All Things in Moderation

Vital Statistics:

Markets are weaker this morning after some disappointing economic data out of Europe. I guess people were hoping for a little bit more out of the Bernank regarding further stimulus when he testified in front of Congress yesterday. The trade deficit narrowed as imports and exports fell by 1.7% and .8% respectively. Bonds and MBS are both up a little. Overall, it feels like a typical Summer Friday and I would expect most of the Street to be on the L.I.E. by noon.

The Fed voted yesterday to accept the Basel III framework. Rob Chrisman has a good piece on how Basel III will impact mortgage pricing. Essentially the new treatment of mortgage servicing rights will force big lenders like Wells to lower the price they are willing to pay for servicing released premiums. In plain English, this means that Basel III has imposed a higher cost on the banks that will be passed on to borrowers. The Fed estimates that the 19 largest US banks are about $50 billion short of meeting new capital requirements, but they also note that these rules will become fully implemented by 2019 and that most banks should be able to meet the new capital requirements through retained earnings and won’t need to raise more capital.

Fannie Mae notes in its National Housing Survey that consumer sentiment seems to be plateauing as we head into the summer selling season. Roughly 1/3 of the respondents expect home prices to rise in the next 12 months and 72% believe now is a good time to buy.

The FHA is planning to announce a bulk sale program today. However, they want to deter “vulture investors” by requiring that the loan buyer to wait 6 months to foreclose and to agree to keep at least half the REO for 3 years.

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Vital Statistics:

Markets are higher this morning after China cut interest rates to boost their economy. The benchmark lending rate will drop from 6.56% to 6.31%, effective tomorrow (such precision!). The allowed discount from the benchmark was widened from 10% to 20%.  Initial Jobless Claims in the US came in at 377k, more or less in line with expectations. Bonds and MBS are flat.

Given last Friday’s dismal jobs report, the market was definitely concerned about the Fed’s Beige Book survey which was released yesterday afternoon. Overall, the tone of the report did not confirm fears of an imminent slowdown. The Fed reported that “overall economic activity expanded at a moderate pace” and that “Economic outlooks remain positive, but contacts were slightly more guarded in their optimism.”

In another positive datapoint for the real estate industry, homebuilder Hovnanian reported better than expected earnings yesterday, with a 50% increase in backlog and a 52% increase in contracts. Perhaps this portends the rise in housing starts and construction we have been waiting for since 2008.

To get an idea how cheap stocks are compared to bonds right now, consider the fact that the 10 year yields about 1.65%, while the dividend yield on the S&P 500 is 2.2%. A dividend yield (let alone earnings yield) higher than the 10-year is a rare event. If you look at the ratio of the 10 year to the dividend yield, it reached  just over 60% last week, and the last couple times it reached that level (2008 and fall of 2011), it portended a huge stock market rally. At any rate, it seems to trigger asset allocation decisions and may account for some of the velocity of the moves in the S&P futures and the bond futures. It also means buy stocks and sell bonds.  Or borrow money long term.

Chart:  Ratio of the 10-year bond yield to the S&P 500 dividend yield:

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Vital Statistics:

S&P futures are higher this morning on hopes of further stimulus in Europe.  The ECB left interest rates unchanged. The world seems to be backing away from the ledge a little, selling government bonds and taking more risk. Mortgage rates moved lower only grudgingly last week, so we should expect them to stay more or less stable as the 10-year yield backs up. Nonfarm productivity came in lower than expected, as did unit labor costs. The Fed’s Beige Book will be released mid-afternoon.

CoreLogic’s April Home Price Index showed a year-over-year gain of about 1%.  Excluding distressed sales, they rose almost 2%. They also introduced a new metric – the Pending Home Price Index – which indicates the trend in prices. This month, the Pending HPI predicts another 2% from April to May. Month-on-month increases are normal seasonal behavior, but year on year increases are more a sign that prices are bottoming.

Clear Capital is reporting more or less the same thing in its June Home Data Index Market Report. It notes that national home prices grew on both a quarterly and yearly basis for the first time since August 2010. Dr Alex Villacorta, Director of Research said:  “While gains in national home prices over the quarter and year were minimal in May, there are encouraging trends continuing to play out and gaining momentum beneath the surface.  Strength in REO-only price trends as well as some early indications of price gains spreading from low tier sections to the mid, and higher priced homes is helping confirm that the country continues to make progress on its recovery, and we are expecting to see improvements extend of the next several months.” RTWT.

Given that the mortgage market more or less IS Fannie, Fred, and Ginnie the question now is what to do with them. The Community Mortgage Lenders Association has sent a white paper to the government recommending that we reduce the GSE’s involvement in the secondary market to around 33% and that there be an explicit backstop fee paid to the government. 

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Vital Statistics:

S&P futures are up 3 points after having been down 12 points in the overnight session. A drop in Euro sovereign yields seems to account for the better tone. China’s non-manufacturing PMI dropped to 55.2 in May from 56.1 in April, indicating that their economy is decelerating. The 10-year yield has increased to 1.5% and mortgage backed securities are down a tick.

This week will be a relatively data-light week, in contrast to last week (especially Friday). However, there will be lots of Fed-speak all week and investors will be parsing each statement for further clues regarding QE.  It may turn out that the Fed conducts Operation Twist by purchasing MBS instead of Treasuries.

One of the reasons why this recovery has proven to be so unsatisfying has been the lack of construction activity, which usually leads the economy out of a recession. The Atlantic has a chart that shows construction jobs as a percent of total jobs is at levels not seen since 1946.

Laurie Goodman of Amherst Securities weighs in on how regulators are creating a credit crunch.

Chart:  Construction jobs as a percent of total jobs:

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