All Things in Moderation

Vital Statistics:

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

No economic data this morning, but we will get some inflation data this week with the consumer price index and the producer price index. Janet Yellen also delivers her 2 day Humphrey-Hawkins testimony on the Hill on Tuesday and Wednesday. My hunch is that monetary policy will take a backseat to banking regulation as the main subject of questioning. Note that top Fed banking regulator Daniel Tarullo has announced his resignation. Tarullo was viewed as a tough regulator (and was disliked by the industry for opacity and for changing the rules in the middle of the game. GE executive and former deputy to Hank Paulson David Nason is the front-runner to replace Tarullo.

Donald Trump will get to fill 3 Federal Reserve Board governorships (maybe 4 as Lael Brainard is rumored to be resigning as well). It is unlikely that he will go with nominees in the mold of Janet Yellen and will choose business leaders instead of academics to fill those seats. While Trump criticized the Fed on the campaign trail as keeping rates too low for too long, there isn’t a politician on the planet that likes a hawkish Fed. In fact, if Trump is successful in making big fiscal changes to the fiscal situation in DC, then he may prefer to have a more dovish Fed to keep rates low.

Foreign investors are dumping Treasuries, although this has been going on for almost a year, so it is hard to characterize it as Trump-related. Foreign selling has been absorbed by US domestic money managers, which has lowered the impact. Ultimately, the Fed is probably driving it: While the Fed sees the light at the end of the tunnel for QE and extraordinary stimulus, the ECB and the Bank of Japan are still in the middle of it. While the US has some of the highest yields in the world, it is at the biggest risk of a big bond market sell-off. The cost to foreign investors in hedging the US currency is also extremely high. For example, a Japanese money manager isn’t getting 2.44% when they buy a Treasury. It turns out to be around 90 basis points when you add in hedging costs.

Treasury Secretary nominee Steve Mnuchin looks like he will get past the Senate today.

The Washington Post has a good run-down on potential changes to Dodd-Frank. Overall, the reforms center on the Volcker Rule, the CFPB, and small banks. The paper obtained a memo from Jeb Hensarling which discussed some of the reforms. The biggest component is the financial CHOICE act, which allows banks an exemption from some of the Dodd-Frank restrictions (think prop trading) if they raise more capital. The CFPB would continue to be run by a single director who could be fired at will by the President. It will also have some restrictions on rule-making and enforcement, making it look more like the Federal Trade Commission. The CHOICE act probably has enough votes to clear the House, but getting it through the Senate will be a challenge.

Professional economists are still scratching their heads over the lack of wage growth in the economy. If we are truly at full employment, the laws of supply and demand say that wages should be increasing. This is the biggest driver for the Fed, so getting it right is important. If the Fed tightens in expectation of wage inflation that was never going to arrive in the first place, they could choke off the recovery. The Bank of Japan made the same mistake twice since 2000. My sense is that the term “full employment”is a misnomer. Yes, we are at full employment according to the Bureau of Labor Statistics, but that is because we no longer count the unemployed once they hit 6 months without a job. They are still unemployed, however and that shadow inventory of workers colors the mindset of both workers and employers.

There is some concern about Ben Carson as the leader of HUD, and what he intends to do with respect to affordable housing. Carson doesn’t have a large body of work discussing housing policy, however he has made some contradictory statements, referring once to efforts by HUD to change local zoning laws as “social engineering” yet mentioning local regulatory impediments to housing affordability in his testimony to Congress. What these regulatory impediments are is anyone’s guess. They could be zoning restrictions, environmental restrictions, or even things like open space requirements. Obama’s HUD was very aggressive in suing localities to change their zoning laws, and we will have to see if that continues. Overall, the Federal government doesn’t have a lot of influence over local zoning rules. and has gotten nowhere in ultra-blue Westchester County NY, even with the the carrot of Federal housing money and the stick of lawsuits.

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Vital Statistics:

Stocks are following through on yesterday’s strength. Bonds and MBS are down small.

President Trump made some comments about corporate tax reform which brought back the Trump reflation trade, at least for a day or two. While everyone agrees we need corporate tax reform, in practice it is going to be a lot harder than it looks, simply because almost everyone has some sort of tax break they don’t want to give up. An undertaking this big will also need some things to bring Democrats onboard, so it will probably be watered down. Initial price talk is a corporate tax rate of 20%, with an exemption on overseas earnings, and some sort of border adjustment tax. As you can imagine, some industries will love this new arrangement, while others will hate it.

Import prices rose 0.4% last month and are up 3,7% YOY. Ex petroleum, they are down small. We will be getting more inflation data next week with the consumer price index and the producer price index.

Consumer sentiment slipped in the preliminary reading for February. It came in at 95.7 after a January reading of 98.5. The drop was almost 100% in the future expectations index, as the current conditions index was more or less flat. Perceptions of Donald Trump and his effect on the economy was pretty much split: 30% favorable, 29% unfavorable.

A top Fannie Mae official (Brian Brooks) is reportedly being considered to replace Richard Cordray as Director of the CFPB. Another possibility is Todd Zywicki, an economist with the Mercatus Center. Discussions are preliminary as the future of the CFPB remains up in the air.

The Mortgage Bankers Association plans to lobby Congress to turn the GSEs into private utilities and allow new entrants to compete on the same terms, meaning their securitizations will have a government backstop as well. Partisan politics will be an issue, as Republicans want to government backstop to become smaller, and Democrats worry about the social mission of the GSEs falling by the wayside.

The Spring Selling season is more or less beginning now, and tight inventory remains the biggest issue. A second problem is mismatched markets, where there is a disconnect  between what buyers want and what is available for sale. Affordable starter homes are the biggest problem, as builders have focused on the luxury end of the market since 2008. Luxury was the only segment that worked for builders post-crisis, but 10 years on, the boomers that bought McMansions are looking to downsize, and the Millennials are beginning to start families.

Millennial women are more likely to use FHA loans than men. Not sure why – it could be any number or reasons: income, education, lenders highlighting them more. Worth watching, however.

Realtor.com has some good advice for the first time homebuyer. Hint: you don’t need 20% down.

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Vital Statistics:

Stocks are up marginally on no real news. Bonds and MBS are down small.

Initial Jobless Claims came in at 234k last week, which is the lowest number since November. Note that the last time initial jobless claims were this low, the Vietnam War was being fought. When you adjust for population growth, we are at record levels. Note that Census has been revising downward its previous estimates for population, as the net immigration numbers have turned out to be lower than initially thought.

Here is the chart for initial jobless claims:

And now initial jobless claims divided by population (in .000s). Record low.

We have some Fed-speak today with James Bullard this morning and Charles Evans in the afternoon. Probably won’t be market moving, but be aware.

The latest trend in banking? People-less branches. You walk in and deal with someone via videoconference. “This is the beginning of the end of the American bank branch,” said Peter Fitzgerald, a former U.S. senator from Illinois, lifelong banker and founder of Chain Bridge Bank in McLean, Va. “Bank branches are dead. They were killed by the iPhone. It’s like the horseshoe when the automobile came along.” Indeed, the iPhone is changing mortgage banking as well, as the Millennial Generation prefers to not interact with humans.

Once of the changes Donald Trump is making to financial regulation is subtle, but important. Typically regulators have to conduct a cost-benefit analysis of new regulations, in order to determine whether the proposed regulations do more harm than good. That requirement was largely ignored by the Obama administration. He is bringing that requirement back, which would require the government to take into account things like restrictions in credit, lost GDP from less lending, and the impact on consumers and financial choice. In fact, a study from Goldman found that low income borrowers and small businesses bore the greatest cost of financial regulation.

While regulation is couched in terms (and intention) to be about public protection, in practice it often acts as a barrier to entry which restricts competition rather than it is something that benefits the public. In fact, restricted credit is only of the big things that is an issue in housing construction. Big publicly-traded homebuilders can borrow all the money they want in the bond market at exceptionally low rates, while smaller builders (who are banked by the smaller guys) cannot borrow because the smaller banks are hamstrung by the regulators. Remember, we haven’t had a 1.5 million year in housing starts (which was normalcy from the sixties until the crisis) since 2006.

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Vital Statistics:

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

Job openings were largely unchanged MOM at 5.5 million, according to the BLS’s JOLTS report. On a year-over-year basis, they were up 4.2%. Hires ticked up slightly, while separations fell. The quits rate ticked down to 2.0% from 2.1% in November and 2.2% last year. This will give some comfort to bond investors as well as the Fed, as an increase in the quits rate usually leads an increase in wage growth.

Home prices rose 0.8% MOM and are up 7.2% YOY according to CoreLogic. They foresee a deceleration of home price appreciation in 2017, with a 4.7% increase. The action was in the Pacific Northwest and Mountain states, with Washington, Idaho, Oregon, Colorado, and Utah leading the charge. Here is a map of the overvalued (red) and undervalued (green) MSAs:

Rising home prices and mortgage rates have hit affordability, which is the lowest in 7 years, when you use the metric of mortgage payment on the median house to median income ratio. Much of the hit took place towards the end of last year as as rates spiked post-election. Tight inventory is driving the price increases, not incomes, which means current prices are vulnerable if wages don’t increase. Eventually builders will start more construction, but as of now they are still holding back.

Economic confidence improved last week according to the Gallup Economic Confidence Index. January was the highest month since 2008. More people are feeling engaged at work, but future expectations drove the index. Despite all the sturm and drang out of Washington, Americans are shrugging it off. Other indices like the VIX, as well as gold prices (despite what the article below says) are confirming this. Separately, Fannie Mae’s Home Purchase Sentiment Index improved two points last month. Most notable in that survey: the net share of people reporting significantly higher household income growth in the past 12 month increased by 5 percentage points. Also, bankruptcy filings are the lowest since 2006.

On the other hand, Washington insiders and journalists (especially) are not feeling that way. Donald Trump has upset the traditional way things are done, and that has a lot of pros spooked. That said, I think creating a confidence index based on the use of the word “uncertainty” in business articles speaks more towards the predilections of journalists than it does to the markets as a whole.

Fixing Dodd-Frank will take some time, along with repealing and replacing Obamacare. Democrats are vowing to go to the mattresses on both, although I think Obamacare will be where the war is going to be fought. As I have said before, I suspect there is enough bipartisan agreement to do something on Dodd-Frank, at least with regards to small bank regulation. Reforming the CFPB is expected to cleave down partisan lines, although the Courts may be forcing Congress’s hand there. Much of the change is going to be done non-legislatively, in how the agencies interpret and enforce the law. Democratic Party priorities like disclosing the pay difference between CEOs and the rank and file are simply going to go by the wayside.

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Vital Statistics:

Stocks are lower this morning as credit spreads widen in Europe. Bonds and MBS are up.

The week after the jobs report is usually data-light and this week is no exception. We have no data this morning, and about the only report of consequence is the JOLTs job opening report tomorrow. All eyes will be on the quits rate, which has been pretty steady. An increase would signal wage inflation ahead.

Goldman strategists are beginning to re-think their initial bullishness on the Trump administration. Instead of tackling things like tax reform, he is spending his energy on immigration and trade. There is a realization that gridlock is going to be the norm for the next two years, and that means no big, sweeping changes. Regulatory relief is still possible, but bureaucrats seem to be preparing to push back against major changes in direction. So the “Trump effect” could end up being a lot smaller than investors (and the Fed) were thinking a month ago. Which means the Fed has more room to be cautious.

MBS investors are beginning to worry about what happens to MBS when the Fed stops re-investing maturing proceeds from its QE portfolio. After all, the Fed has been the biggest buyer of MBS paper. Will the lower demand for mortgage backed securities translate into higher mortgage rates, even if the 10 year goes nowhere? It is possible, however take a look at the chart below: I plotted the 10 year yield and the 30 year mortgage rate, with the difference between the two (the spread) below. The two blue shaded regions were QE1, 2 and 3. The green line didn’t really move all that much during QE. MBS spreads are about where they were prior to QE. Since the Fed isn’t entertaining selling bonds, just not buying them anymore, the pre-QE level of something like 167 basis points is about right. Right now, the spread is 177 basis points, which probably represents some of the lag you see in mortgage rates versus Treasuries. My point is that MBS spreads vary over time, but they have historically been around these levels. I can’t see MBS spreads making or breaking a homebuying decision. They just aren’t that significant.

On Friday, Donald Trump signed an executive order which directed a review of Dodd-Frank. There were the expected breathless headlines in the business press (with a stroke of a pen, Donald Trump eliminates Dodd-Frank, he’s “gutting” Dodd-Frank), however this is just a “review and report back to me” order. A full repeal of Dodd-Frank would be impossible, and probably would not be supported by the industry: after all, they have spent the past 6 years getting compliant with D-F and the last thing they want to do is have to adopt some new system. The unintended consequences will be addressed, but the structure will probably remain in place. These will turn out to be addressing the CFPB and small banking regulation in order to get credit flowing for smaller borrowers, addressing the Volcker rule to encourage market making, and the fiduciary rule, which many financial advisors interpret as a gag order and a limitation of the investment options menu. What does this mean for the mortgage business? Probably not much, although the biggest potential is in an easing of CFPB enforcement and an increase in mortgage products as the private label securitization market returns.

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Vital Statistics:

Stocks are up after a decent jobs report. Bonds and MBS are up as well.

Jobs report data dump:

• Nonfarm payrolls up 227,000
• 2 month prior revision down 39,000
• Unemployment rate 4.8%
• Underemployment rate 9.4%
• Labor force participation rate 62.9%
• Average hourly earnings up 0.2% MOM / up 2.5% YOY

Overall, a pretty decent report. Payrolls were much better than expectations, although the downward revision of 40,000 to November offset that somewhat. The employment to population ratio ticked up from 59.7 to 59.9, which is something the Fed pays close attention to. The year-over-year increase in wages took a step back, but part of that is due to very strong January 2016 number which fell off the YOY comparison. In terms of industries, we saw big increases in construction and retail. The oil patch is hiring again as well. In some ways this was a Goldilocks type report: strong enough to make the stock market happy, and weak enough in wage growth to keep bonds from selling off.

The ISM non-manufacturing index took a step back in January from December’s strong pace. Factory orders increased 1.3%.

President Trump has ordered a comprehensive review of Dodd-Frank and suspended Obama’s fiduciary rule executive order which was to take effect in April. The goal of the review is to remove regulatory burdens to the financial industry and to increase investor options, according to an administration official. Areas of focus include reforming the CFPB, the Volcker rule, and the fiduciary order. Critics claim that the CFPB is restricting credit, the Volcker rule is restricting liquidity in the markets, and the fiduciary rule amounts to a gag order for retirement advisors.

US CEOs are meeting with Donald Trump today, as the relationship between the two becomes more tenuous. The problems are twofold. First, the left is organizing boycotts on any company associated with the Trump administration, while culminated in Uber’s CEO resigning from Trump’s business panel after the #deleteUber campaign. Second, fears of immigration limits are worrying many, particularly in the tech space. Finally Trump’s naming and shaming of companies via Twitter is causing uncertainty as well.

Interesting article in the Wall Street Journal about the future of the labor market and the business world’s continued move towards outsourcing, even within the US. Companies like Pratt and Whitney are now using UPS to handle parts of the logistics chain that used to be done by Pratt and Whitney employees. This obviously gives the company more flexibility and they don’t have to deal with the HR issues of hiring and firing. Temporary worker agencies continue to grow and allows companies to have “just in time” employee management. Accenture sees a future where the only full time employees at some companies are C-level: the rest will be temps. I wonder if it will work out the way these companies imagine however. Once these agencies control vast parts of the company’s operations, the agency will be able to hold up a company for higher rates the way unions used to hold up companies for higher wages.

Freddie Mac has a somewhat gloomy outlook for origination next year, forecasting a drop of 25% from 2016’s level of $2 trillion in origination. They see the 30 year mortgage rate averaging 4.4% and total home sales falling from 6 million to 5.75 million. House price growth is expected to moderate to 4.7% from 6%. Freddie Mac is baking in some possibility of expansionary fiscal policy coming out of Washington, especially with respect to tax reform, where an increase in the standard deduction will reduce the incentive to itemize and reduce the subsidy from the mortgage interest deduction. They do point out that increases in interest rates have been generally short-lived over the past 8 years as slow global growth and excess savings find their way into the bond market. Freddie Mac caveats this outlook with the fact that the new administration provides a lot of uncertainty. FWIW, it is looking like it will take 60 votes to get anything done in the Senate, which means a fiscal status quo. That will likely mean only 2 hikes in 2017, not 3. Rates may not be going up as much as people think.

You can see the refinanceable population has decreased significantly as rates have risen:

The CFPB had another setback in the PHH case.

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Vital Statistics:

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

The Fed maintained interest rates at current levels and made no changes to its reinvestment policy. The statement itself was relatively dovish, which caused a small rally in bonds in the afternoon. The money quote: “In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.” There was no mention of Washington, and a slight reference to improving sentiment.

Productivity remains a problem as it increased at an anemic 1.3% pace in the fourth quarter. Output increased 2.2% and hours worked increased 0.2%. Unit labor costs increased 1.7% as wages and compensation increased 3% and productivity increased 1.3%. Part of the problem is that business capital expenditures have been in maintenance mode since the financial crisis. Morgan Stanley believes that sentiment is changing, and that means more capital expenditures going forward. Higher productivity means higher non-inflationary wage growth, which translates into higher standards of living. Note the recent divergence between capital expenditure plans and actual spending.

Announced job cuts increased to 45,934 in January, according to outplacement firm Challenger, Gray and Christmas. The holiday season was atrocious for many bricks and mortar retailers, and some are shuttering stores and declaring bankruptcy. Macy’s accounted for almost a quarter of the layoffs. The energy patch is finally on the mend and hiring again.

Initial Jobless Claims fell to 246,000 last week.

The homeownership rate ticked up to 63.7% in the fourth quarter after hitting a 52 year low in the second quarter. Overall, the homeownership rate for 2016 was the lowest since records began in 1965.

NAR took a look at the aspiring homeowner in its latest survey. Affordability was the #1 reason for people not owning a home, followed by flexibility concerns. That said, 88% of non-owners eventually do want to own a home. There still seems to be a disconnect between what people think they need (as far as a downpayment) versus what is actually required. FHA loans remain the best way to get these people their first home.

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