the last 2 cycles, the yield curve inverted, by a lot. In late 2000, the yield curve inverted by 100 basis points – that would be like the Fed taking the FF rate up to 4% while the 10 year hovers around here – at 3%. I would note that the mid 90s tightening cycle didn’t cause a recession, and the late 90s and mid 00s tightening cycles didn’t result in recessions immediately – it took years before the economy entered into a recession.

The question is whether the Fed caused these recessions. It is possible, and the Fed was probably the catalyst to burst the late 90s stock market bubble and the mid 00s real estate bubbles. But these were going to burst anyway. It doesn’t really matter what the catalyst is. This time around, we don’t really have a similar bubble – we may have pockets of overvaluation, but we don’t have bubbles that the typical American is invested heavily in. Not like stock or houses. I think the Fed is happy to gradually get off the zero bound and once we are at 3% on the Fed funds rate will be content to stop. I could see the 10 year going absolutely nowhere during that time.

My take is this: take the shape of the yield curve as a very weak and distorted economic signal – the labor data will tell you what is really going on, and the labor data is signalling expansion, not recession.

Don’t forget that bond rates are set in a global market, and relative value trading between sovereign bonds will play a role. The US 2 year is at a multi-decade premium to the German 2 year, and in theory, that should mean that investors sell Bunds to buy Treasuries. The reason why that isn’t happening? The US dollar, which isn’t buying the Administration’s rhetoric.

Facebook wants to get into the semiconductor business. Really. First Zillow wants to get into the house flipping business and now this. I don’t understand why companies with great business models want to dilute them. Both companies have a competitive moat with a largely recession-proof business model. The semiconductor business is one of the most cutthroat, lousy businesses this side of refineries and airlines. Take a look at QCOM today.

The NAHB remodeling index dipped in March, driven by bad weather in the Northeast and the Midwest. With home affordability slipping due to higher interest rates and home prices, remodeling remains a good substitute for moving up.