All Things in Moderation

Buy the rumor, sell the fact. Markets are down small after the government came up with a deal to keep the lights on. Lousy earnings from Goldman aren’t helping things. Bonds are rallying as the Fed is probably on hold for a while.

So the shutdown is over. Democrats won a few month reprieve before we go through this whole process once again. Republicans won a minor concession that the government will try and prevent fraud with obamacare subsidies. We’ll see if this is where the Tea Party finally jumped the shark. I suspect it is.

If you want a deeper dive into this, I discussed this along with a whole host of other issues on Louis Amaya’s Mortgage Markets Today show yesterday. You can hear it here:

http://www.blogtalkradio.com/capitalmarketstoday/2013/10/16/debt-ceiling-explanation-and-implications

Initial Jobless Claims came in at 358k, a drop of 16k, but higher than expectations. It appears California is still working through its computer issues.

It is looking like tomorrow will be the day when we will get all the of the economic reports that have piled up since the shutdown. The biggest of course will be the employment report we were supposed to get two weeks ago. We will also get industrial production, consumer and producer prices, retail sales, inventories, housing starts, amongst other reports. So tomorrow could be market moving in a big way.

Fannie Mae priced a $675 million risk-sharing deal yesterday, the first of its kind. Investors will share in the guarantee fee and will bear some of the credit risk of the underlying mortgages. Given the underlying bonds were all very recent vintages, with very tight underwriting, investors were aggressive in bidding the paper. The senior tranches went for L+200. The mezz tranches went at L+525. This is part of a deal to wean Fannie Mae off the government and to “crowd in” private capital into the mortgage markets.

The Fed released its Beige Book report yesterday. Pithy punch line: Moderately modest.

Markets are higher this morning on optimism that a deal is unfolding in the Senate. Bonds and MBS are down. The Mortgage Bankers Association reported that applications increased .3% last week.

Last night, Fitch put US sovereign debt on rating watch negative. “Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default”

Harry Reid and Mitch McConnel are finalizing plans to raise the debt ceiling through Feb 7 and fund the government through Jan 15. Technically the government runs out of money tomorrow, however independent analysts say that the real D-day is November 1. Note that T-bills maturing Oct 31 are trading with a yield of 36 basis points, which means the market is discounting the possibility that they get paid late. Both sides have been making small concessions to get a deal done. Of course the wild card is the House, and whatever solution that comes out of the Senate will leave obamacare largely intact. Note, as I write this, Bloomberg is saying that the T-bills maturing 10/31 now yield 52 basis points.

The dog that didn’t bark – shadow inventory. People have been warning of mass dumping of REO properties, but it never occurred, and now shadow inventory is working its way down. Regulators never forced the banks to write down / dispose of bad assets like they did after the S&L crisis in the late 80s. Billions of dollars were raised to capitalize on this, and the flow has been a slow trickle. Second, judges have been slow to approve foreclosures, particularly in the Northeast. This explains the wide disparity between home price appreciation in the West, where the shadow inventory has largely been worked off and the Northeast.

Bank of America announced 3Q earnings this morning, and came in better than expected. The pipeline ended the quarter down 59% quarter on quarter. Production was $465m vs $860 in Q2 based on lower gain on sale margins and a reduction in rate lock volume. 78% were refis.

Markets are flattish after Citi missed and Coca Cola and Johnson and Johnson beat earnings expectations. The Empire Manufacturing Survey came in at 1.52. Bonds and MBS are down

The Senate appears close to a deal on the government shut down and the debt ceiling. The plan would fund the government through mid-January, and extend the debt ceiling until early February. Obamacare would remain largely intact, although Republicans were able to extract a concession that would force the government to verify that people are eligible for subsidies. Democrats also want to delay a tax on existing policies which is on Big Labor’s wish list. This whole thing is designed to take the pressure off and allow the government to enter into budget negotiations. Another round of spending cuts is scheduled to take effect at the beginning of the year, with defense bearing the brunt of it. Of course the problem is not in the Senate, but the House. Will the requirement that the government try and prevent fraud in obamacare enough to get the Tea party onboard? We’ll see.

What date actually matters for the debt ceiling? The government says Oct 17, when the government exhausts its borrowing authority. The Bipartisan Policy Center estimates that sometime between Oct 22 and Nov 1 the government will be unable to pay all the government’s bills on time. And Bank of America is saying that by Nov 15, default is more or less inevitable.

Surprisingly, T-bills make up only 13% of the $11.6 trillion in marketable debt outstanding, the smallest share since Eisenhower was president. This is due to the Fed’s Operation Twist as well as government extending duration to take advantage of low interest rates. Such short supply has had the shorter dated T-bills trading with negative yields for brief periods of time.

Speaking of T-bills, the 1 month T-bill has been getting hammered as we approach the debt ceiling, with the yield increasing from basically zero a month ago to 33 basis points a few days ago. It is heading back down, but it is worth keeping an eye on it. Investors are dumping the short end of the curve as major banks have been discussing which T-bills they may restrict as collateral for repo transactions.

Stock markets are weaker this morning as a deal fails to emerge over the weekend. The bond market is closed.

No deal emerged over the weekend, and it appears Democrats are moving to the left as they want to address the sequestration cuts. Not sure if this is just a negotiating posture or something they intend to hold on to. Supposedly we will hit the debt ceiling this week. Republicans offered a 6 week clean extension of the debt ceiling over the weekend, with the government remaining shut. This was rejected by Democrats.

Earnings season kicks off in earnest this week, with heavyweights like Coca Cola, Citi, Johhny John, Goldman, Google, and GE.

Markets are flattish after yesterday’s rally on the possibility of a deal on the debt ceiling. Bonds and MBS are rallying.

John Boehner and Obama met to discuss a 6 week clean extension for the debt ceiling. The government “shutdown” would remain in place.Neither side agreed to anything.

Earnings season is upon us, and we heard from Wells Fargo and JP Morgan this morning. Wells reported residential mortgage originations were $80 billion for the third quarter, down 29% from the $112 billion in the second quarter. JP Morgan reported a loss due to legal expenses. Their origination volume decreased 18% from the prior quarter.

The government is re-thinking how it releases market-sensitive economic data. Under the current system, the government releases data to the media under an embargoed basis – the reporters have an hour to write their reports and then the data is released to the market. At issue is the fact that high frequency traders have paid for high speed transmission lines to media outlets and they get the raw data a few milliseconds before everyone else does. The idea would be for the government to release the data directly to the media so no one gets a jump on market moving reports.

Monday is a bank holiday and the bond market will be closed, although the equity market will be open. Should be a slow news day.

Markets are higher on talk of a short term bump in the debt ceiling. Bonds and MBS are selling off.

Initial Jobless Claims increased to 374k. The jump was attributed to the unwinding of a computer problem in California and furloughed government employees.

The debt ceiling machinations are beginning to have more effects – in Hong Kong, the exchange increased the haircut on T-bills citing default concerns. Jack Lew is in front of the Senate Banking Committee this morning warning about the risks of not raising the debt ceiling. FWIW, Bill Gross is a buyer.

There was nothing earth-shattering in the FOMC minutes, which were released yesterday. On housing, they mentioned that the sector continued to strengthen, but they were worried about the increase in rates and what effect it would have. They noted the recent weakness in housing starts. The debt ceiling / government shutdown was mentioned as a further risk to the economy. Their estimates for GDP growth were taken down by 30 basis points.

On Page 8, they discuss the thought process behind the decision not to taper at the September meeting. For the most part, they were disappointed at the economic data and the ones who supported no changes to QE felt that reducing asset purchases would harm the housing recovery and the economy in general. The ones who were supported a reduction in QE were in favor of reducing it because they worried about sending mixed messages to the market, not because they were satisfied with the economy or were worried about inflation or asset bubbles. Because they sent the signal in June that they planned to reduce purchases and the market internalized it, they felt like they had to follow through, or else risk credibility at the Fed. They were worried about creating uncertainty. So here is the takeway, at least for me. They don’t want to end QE, they don’t even want to reduce it, but you may see a small tweak at the December meeting, just to prove that the Fed’s communications about its intentions can be relied upon. And if the economy continues to stagnate, that may be it for a while.

Markets are up small after Alcoa kicked off earning season with good numbers. Bonds and MBS are down small.

Mortgage Applications increased last week by about a percent, according to the Mortgage Bankers Association. The refi index was up about 2.5%, while the purchase index fell small.

The FOMC minutes will be released at 2:00 pm EST. In the absence of economic data this will undoubtedly take on more importance.

In a move that surprised exactly no one, Obama is expected to name Janet Yellen to replace Ben Bernanke when his term expires in January. Basically it means Alan Greenspan’s third term. Yellen is a dove, a bigger dove than Bernanke, who was a bigger dove than Greenspan. Expect fawning support from the media due to the groundbreaking nature of the nomination. (If only Janet Yellen had been running the Fed, we wouldn’t be in this mess – never mind that while Ben Bernanke just spiked the punch bowl, Janet will be adding oxycontin to it.) The extra juice will have the Street singing Dammit Janet.

The shenanigans regarding the debt ceiling are not being felt in the 10-year, but they are being felt in the 1 month T-bill. The yield has increased from almost zero in mid September to 29 basis points currently. Any sort of default will wreak havoc in the repo market as defaulted securities are ineligible to be used for collateral. That has the makings of a credit crunch and bears watching. If there is one thing that is sure to get the market’s attention it would be liquidity problems somewhere because someone can’t roll over their repo lines.

Markets are flattish this morning on no real news. Bonds and MBS are down. Earnings season kicks off after the close with Alcoa.

China and Japan are warning the US not to default on its debt. China holds just under 1.3 trillion of US Treasuries. Beijing warned that “the clock is ticking” and urged Washington to get its act together to “ensure the safety of the Chinese investments.” The White House says it is open to a short-term increase in the debt ceiling, which may allow us to kick the debt ceiling can to the end of the year while we figure out the government shutdown. However, both sides are dug in, with the White House insisting on a clean debt ceiling increase, and John Boehner insisting that some spending cuts have to be a part of any deal.

Corelogic is reporting there were 48,000 completed foreclosures in August, down 34% year-over-year and up 1.3% from July.The shadow inventory is estimated to be 1.9 million homes. 2.1 million mortgages, or 5.3% of all mortgages are seriously delinquent, the lowest level since November 2008. The Northeast, Florida, and Nevada have the highest foreclosed inventory.

Corelogic also released its 2013 mortgage fraud report. They estimated that $10.5 billion of mortgage applications had fraudulent information in the first half of 2013. The mortgage fraud index decreased 5.6% nationally on a year-over-year basis. They identify six types of fraud – employment, identity, income, occupancy, property, and undisclosed debt. Income fraud is the highest risk, while property fraud is the lowest.

The National Federation of Independent Businesses say that optimism fell in September as pessimism about future business conditions increased. Small business optimism is still well below pre-crisis levels. Keep this in mind when you start hearing blowout earnings numbers from the S&P 500 companies. Many of them are overseas earning stories and you shouldn’t draw too many conclusions from their strength.

Chart: NFIB Small Business Optimism Index

Markets are lower as the government shutdown stretches into Week 2. Bonds and MBS are rallying. Earnings season kicks off with Alcoa tomorrow. We will hear from JP Morgan and Wells on Friday.

On Wednesday, we will get the minutes from the September FOMC meeting. Should make very interesting reading, although the shutdown pretty much means tapering is off the table for a while.

Back of the envelope calculations:  The drop in government spending is about 13% from the shutdown because most government functions, specifically entitlements, are still being done. So, on a 3.8 trillion budget, 13% amounts to just a hair under 500 billion for the year, or about 9.5 billion a week. On a 16 trillion GDP, that amounts to 6 basis points of GDP. Tack on a government spending multiplier of 1.3 and you get about 8 basis points of fiscal drag for each week the government is shut down.

Ginnie Mae has denied rumors that the Ginnie Mae I MBS is about to be sunsetted. Ginnie Mae I securities have usually traded at a premium to Ginnie II MBS but have been trading at a discount since May when rates started backing up. The other security which is rumored to be going away is the Freddie Mac (or Gold) MBS. This would simplify the MBS market into conforming and Ginnie.

The debt ceiling debate is going to get ugly. The Administration has said it will not negotiate on the debt ceiling. John Boehner has said he doesn’t have the votes to pass a clean debt ceiling increase. While it seems easy to just decide which checks to write and which ones not to, it is actually a knotty piece of re-programming at Treasury to do that. And with the government shut down, it is even more difficult. Still nobody thinks the US will fail to make interest and principal payments. The Bipartisan Policy Center has a really good breakdown on the shutdown and debt ceiling issue