Morning Report: Senate resolution complicates trade negotiations

Vital Statistics:

 

Last Change
S&P futures 3111 -6.25
Oil (WTI) 55.69 -0.74
10 year government bond yield 1.74%
30 year fixed rate mortgage 3.96%

 

Stocks are lower this morning as tensions increase between China and the US over Hong Kong. Bonds and MBS are up.

 

The Senate passed a resolution last night supporting democracy for Hong Kong and urging China to not use violence to suppress the demonstrations. This will undoubtedly complicate trade negotiations, and will push the markets to more of a “risk-off” (stocks down, bonds up) posture. Bond yields are lower this morning, with the 10 year trading at 1.74%.

 

Mortgage Applications decreased by 2.2% last week on a seasonally adjusted basis as purchases rose 6.7% and refis fell 7.7%. Veteran’s Day influenced the numbers. “U.S. and China trade anxieties and protests in Hong Kong pulled U.S. Treasuries lower last week, and the 30-year fixed mortgage rate followed the same path, dipping below 4 percent,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Despite lower rates, mortgage applications decreased 2.2 percent, driven by an 8 percent slide in refinance activity. Rates have stayed in the same narrow range of around 4 percent since July, so we may be starting to see the expected slowdown in refinancing as the pool of eligible homeowners shrinks.”

 

The retailers are announcing earnings and the markets are looking for indications of how this year’s holiday shopping season will shake out. Target and WalMart both announced strong earnings and took up their Q4 guidance. These two stocks are a bellwether for John Q Public’s spending habits.

 

The FOMC minutes will be out at 2:00 pm today. The minutes usually aren’t market-moving, but given the somewhat abrupt change in the Fed’s posture there is always the possibility that we could see some action. Just be aware when locking around that time.

 

 

 

 

Morning Report: Experts talk about 2020 forecasts

Vital Statistics:

 

Last Change
S&P futures 3116 -1.25
Oil (WTI) 57.29 -0.24
10 year government bond yield 1.82%
30 year fixed rate mortgage 4.00%

 

Stocks are flattish this morning as violence continues in Hong Kong. Bonds and MBS are flat as well.

 

Optimism for a trade deal with China waxes and wanes, and we had some conflicting reports this weekend. CNBC said that the government was disappointed in Trump’s reluctance to roll back tariffs, while the Chinese state media company said Beijing and Washington had constructive talks over the weekend.

 

The upcoming week has some real-estate related data with housing starts and existing home sales, but nothing much market moving. We will get the FOMC minutes on Wednesday, but the sense in the market is that the Fed is on hold for a while, and probably through the election.

 

The Fed said the US financial system “appears resilient” in its semiannual report on financial stability. “The current combination of very low credit spreads and high levels of indebtedness among risky nonfinancial corporates, including through leveraged loans, merits heightened vigilance,” Fed Governor Lael Brainard said in a prepared statement. “Over the medium term, the low-for-long environment and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.” They were also critical of cryptocurrencies, warning they could destabilize the system if implemented without regulation and oversight. Wasn’t the whole point of cryptocurrencies to have a medium of exchange that is beyond the reach of governments?

 

Predictions for 2020:  Rates will remain low, with Fannie Mae predicting the 30 year fixed rate mortgage will end up in a tight range around 3.5% – 3.6%. Home price appreciation will re-accelerate, with home prices rising 5.6% next year versus 3.5% this year. Inventory will remain tight, however especially at the lower price points. “While historically low rates increase buying power and make it more likely for potential buyers to attain their homeownership dream, they also increase the risk of a long-run housing supply shortage, which we predict will continue through 2020 and possibly intensify,” Kushi says. “As first-time buyers lock-in these historically amazing rates and existing owners refinance—in droves in recent months, everyone will stay put and not sell. Where’s the incentive?”

Morning Report: Trump talks trade at noon today.

Vital Statistics:

 

Last Change
S&P futures 3087 -0.25
Oil (WTI) 57.09 -0.04
10 year government bond yield 1.94%
30 year fixed rate mortgage 4.02%

 

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

 

Donald Trump will speak at the Economics Club today around noon and markets will be listening for any sort of information on trade with China. This will probably be something that affects stocks more than bonds, but just be aware.

 

Small business optimism remained strong in October, according to the NFIB Small Business Optimism Index. Job creation, inventory investment and capital spending drove the increase. While we are seeing increases in labor compensation, prices paid are still flattish so we aren’t seeing inflation. “Labor shortages are impacting investment adversely – a new truck, or tractor, or crane is of no value if operators cannot be hired to operate them,” said NFIB Chief Economist William Dunkelberg. “The economy will likely remain steady at its current level of activity for the next 12 months as Congress will be focused on other matters, and an election cycle will limit action. Any significant change in trade issues will impact financial markets more than the real economy during this period. Adjustments to a new set of ‘prices,’ such as tariffs, will take time.”

 

Homebuilder D.R. Horton reported better than expected earnings this morning, sending the shares up 3% pre-open. Forward guidance for 2020 was also above expectations. The homebuilders have been on a tear this year, as interest rates have fallen. The homebuilder ETF (XHB) is up something like 50% YTD.

 

Mortgage credit availability increased in October, according to the MBA. “Mortgage credit availability increased in October, driven mainly by an increase in conventional loan programs, including more for borrowers with lower credit scores, as well as for investors and second home loans,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Credit supply for government mortgages continued to lag, declining for the sixth straight month. Meanwhile, the jumbo credit index increased 3 percent to another survey-high, as that segment of the market stays resilient despite signs of a slowing economy.”

 

CBS is out with a piece claiming that climate change will eliminate the 30 year fixed rate mortgage. The fear is that flood insurance could get too expensive and wildfires will make certain areas uninsurable / uninhabitable. How that translates into the end of the 30 year fixed rate mortgage is anyone’s guess, since the piece fails to show its work. FWIW, this article is just clickbait. The 30 year mortgage is going nowhere, and climate change isn’t going to destroy the financial system. The Union of Concerned Scientists frets about the “short sighted” market, but a typical mortgage lasts about 7-10 years, so something that might happen in 30-50 years is going to be off the radar, by definition.

Morning Report: Risk-on feel as China and US strike a trade deal

Vital Statistics:

 

Last Change
S&P futures 3088 12.25
Oil (WTI) 57.27 0.94
10 year government bond yield 1.88%
30 year fixed rate mortgage 3.97%

 

Stocks are higher this morning after the US and China agree to remove tariffs. China also made some high profile arrests to stem the tide of fentanyl coming into the US. The fentanyl issue was a key part of the US’s issues with China. Bonds and MBS are down on the “risk-on” trade.

 

After a dismal start to the year, the luxury end of the market (homes over $1.5 million) rebounded in the third quarter as rates fell. Prices rose 0.3% on average, but they had been falling since 2018. Manhattan was hit particularly hard on the new mansion tax. Florida was the beneficiary as prices rose over 100% in West Palm and some of the other nearby areas. Previously hot markets like San Diego also remained in the losing category. “Because recession fears peaked over the summer, I expected luxury home prices and sales to dip. But it appears that nerves alone weren’t enough to scare off wealthy homebuyers,” said Redfin chief economist Daryl Fairweather. “The U.S. economy grew faster than expected in the third quarter, partly as a result of healthy consumer spending. Those results, along with flat luxury home prices and rising sales, go to show that Americans are basing their spending habits on their own personal financial situation rather than concerns about global economic tensions. For many, that means strong incomes and good employment prospects.”

 

Fannie Mae is out with their housing forecasts for 2020. They anticipate the 30 year fixed rate mortgage will continue to fall, hitting 3.5% by the end of 2020, and home prices will rise about 4%. Interestingly, they do not anticipate any sort of pickup in housing starts – in fact they anticipate they will be flat with 2019. Despite the drop in rates, they anticipate origination volumes will fall to 1.86 trillion from 2.04 trillion as the refinance share of the market falls from 37% to 31%.

 

New York Fed President John Williams said that the FOMC sees no reason to cut interest rates further: “The three rate cuts we did were very effective at managing the risks” slowing global growth and trade uncertainty present to the U.S. economy, New York Fed President John Williams said at a Wall Street Journal event in New York. Chicago Fed President Charles Evans echoed the same sentiment.

 

Finally, we know that gathering strength in the US economy is helping push rates higher. It is important to note that rising rates is not simply a US phenomenon. US Treasuries don’t trade in a vacuum – they are always going to be subject to moves in overseas rates. For now, the key overseas interest rate to watch is the yield on the German Bund, which has increased by 45 basis points since early September. The Bund still has a negative yield, but it is now -27 basis points after bottoming at -72 basis points 2 months ago.

 

bund

Morning Report: Adjustable rate mortgages becoming less attractive

Vital Statistics:

 

Last Change
S&P futures 2875 19.5
Oil (WTI) 55.05 0.84
10 year government bond yield 1.53%
30 year fixed rate mortgage 3.84%

 

Stocks are higher after Trump toned down the rhetoric with China at the G7. Bonds and MBS are flat.

 

Both the US and China made statements intended to de-escalate the trade war, which is adding a spring in the step of the S&P futures. China supposedly wants to get back to “calm” negotiations, while Trump has mused over canceling the recent new tariffs. On Friday, Trump ordered US companies to start looking for alternatives to China, which he doesn’t really have the power to do. S&P futures sold off on Friday afternoon, and bond yields fell. That said, the market do seem to be adjusting to Trump thinking aloud on Twitter.

Durable Goods orders increased 2.1% in July, which was way more than expectations. Nondefense capital spending ex aircraft (which is a proxy for corporate capital expenditures) rose 0.4%, much higher than the decrease the Street was looking for. For all the handwringing in the business press over the state of the economy and trade, it isn’t showing up in the numbers, at least not yet.

 

The upcoming week looks to be relatively non-eventful, with only some meaningful data late in the week – the second revision to Q2 GDP on Thursday, and personal income / spending data on Friday. Another rate cut seems baked into the cake for September, so a strong number probably won’t have that big of an impact on markets.

 

The spread between adjustable-rate mortgages and fixed rate mortgages has been contracting as the yield curve has flattened. This is because the difference in long term rates and short term rates has fallen. Currently the difference between a 30 year fixed and a 5/1 ARM is about 55 basis points, whereas it was closer to 100 basis points during the post-bubble era. If you only plan on living in your home for 5 years or so, ARMs generally make sense, however if you can lock in your rate for 30 years at a similar rate to an ARM, it doesn’t make sense to go adjustable.

 

adjustable vs fixed.

 

Regulators are thinking about raising the threshold where homes require an appraisal, from 250,000 to 400,000. This would be the first increase in the threshold since 1994. About a year ago, the FDIC, OCC and Fed released a proposal which would make the change, and the FDIC just published the final rule.

 

SUMMARY: The OCC, Board, and FDIC (collectively, the agencies) are adopting a final rule to amend the agencies’ regulations requiring appraisals of real estate for certain transactions. The final rule increases the threshold level at or below which appraisals are not required for residential real estate transactions from $250,000 to $400,000. The final rule defines a residential real estate transaction as a real estate-related financial transaction that is secured by a single 1-to-4 family residential property. For residential real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

 

 

Morning Report: Why we aren’t headed for a recession

Vital Statistics:

 

Last Change
S&P futures 2874 24.5
Oil (WTI) 54.62 -0.14
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.78%

 

Stocks are higher on no real news this morning. There is a risk-on feel to the tape after a tumultuous week. Bonds and MBS are down.

 

Housing starts disappointed (again!) coming in at 1.19 million, lower than the 1.26MM street estimate. This is down 4% on a MOM basis, and up about 0.6% on a YOY basis. On the bright side, building permits surprised to the upside, coming in at 1.34 million versus the 1.27 million street estimate. Still, new home construction remains depressed due to labor shortages and lack of buildable lots.

 

Despite these issues, homebuilders remain optimistic. The NAHB / Wells Fargo Builder Sentiment Index rose in August to 66. Current sales conditions improved, while expectations for the next six months moderated. “While 30-year mortgage rates have dropped from 4.1 percent down to 3.6 percent during the past four months, we have not seen an equivalent higher pace of building activity because the rate declines occurred due to economic uncertainty stemming largely from growing trade concerns,” said NAHB Chief Economist Robert Dietz. “Although affordability headwinds remain a challenge, demand is good and growing at lower price points and for smaller homes.” Interesting about the tariff issue – building materials prices are down quite substantially. If tariffs were really that big of a deal, you would expect to see shortages and increases. We aren’t.

 

Given all the chatter about the yield curve and a possible recession, it is worthwhile to step back and take a look at the facts on the ground. The business press is awash with stories about the yield curve and how it is possibly signalling a recession. Quick explanation: the yield curve shows interest rates along the spread of maturities, and short term rates are usually lower than long term rates. However, we are flirting with a situation where long term rates are lower than short term rates. That is a yield curve inversion, and historically a yield curve inversion has been a decent (but not perfect) predictor of an imminent recession. The reason for this is that it implies that businesses are taking less risk, which means they must see something wrong in the economy.

 

The problem with the inverted yield curve model is that it gives off a lot of false positives – an old market saw is that an inverted yield curve has predicted “15 of the last 10 recessions.” Many times an inverted yield curve is the result of technical issues in the bond markets, which are temporary and don’t really spill through to the overall economy. This current period is probably one of those cases, and the technical issue is central bank behavior. The Fed, ECB, Bank of Japan have been pushing down long term rates in order to stimulate the economy for years, and now we have negative interest rates in much of the world. Negative interest rates in Germany and Japan (two huge bond markets) are pulling down US bond yields as overseas investors sell government debt that pays less than nothing (German Bunds and Japanese Government bonds) to buy government debt that does pay something (US Treasuries).

 

The business press is emphasizing the Trump / tariff / recession angle here because (1) it is a much simpler story to tell, (2) the partisans get to blame it on Trump, and (3) many strategists reluctant to stick their necks out and discuss the implications of negative rates worldwide – this is a completely new phenomenon and quite simply people don’t know.  We have a bubble in sovereign debt that has been engineered by global central banks – and unlike stock and real estate bubbles, we don’t have any historically similar periods to review. We know that bubbles end eventually, but when and how this resolves is anyone’s guess.

 

That said, what is the current economic state of play? Europe is doing its same-old Euro-sclerosis thing, which it has been doing for decades. Germany had a slightly negative GDP quarter and most of the Eurozone is slowing down in sympathy. Japan has been in the throes of a sclerotic economy since the New Kids on the Block ruled the charts. China is also tempering its growth. On the other side of the coin, the US has the lowest unemployment rate in 50 years, initial jobless claims are the lowest since we had a military draft, wages are rising, inflation is under control, and the consumer is increasing spending. This simply is not a recipe for a recession. And to take this a step further, tariff income has been about $60 billion since they have been implemented. In the context of a $21 trillion economy, this is insignificant – about 1/3 of 1%. It is a humorous state of affairs with partisan talking heads accusing Trump of destroying the economy over small-beer tariffs, while Trump accuses partisan journalists of sabotaging the economy with negative stories – as if the press had the power to do that.

 

Here is the big picture: The US economy has been strong enough to withstand a tightening cycle from the Fed, and has had 2.6% GDP growth in the immediate aftermath of a tightening cycle. Inflation is low, and is probably going to go lower as Europe and China begin exporting deflation to the US. Oh, and by the way the Fed is now cutting interest rates, which is the equivalent of giving a can of Red Bull to your kid at 9:00 pm on Halloween night. Don’t buy the recession narrative. None of the required pieces are in place.

Morning Report: 30 year treasury yield near a record low

Vital Statistics:

 

Last Change
S&P futures 2871 -14.5
Oil (WTI) 54.49 -0.44
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.85%

 

Stocks are lower this morning after the Argentinian markets blew up overnight and the Hong Kong airport remains occupied by protesters. Bonds and MBS reversed their rally and are down after the Trump Administration announced they would delay the tariff increases on Chinese goods until mid-December. They were scheduled to take effect September 1.

 

The German Bund yield has hit a record low at negative 61 basis points. While the 10 year bond yield is still some 30 basis points from a record, the 30 year bond is getting close at a yield of 2.13%. Note that with the 10 year yield of 1.63% is lower than the dividend yield of the S&P 500.

 

30 year bond yield

 

Some economic data this morning: the consumer price index rose 0.2% MOM / 1.8% YOY, which was a touch higher than the Street forecast. Ex-food and energy, it rose 0.3% / 2.2%. The CPI remains pretty much where the Fed wants it, and is not going to be the driver of Fed policy, at least in the near term. Like it or not, the Fed is watching the markets and following them even if the signal-to-noise ratio is heavily distorted.

 

Small Business Optimism continued to increase as the index improved in July. Despite all of the handwringing in the business press over growth small business continues to grow and invest. Biggest headwind? Labor. The top concern of business was finding quality labor at 26%, which is a record. 57% reported capital expenditures, which means they have enough confidence to invest in infrastructure to grow their businesses. Only 3% of businesses reported not having their credit needs met, which is close to historical lows and kind of begs the question of what the Fed hopes to accomplish with lowering rates.

 

Mortgage delinquency rates continued to fall, hitting 20 year lows for most of the country. 30 day DQs fell to 3.6% and the foreclosure rate fell to 0.4%. The only areas with elevated DQ rates are in the Midwest and Southeast and are the result of flooding.

 

delinquencies

 

Fitch is out saying that GSE reform will probably not result in near-term downgrades.