All Things in Moderation

Markets are lower this morning on some disappointing economic data out of China. Bonds and MBS are up small.

Not a lot of big data this week, but we do have some stuff related to real estate. Tomorrow, we will get housing starts and building permits. On Thursday, we will get existing home sales and the FHFA House Price Index. We will also hear from homebuilder Pulte on Thursday.

The NAHB Housing Market Index rose to 64 in October from a downward-revised 61 in September. This is the highest reading since October 2005. Tight supply means that builders can increase average selling prices pretty easily. Unfortunately, since wage inflation remains muted, the median house price to median income ratio has become stretched again.

Everyone knows China has been dumping Treasuries, yet rates aren’t increasing. The reason why is that US firms are buying them. This means that (a) US investors are more making bearish bets on the US economy (b) the Fed will probably be watching this closely as a “tell” whether they need to raise rates, and (c) even if rates go up, you might not see any effect out on the curve, which means that mortgage rates might simply brush off any tightening for a while.

Deutsche Bank is beginning to discuss scenarios where the next move could be something like a re-introduction of Operation Twist, which is where the Fed sells short term T-bills to fund purchases of long term Treasuries.

Speaking of the Fed, Republican presidential candidate Donald Trump accused the Fed of keeping rates low for political reasons – to help Barack Obama and Hillary Clinton. Cleveland Fed President Loretta Mester fired back saying that politics is never a factor in their decisions. The political independence of the Fed is extremely important – no politician would ever argue that the Fed should hike rates. One thing to keep in mind however is that as we approach the election in 2016, the Fed will probably hold off on making any rate hikes late in the year to prevent the appearance of being political.

Markets are higher this morning as commodities continue to rebound. Bonds and MBS are down.

Import Prices fell 0.1% in September and are down almost 11% on a year-over-year basis.

Wholesale inventories rose 0.1% in August, while wholesale sales fell 1%. Both numbers were worse than expectations. The increase in the inventory to sales ratio is a worrisome sign., You typically see the ratio build ahead of a cyclical recession.

The FOMC minutes confirmed what everyone suspected – that international worries prompted the Fed to hold interest rates steady at the September FOMC meeting. Overall, the Committee seemed rather constructive on the US economy in general. The Fed Funds futures are currently handicapping a 10% probability of a hike at the October meeting and something like 40% in December.

Note that while the Fed is sanguine on the US economy, economists are generally more cautious. A survey of strategists and economists puts the chance of a US recession at 15% over the next 12 months. It is important to note that the Fed’s forecasts for economic growth have been consistently high since the Great Recession.

Representative Kevin McCarthy withdrew his name from consideration for the next House speaker after allegations of an affair ended up on a Wikipedia page. This leaves current speaker John Boehner in charge for the time being. Interestingly, the Wikipedia edit emanated from the US government itself – someone in the Department of Homeland Security. After the Secret Service started distributing confidential information on Representative Chaffetz, it looks like the worker bees in the government are going directly after Republican politicians. It will be interesting to see if anyone in the Obama administration actually cares.

Hillary’s plan for the financial system. A surtax on banks with over $50 billion in assets, an increase in the statute of limitations for financial crimes, and toughening the Volcker rule regarding proprietary trading.

Note that margin debt is falling on the stock exchanges. This could be a reaction to the turmoil in overseas markets. Generally speaking margin selling tends to exacerbate downward moves, so having less margin debt is actually a good thing.

The share of foreign homebuyers is at an 8 year low in California.

Markets are lower this morning on overseas weakness. Bonds and MBS are up.

Third quarter earnings season starts tonight with the traditional report out of Alcoa.

Initial Jobless Claims fell to 263k last week, the lowest since July.

The minutes from the September FOMC meeting will be out at 2:00 pm EST. Be aware of possible bond market volatility as the market digests it.

The Bloomberg Consumer Comfort Index rose to 44.8 from 43 last week.

Fannie Mae is announcing further reps and warranties guidance for loans starting Jan 1. It will include new alternatives to repurchase if the loan has a defect. The government is sick and tired of tight credit, especially at the lower end of the credit spectrum. These are intended to ease credit by giving lenders more certainty. The government is clearly worried given that the big banks like JP Morgan are backing away from FHA originations.

A case for allowing student loan debt to be discharged in bankruptcy is winding its way through the courts. There is about $1.2 trillion in student loan debt outstanding.

It looks like a strike at Fiat-Chrysler has been avoided. It sounds like the union got some of what they wanted so we could start seeing the beginnings of increasing wages.

Larry Summers makes the case for going big on expansionary fiscal policy. His argument is that China’s slowdown threatens to drag the global economy into a secular stagnation similar to what Japan has been going through. He argues that monetary policy is pretty much played out: rates are at zero, and the stimulative effect of additional QE with the 10 year at 2% would be de minimus. He argues for a new “New Deal” where the government deficit spends on infrastructure spending. Of course this isn’t a new idea in the modern age: Japan has been doing precisely that for 25 years and has nothing to show for it except for a debt to GDP ratio of 2.3x. That would be like the US spending $40 trillion over 25 years. Before we advocate spending that kind of money, we should figure out  why it hasn’t worked in Japan.. And if over 1 quadrillion yen is not enough, then what is? We need a better answer than the un-falsifiable “More Cowbell.” If the Rx only works in theory, then maybe the answer is to just slug it out until the economy corrects on its own.

Mortgage applications rose 25% last week as purchases rose 27%% and refis rose 24%. That is a surprising result given the Bankrate 30 year fixed rate mortgage rose 5 basis points last week. Some think that it was partly TRID-driven.

Janet Yellen’s intention to let the labor market run hot for a few years has some Fed watchers worried. The criticisms range from fears about creating another 1970s – style inflationary environment to worries about the Fed’s credibility. We are in uncharted territory with the amount of control central banks worldwide are exercising over the economy. FWIW, I do not see much in the way of similarities between the 1970s and today: capacity utilization is low, and the chance of an oil shock is pretty remote. In fact we have the exact opposite situation. The inflation hawks make the case that monetary policy acts with such a lag that the die may already be cast for higher inflation (a similar argument that some of the global warming alarmists make with respect to CO2 in the atmosphere) The other point is more valid: the evidence that the Fed can influence wages and labor force participation is weak and the Fed is setting up unrealistic expectations that could damage its credibility down the road.

Of course the other unintended consequence of ZIRP is the pressure it puts on pension funds. That probably is going to be the next crisis. We saw this movie before, in the 1950s.

As we contemplate higher interest rates, foreigners are selling US Treasuries. While economic fundamentals will ultimately matter more than foreign fund flows, but it looks like foreign investors are cutting exposure ahead of higher rates. It probably will affect volatility, as primary dealers have pulled back market-making activity and Treasury markets have become less liquid in general.

Now that house prices are approaching the 2006 peaks, some are arguing that we are in another bubble. Affordability is down as wages have gone nowhere, and scarcity is driving up prices. FWIW, bubbles are psychological phenomenons – the occur when buyers (and lenders) believe an asset is special and cannot go anywhere but up. We won’t see another housing bubble in the US, but our grandkids might.