Morning Report: The Fed takes up its GDP forecast for 2018 12/14/17

Vital Statistics:

Last Change
S&P Futures 2671.0 2.0
Eurostoxx Index 389.3 -1.4
Oil (WTI) 56.3 -0.4
US dollar index 86.9 0.1
10 Year Govt Bond Yield 2.37%
Current Coupon Fannie Mae TBA 102.531
Current Coupon Ginnie Mae TBA 103.591
30 Year Fixed Rate Mortgage 3.88

Stocks are higher after a relatively dovish FOMC statement. Bonds and MBS are down small after rallying hard after the announcement yesterday.

As expected, the Fed raised rates a quarter of a percent yesterday and released their economic forecasts. This was Janet Yellen’s last hurrah. The vote was 7-2 with two dissenters: Evans and Kashkari, who both wanted to maintain the current Fed Funds rate. Bonds rallied on the FOMC decision, largely due to the dot plot, which showed virtually no change from September, despite a big upward revision in the Fed’s 2018 GDP forecast, which went from 2.1% to 2.5%. Their forecast for unemployment was revised downward from 4.1% to 3.9%, while their forecast for core inflation remained unchanged at 1.9%. It was a Goldilocks report for the markets. You can see the dot plot comparison below, with the central tendency right around 2%.

dot plot sep versus dec 2017

Note that the Fed Funds futures are currently predicting 1-2 hikes next year through November (we don’t have December 2018 Fed Funds futures yet). So, the market is somewhat more dovish than the FOMC is, but they are pretty close. Note that one of the big trades on the Street right now is a bet that the Fed will blink and only raise rates 1-2 times next year. The other big trade that is happening right now: yield curve flattening trades, where traders bet that the difference in yield between the 2 year and the 10 year will decrease.

Initial Jobless Claims fell to 225k last week. This is just off the post-crisis low of 223k, and you would have to go back to the early 1970s to find similar readings. The job market is pretty strong, provided you are employed. The long-term jobless still are with us, although it remains to be seen how many will (or even want to) re-enter the workforce. That untapped reservoir is probably one big reason why wage inflation continues to be muted.

Retail Sales came in way stronger than expected, pointing to a strong holiday shopping season. The headline number was up 0.8%, as was the control group, which was a big jump from October, and above the highest point in the consensus range. The S&P SPDR Retailer ETF (XRT) is up about .63% in an otherwise flattish market early.

The ECB maintained interest rates at current levels and cut their QE buying in half. Central bank demand for sovereign debt is being cut back globally. FWIW, we aren’t really seeing that much of an impact in yields (Probably as people pile into curve flatteners, as described above). The German Bund is down with Treasuries.

The NAR points out that the median age of renters is rising – it rose to 40 from 38 a year before. Given that the relative attractiveness of buying compared to renting is about as big as it ever has been, what gives? It is mainly empty-nest Boomers who are choosing to go with rentals, which means no more home maintenance.

Bill Gross warns that the Fed really has to stop hiking rates once the Fed Funds rate gets around 2 – 2.25% or else it runs the risk of hurting the housing market. “A lot [of mortgages] are variable, floating-rate mortgages. And to the extent that the Fed has already raised interest rates by 75 to 100 basis points and is expect to raise by another 50 to 100 that affects the average monthly payments.” He is correct on the ARM part of it, and with the Fed raising short term rates, while long-term rates stay in place, it is the time to refinance out of an ARM and into a 30 year fixed rate mortgage. While he does draw upon 2005 – 2006 as a comparison, we were in a bubble then. It really isn’t similar to today, where inventory is so tight we probably won’t see any price decreases. If anything, we are seeing bidding wars.

Morning Report: Awaiting the Fed 12/13/17

Vital Statistics:

Last Change
S&P Futures 2667.8 0.0
Eurostoxx Index 391.3 -0.4
Oil (WTI) 57.7 0.5
US dollar index 87.3 0.0
10 Year Govt Bond Yield 2.42%
Current Coupon Fannie Mae TBA 102.531
Current Coupon Ginnie Mae TBA 103.591
30 Year Fixed Rate Mortgage 3.88

Stocks are flat as we await the FOMC decision today at 2:00 pm. Bonds and MBS are up on a weaker-than-expected CPI number.

The FOMC decision is set to be released around 2:00 pm EST. The Fed is almost certainly going to hike by 25 basis points, but the economic forecasts and the fed funds forecasts (the dot plot) will be the focus. The language of the statement will come into play as well, but the dot plot will be the first thing traders will look at. Loan officers, be careful locking around then.

Mortgage applications fell 2.3% last week as purchases fell 1% and refis fell 3%. The 10 year bond yield inched up and mortgage rates hit their highest levels since March.

Prices at the consumer level rose 0.4% in November and are up 2.2% YOY. Ex-food and energy, they rose 0.1% MOM and 1.7% YOY. The Fed prefers to focus on the personal consumption expenditure index, not CPI. Energy prices rose smartly in November, and accounted for about 3/4 of the increase in the index. The core rate was a touch below expectations.

The House and Senate continue to work on reconciling their tax bills. It looks like the final compromise will result in a corporate tax rate of 21%, a mortgage interest cap of $750k, lowering the top rate to 37%, and setting the pass-through rate at 23%. Congress hopes to vote on a bill early next week, before Democrat Doug Jones, who won in Alabama last night, takes his seat.

If the mortgage interest deduction cap falls to $750,000 it probably shouldn’t make that big of a difference for home prices, and certainly not at the lower price points. Remember, the median house price in the US is about 1/3 of that number. But the bedroom communities of some of the bigger cities could see a softening, especially at the top end.

The lack of affordable housing is a critical problem in this country, and many advocates are worried about tax reform. Affordable housing is largely driven by tax benefits, and those benefits are a function of tax rates. Lower tax rates, and the value of the tax benefits fall. A second issue is that commodity prices are rising, which increases construction costs. Lumber is up almost 15% from the beginning of the year, and OSB products are up 30%.

Homeowners’ equity increased by 1.3 trillion over the past year ending in September, as the value of the housing assets rose to $24.2 trillion and outstanding mortgage debt rose to $10 trillion. Homeowner’s equity as a percentage of home value is pretty much back to pre-crisis levels. It has been mainly driven by home price appreciation, not decreasing mortgage debt, however.

Morning Report: Stirrings of inflation at the wholesale level 12/12/17

Vital Statistics:

Last Change
S&P Futures 2666.3 1.8
Eurostoxx Index 390.4 1.4
Oil (WTI) 58.4 0.5
US dollar index 87.3 -0.1
10 Year Govt Bond Yield 2.39%
Current Coupon Fannie Mae TBA 102.531
Current Coupon Ginnie Mae TBA 103.591
30 Year Fixed Rate Mortgage 3.88

Stocks are up this morning as we begin the FOMC meeting. Bonds and MBS are flat.

Inflation at the wholesale level came in slightly above forecast according to the Producer Price Index. The headline number was 0.4% MOM and 3.1% YOY. Ex-food and energy, it rose 0.3% / 2.4% and ex-food, energy, and trade services it was up 0.4% / 2.4%. This report confirms building inflationary pressures in the system. It won’t have an effect on this Fed meeting, but it is something to watch.

Speaking of inflation, one of the bigger complications for the Fed is the effect of Amazon on price discovery. Amazon (and the Internet in general) allow consumers to compare prices easily, something that was not possible a generation ago. Goldman tried to estimate the effect of the internet on core CPI, and they found it to be about 0.1%. All of the Fed’s inflation models were conceived pre-internet. While price comparison on the web is not the only reason why inflation is low, it is a new factor. Deflation is generally experienced in the wake of asset bubbles – Japan has experienced it for a generation, the US had low inflation from the Depression that lasted until the 60s, and we have had persistently low inflation since the residential real estate bubble burst. Low productivity hasn’t helped either, as productivity growth drives wage inflation.

Small business optimism hit the highest level in 34 years on tax reform according to the NFIB. “We haven’t seen this kind of optimism in 34 years, and we’ve seen it only once in the 44 years that NFIB has been conducting this research,” said NFIB President and CEO Juanita Duggan. “Small business owners are exuberant about the economy, and they are ready to lead the U.S. economy in a period of robust growth.” While small business didn’t add any workers last month, hiring plans increased, and difficulties in finding workers remains a big problem.

CoreLogic reported that delinquency rates in July were the lowest in a decade. The foreclosure inventory rate was 0.7%, down from 0.9% a year ago and is the lowest level since 2007. Delinquency rates are the lowest in the West, while New York has the highest. The Northeast judicial states like New York, New Jersey, and Connecticut still have a foreclosure inventory to work through. Lower oil prices were beginning to push up DQ rates in places like Alaska and Louisiana.

Congress hopes to pass tax reform by Christmas. The bill is in committee right now, where the House and Senate are trying to reconcile their differences.

Bitcoin mania: People are taking out mortgages to buy bitcoin. This will not end well. That said, can bitcoin double from here? Of course. Can it go to zero? Of course.

Morning Report: Job openings at 6 million 12/11/17

Vital Statistics:

Last Change
S&P Futures 2651.8 0.8
Eurostoxx Index 389.0 -0.2
Oil (WTI) 57.5 0.2
US dollar index 87.2 -0.1
10 Year Govt Bond Yield 2.37%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.92

Stocks are flat this morning after a bomb went off in New York City’s Penn Station. Bonds and MBS are up small.

This week will be dominated by the FOMC meeting on Tuesday and Wednesday. The markets are forecasting a 25 basis point hike in the Fed Funds rate, but the economic forecasts will be the focus, as well as the dot plot. It will be interesting to see the 2018 GDP forecast. The Fed was consistently high in their GDP estimates during the Obama administration, however their 2.1% forecast for 2017 looks to have been way light, given that the NY Fed just upped its Q4 GDP estimate to 3.92%. That would put 2017 GDP growth just shy of 3% for the year.

Job openings were largely unchanged at 6 million in October, according to the JOLTS survey. The hires rate increased to 5.6 million. The quits rate was unchanged at 2.2%. The quits rate is the most important number in this release, as increases in the rate usually correspond to increases in wage growth.

So far, the Fed’s tightening has had almost no effect on the market. In the old days, a couple Fed Funds hikes and you would start to see a slowdown. If anything, the economy is accelerating, not decelerating. JP Morgan believes that we won’t see a meaningful effect on the economy until we get to a real 1% Fed Funds rate, where “real” means inflation-adjusted. Currently, the Fed Funds real rate is negative (inflation is higher than the Fed Funds rate). Once the Fed Funds rate is 1.5% higher (or around 2.5%, we should see an impact, which makes that a 2019 event, not a 2018 event.

35% of new home sales in October were for homes that hadn’t even begun construction, the highest number since 2005. Shortages of skilled labor, along with increasing commodity prices are preventing new home sales and housing starts from being high enough to meet demand. Housing will almost certainly be the engine to propel US economic growth over the next few years.

Last week, a news story suggested that the Trump CFPB would back off the banks, referring mainly to Wells Fargo. He then tweeted that the story is false, and if anything, he would increase penalties on the banks for bad behavior.

Morning Report: Movement on housing reform 12/8/17

Vital Statistics:

Last Change
S&P Futures 2647.0 7.8
Eurostoxx Index 389.5 3.1
Oil (WTI) 57.6 0.9
US dollar index 87.3 0.0
10 Year Govt Bond Yield 2.38%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.92

Stocks are higher after a strong jobs report. Bonds and MBS are down small.

Jobs report data dump:

  • Payrolls up 228,000
  • Two month revision up 38,000
  • Unemployment rate 4.1%
  • Labor Force participation rate 62.7%
  • Average hourly earnings up 2.5% YOY

Overall a strong report, and probably good for the markets. The modest wage inflation will keep the Fed cautious, while slack continues to be taken up. That said, a rate hike is more or less a certainty next week. We probably won’t see any big pickup in wage inflation until the labor force participation rate gets back up to the 65% – 66% level.

In other labor news, job cuts increased slightly according to outplacement firm Challenger, Gray and Christmas, while initial jobless claims fell to 236,000.

Consumer sentiment edged up slightly in November, according to the University of Michigan survey.

Congress came up with a deal to keep the lights on for two weeks. The debt ceiling will have to be raised at some point, although the government can use cash on hand and other extraordinary measures to get through until Spring. Expect to see some conservative Republicans to balk at additional spending, which makes bringing aboard some Democrats a necessity. A deal with Democrats will involve an equal hike in defense and non-defense spending as well as some sort of immigration deal. A shutdown doesn’t seem to be in the cards, at least not yet.

With all the commotion going in Washington right now, it is easy to forget about housing reform, but Bob Corker and Mark Warner are beginning to come to a consensus over what the future of housing finance should look like. Fannie and Fred will remain, but the government will make it easier for new competitors to enter the market. Jeb Hensarling of Texas has moderated his stance on government guarantees of mortgages, which helped move things along. The goal is to keep the mortgage market more or less as-is for borrowers, while increasing competition in the secondary market and bolstering taxpayer protection. In one wrinkle, the Fannie Mae preferred shareholder might get some sort of recovery. The prefs were up 24% on the news, while the common fell slightly.

The FHA will no longer insure mortgages for properties that include Property Assessed Clean Energy (PACE) assessments.”FHA can no longer tolerate putting taxpayers at risk by allowing obligations like these to be placed ahead of the mortgage itself in the event of a default,” said U.S. Department of Housing & Urban Development (HUD) Secretary Dr. Ben Carson. “Assessments such as these are potentially dangerous for our Mutual Mortgage Insurance Fund and may have serious consequences on a consumer’s ability to repay, or when they attempt to refinance their mortgage or sell their home.” Dave Stevens of the MBA also welcomed the decision.

Ginnie Mae is tightening requirements on securitizations in order to combat the high prepayment speeds that the securities have been experiencing. They targeted VA IRRRLs last year by making IRRRLs that refinanced a loan less than 6 months old ineligible for standard securitizations. Ginnie is now including cash-out refis and FHA streamlines as well. Some MBS strategists have predicted that this will weaken demand for the higher coupon Ginnie Mae securities, which would mean that borrowers get less and less of a pickup in points for going higher in rate.

Morning Report: Productivity increases 12/6/17

Vital Statistics:

Last Change
S&P Futures 2625.0 -3.3
Eurostoxx Index 384.5 -2.3
Oil (WTI) 56.9 -0.8
US dollar index 86.8 0.0
10 Year Govt Bond Yield 2.32%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.88

There is a slight risk-off feel to the market today as stocks are lower and bonds rally.

Mortgage Applications rose 5% last week as purchases rose 2% and refis rose 9%. The average 30 year fixed rate mortgage dropped a basis point to 4.19%.

The economy added 190,000 jobs last month according to the ADP Employment Survey. The Street is looking for 204,000 jobs in this Friday’s payroll report. This ADP number is more or less close to the average for the past year. Moody’s Chief Economist Mark Zandi is warning that the job market could overheat next year, as he sees the unemployment rate going below 4%. Will that cause the Fed to start hiking rates more aggressively? Perhaps, but until we start seeing broad-based wage inflation and begin to see it flow through to prices the Fed will probably be content to gradually normalize policy and not push the economy into a recession.

Productivity rose 3% in the third quarter, according to BLS, as output increased 4.1% and hours worked increased 1.1%. Generally speaking productivity increases drive wage increases, although that relationship has broken down somewhat over the past 15 years or so. Unit labor costs declined 0.2% as the increase in productivity offset the 2.7% increase in wages. At a recent CEO roundtable, labor costs have taken over regulation as the top concern of Corporate America. Tax reform will probably encourage more capital investment to make workers more productive, and that should translate into wage inflation, although not necessarily into a larger number of workers.

As tax reform gets resolved, the next issue will be funding the government. It won’t take many conservatives to balk at funding the government to make Democrats necessary to keep the lights on. Democrats want some sort of immigration deal to go along with voting for a continuing resolution, which will be a non-starter for many Republicans. Don’t forget the last time we had a government shutdown, you couldn’t get 4506-Ts from the IRS, loan officers, plan accordingly.

Ray Dalio of Bridgewater warns that tax reform will cause an exodus from high tax states like California, New York, New Jersey, and Connecticut. Many big names in the hedge fund business have already relocated to Florida, where there are no state income taxes. Connecticut will be especially vulnerable, as it gets most of its revenue from one county. Meanwhile, NAR and Trulia warn that tax reform will hit property values in these high tax states, and will exacerbate the inventory shortage as it will discourage sellers. As I have said before, it may affect the higher end of the market in these areas, but the sub $750,000 sector should be fine. If anything, it might encourage those that are thinking of buying a million dollar home to lower their price point, which would increase demand in that sector. As a general rule, the multi-million sector in the Northeast has been moribund to begin with, and the multi-million sector in the West has been driven by foreign money and stock market appreciation.

Affordable Housing Advocates are also staunchly opposed to the new tax bill. Many for simple ideological reasons, however tax reform will affect the value of the tax write-offs that act as the incentive to build affordable housing. It will make affordable housing construction less attractive (and may turn it into a money-losing enterprise). Some groups claim that the home price appreciation has been so fast (especially in California) that it is creating a homelessness problem. A lack of affordable housing has been an issue for a long time, and tax reform certainly won’t make it less of one.

The hurricanes accounted for 10% of the country’s mortgage delinquencies. This is going to be a huge headache for lenders with servicing portfolios in Texas and Florida.

The emergence of fraud and swindles usually signals the top of bubbles. Liar loans and CDO squareds were the bell ringing at the top of the US residential real estate market. It looks like we are getting to see some of this in China as well, which has a residential real estate market of epic proportions. When China’s residential real estate bubble finally bursts, it will be a massive battle of wills between Mr. Market and Mr. Big Government. When Japan’s bubble burst, the government used all sorts of ham-handed methods to prevent a crash, and I wouldn’t be surprised to see China try some of the same things. Once China’s bubble bursts, they will export deflation to the world, which will keep inflation in check in the US, however it will also sap global growth. Luckily Japan seems to be picking up at long last (almost 30 years).

Morning Report: Toll Brothers misses 12/5/17

Vital Statistics:

Last Change
S&P Futures 2642.0 3.8
Eurostoxx Index 386.6 -0.9
Oil (WTI) 57.3 -0.2
US dollar index 86.7 0.1
10 Year Govt Bond Yield 2.39%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.88

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

Toll Brothers announced earnings this morning that missed analyst expectations. The sector has been on a tear this year, so weak earnings are expected to be punished by the markets. Revenues increased 9% and earnings increased 68%. The company used a lot of its cash to repurchase stock and bonds, which isn’t a great sign for future growth. Generally when companies are seeing great opportunities, they re-invest in the business. When they don’t, they buy back stock. The street didn’t like the guidance, and the stock is down about 6% pre-market.

Toll is in the luxury end of the housing market, covering McMansions in urban areas out West and luxury apartments in the East. The change in the mortgage interest deduction is probably going to impact demand. Note that the builders that focus on entry-level building are doing much better. For the past 10 years, the luxury end of the market was the only part that was working. Now the market is shifting to the first time homebuyer.

Speaking of the luxury end of the market, the New York Times frets about the effect tax reform will have on New York City. It turns out that 40,000 residents in New York City account for half the city’s revenue. If they leave, it will have a huge impact on the city’s finances. The people most affected will be those making over $200,000, and in a high cost area like New York City and the suburbs, that is not rich by any stretch of the imagination.

Factory orders fell 0.1% in October, ending a generally good month for manufacturing. Capital Goods orders were strong however, and that points to a stronger Q4 and 2018. Capital Goods orders are generally associated with business expansion, capacity increases, and modernization.

The services economy decelerated in November from a record in October, according to the ISM Non-Manufacturing Survey.

Tax reform heads to committee to resolve the differences between the House and Senate versions. Here are the biggest sticking points. The committee starts work on Monday, with an eye to have a final vote in Mid-December.

Home prices rose 0.9% MOM and are up 7% YOY, according to CoreLogic. The fastest growth continues to be in the West and Mountain states. Much of the Midwest remains undervalued while we are seeing overvaluation in places like Florida, Texas, and the West Coast. Note that fears about climate change are not evident in Florida real estate.

First time homebuyers are still relatively uninformed about mortgages. According to a recent survey, 20% of Americans think it is impossible to get a mortgage with less than 5% down, despite the fact that FHA goes down to 3%, VA allows nothing, and the GSEs have 3% down products. Most people get their information on the Internet, and surprisingly almost nobody gets their mortgage information from the CFPB.

How did HAMP and HARP help struggling homeowners? It turns out, not much. In fact, borrowers who had a principal reduction had pretty much the same default rates as borrowers without a principal reduction. These reductions were big: 32% or about $112,000 on average. These results pour cold water on the strategic default theory, which says that borrowers will choose to toss the keys to the bank once the home value is less than their outstanding mortgage. FWIW, I think the defaults in 2006 were strategic defaults, as the economy had yet to roll over and professionals were playing the greater fool game. Note that modifying a mortgage payment to a percentage of income didn’t really help either. The punch line is that many defaults were caused by a short term blip in a borrower’s financial situation – often an unexpected expense like a medical bill – and servicers should work on creating a solution to help the borrower over that hump and then re-evaluate.

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