All Things in Moderation

Vital Statistics:

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

Pending Home Sales rose 1.5% in June, according to NAR. On a YOY basis, the index is up half a percent. Housing inventory is down 7% YOY.

Freddie Mac explores the issue of tight inventory and asks why builders aren’t adding much supply. The issue largely concerns labor, especially skilled labor. The bust laid off about 1.5 million construction employees, who ended up finding new jobs in different sectors of the economy (especially the energy sector). These people are probably not coming back to the construction sector without some sort of catalyst. Second, young people don’t seem all that interested in working construction, and the ones that are cannot pass a drug test. Tighter immigration enforcement and the economy in general have led to a drop in immigrants, who have historically been about 25% of the construction industry. Land costs as a percent of new home costs have been rising as well, which is creating pressure on margins. Land use regulations are also stretching out the time it takes to work through the permitting process.

Speaking of drug tests, a factory owner in Ohio says they have plenty of jobs, but can’t find people who can pass the drug test. 40% of their applicants cannot pass a drug test.

The Fed plans to unveil soon its recommendation to replace LIBOR. LIBOR had been the benchmark interest rate for all sorts of variable rate products for decades, but had one fatal flaw: it was set based on self-reports from a consortium of investment banks. The problem is that the bank could say it was pricing LIBOR at a rate that it wasn’t prepared to actually honor. Since banks have all sorts of products that are pegged to LIBOR, they have an incentive to manipulate the measure in order to get the most favorable mark for their own positions. The group is recommending a broad treasury financing rate based on Treasury repos. This rate will be based on what people are actually paying for financing in the markets, not a survey. There are something lie, $330 trillion of derivatives and loans (everything from mortgages to student loans) that are pegged to LIBOR.

New documents bolster the case for Fannie Mae shareholders that the government lied when began to sweep all of Fannie’s profits. The cover story was that Fannie was in a “death spiral” and this was necessary to hasten the wind-down of their business. The documents show Tim Geithner saying that Fannie will be earning strong revenues and can support the 10% dividend for years into the future. Does that mean shareholders will get anything? They probably shouldn’t, as the government maintained a 20% public minority stake only so it didn’t have to consolidate Fannie’s debt on its own balance sheet. Under any sort of bankruptcy scenario shareholders would have been wiped out. The stock is a litigation lottery ticket.

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Vital Statistics:

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

The advance estimate for second quarter GDP came in at 2.6%, in line with expectations. This is an increase from the first quarter estimate of 1.2%. Personal consumption increased 2.8%, while the price index increased 1% while the savings rate inched down. This should give the Fed the room to maintain interest rates at this level if they choose to do so.

The employment cost index rose 0.5% in the second quarter and is up 2.2% YOY. Wages and salaries increased 0.5% and benefit costs increased 0.6%.

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

I had some questions yesterday regarding LIBOR and what happens to ARMs once it is gone in 2021? The short answer is that nobody knows for sure. The US will probably migrate to some other repo rate to set short term rates. Perhaps once LIBOR goes away, there will be a LIBOR reference rate which is pegged to whatever short term rate is being used and will move at a constant spread to that rate.

I was discussing housing affordability a couple days ago and talked about mortgage payments as a function of income over time. I showed that the post bubble days hit 40 year lows (at least) and that we are still well below historical levels. The issue with that analysis is that it ignores the tax effects of the mortgage interest deduction, which really mattered in the late 70s / early 80s when tax rates and interest rates were much higher. Up until the mid 80s, the marginal tax rate for the median income was between 22% and 24%. It has been 15% ever since. Also, when interest rates were much higher, the vast majority of your payments for the first few years went to interest, not principal – in fact when mortgage rates were 17%, 99% of your first year’s payment went to interest. Today, that number is much lower, and even ticked below 70% in 2012. Check out the chart below:

That chart also speaks to how much quicker one can build equity simply by paying their mortgage on time. Back in the 70s / 80s, you were probably lucky to have enough home price appreciation and principal paid to cover your closing costs if you moved after a few years. Today, you have both strong home price appreciation and a higher principal payment percentage. This helps emphasize how real estate is a great way to build wealth.

Here is the chart comparing the gross percentage of income that a mortgage payment consumed over time and also the tax effected percentage: As you can see, it is pretty linear, and we are still in a great position now compared to 30 years ago.

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Vital Statistics:

Stocks are higher after the Fed maintained existing policy yesterday. Bonds and MBS are flat.

As expected, the Fed kept the Fed Funds rate the same. The statement was almost identical to the June statement. The September Fed Funds futures went to a 100% probability of no hike, and the December futures went to a 51% chance of no hike. The Fed said balance sheet reduction will begin “relatively soon.” The consensus seems to be that “relatively soon” means September. The Fed Funds futures are hinting that as well, by going to a 0% probability of a rate hike, which means they are betting September will the meeting where tapering is announced. One complicating factor will be the debt ceiling hike, which will be happening around that time. If we get a stand-off, we might see the Fed punt until the December meeting.

June Durable Goods orders were up big on aircraft. The headline number was an increase of 6.5% MOM and 16% YOY. Ex-transportation, they were up 0.2% MOM and 6.8% YOY. Core capital goods orders (a proxy for business capital expenditures) fell 0.1% and are up 5.6% YOY.

Initial Jobless Claims ticked up to 244k, while the Chicago Fed National Activity Index rebounded to .13.

The UK banking regulator has decided to kill LIBOR by phasing it out by 2021.

Freddie Mac changed its guidelines on Home Possible Loans. No gift money until 3% down.

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Vital Statistics:

Stocks are higher this morning as oil rallies. Bonds and MBS are flat.

The FOMC decision is due out at 2:00 pm EST. Be careful locking loans around that time. No change in interest rates is expected, however the language in the statement always has the potential to move markets. You are starting to see some movement in the Dec Fed Funds futures, with the market currently handicapping a 48% chance of no change, 47% of 25 bps and a 5% chance of 50 bps between now and then. Sep futures are stuck at 92% chance of no change and an 8% chance of a 25 basis point hike.

Mortgage applications rose 0.4% last week as purchases fell 2% and refis increased 3%. Mortgage rates in general fell about 5 basis points during the week. ARM share increased to 6.8%.

Despite all the consternation in DC, consumer confidence continues to rise. The Consumer Confidence index rose to 121, largely on the strength of the jobs market. The number of people who think jobs are “hard to get” fell to 18%, while those that think jobs are “plentiful” rose to 34%.

New Home Sales ticked up to 610k in June, which is up 9% on a YOY basis.

Homebuilder Pulte reported earnings yesterday. Orders were up 12%, and backlog was up 19%. They did warn on gross margins, as wildfires in Canada are pushing up framing lumber prices. Pulte has a national footprint, but it is big in the Midwest, which shows that things are picking up in that part of the country.

D.R. Horton reported earnings as well. Orders increased 13% and backlog increased 5%. Tight labor markets are affecting margins. D.R. Horton is more exposed to the South and Southwest, and therefore will be more sensitive to what is going on in the oil patch.

Since the election, the XHB (S&P Homebuilder ETF) has been on a tear, increasing 23% since the election.

The House is expected to use the Congressional Review Act to overturn the CFPB’s recent rule on mandatory arbitration. It is expected to fall 100% on partisan lines. In the Senate, all Democrats are expected to vote against overturning it, and there are a few Republicans who are undecided.

Interesting stat on GNMA servicing portfolios since 2014. Down 25% at major banks, up 15% at smaller banks, doubled at non-banks. GNMA servicing rights have been weighed down by the costs of FHA delinquencies as well as higher than expected prepayment speeds due to the VA IRRL program. The government recently changed the rules for quick IRRL refis, but servicing values have yet to rebound.

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Vital Statistics:

Stocks are lower this morning as earnings continue to come in. Bonds and MBS are flat.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. No change in rates is expected, however the language in the statement always has the potential to move markets, so just be aware. We will have some important data, especially in housing, as well as GDP this Friday. No data this morning, however.

Affordable housing advocates will be spending the week marching and discussing the need for more affordable housing, as well as advocating for no cuts the HUD’s budget. The biggest proposed cut to HUD involves the Community Development Block Grant program, which famously funds Meals on Wheels, but is in reality just funds pet projects in various districts, especially in the counties surrounding DC.

The Fed will probably discuss tapering this week, which concerns letting its portfolio of bonds bought during quantitative easing to mature. The European Central Bank is also contemplating doing something similar. While there is concern that tapering will push up longer-term interest rates, these are probably overblown. Certainly QE did not affect mortgage backed spreads much at all, and tapering will be a fraction of what full-blown QE was.

Existing Home Sales dropped 1.8% in June as tight inventory is driving up prices and affecting affordability. The median home price increased 6.5% to $263,800. This puts the median house price to median income ratio at about 4.4x, which is elevated. That ratio peaked at 4.8x during the bubble, and fell to 3.3x during the bust years. Historically that number has been in the 3.2x-3.6x range, although you have to correct for interest rates, which does affect affordability. You can see the index of home prices versus incomes diverging again.

Total housing inventory fell to 1.96 million units, which represents a 4.3 month supply. A balanced market is usually around 6 month’s worth. Affordability concerns also hurt the first time homebuyer, who fell to 32% of sales, down from a 33% the prior month. All cash sales were down to 18% from 22% the year prior. The REO to rental trade might be driving that as professional investors stop buying. In fact, pros should be looking at selling – prices are elevated.

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Vital Statistics:

Stocks are flat this morning on another Summer Friday. Bonds and MBS are flat.

Should be a dull day as much of the mortgage business is at the Western Secondary conference, there is no data or Fed-Speak, and the rest of the Street will be on the LIE by noon.

What states still have the highest foreclosure issues? New Jersey is the worst, with 1% of all homes in some state of foreclosure. They are followed by DE. MD, IL, CT, NV, FL, SC, OH, and NM. Note there isn’t a lot of overlap between these areas and the best places to start a business.

Republicans in Congress plan to use the Congressional Review Act to overturn the Obama-era CFPB ruling that eliminates mandatory arbitration. The left wanted to overturn mandatory arbitration in order to make it easier to use class-action lawsuits to attack what it considers bad corporate behavior. The right worries that it will restrict credit, and amount to nothing more than a sop to the trial lawyers lobby.

Are we beginning to see the stirrings of wage inflation” Certainly at the low end of the wage scale we are. We are also starting to see wage inflation at the high end, where there are shortages of skilled labor. The middle is still lumbering along at 2.5% wage growth or so – better than inflation, but not all that satisfying. Especially since rental costs are outpacing inflation due to tightness in the real estate market. I have said this before: getting housing starts up fixed two major problems: lack of middle class jobs and a tight real estate market. Both would go a long way towards making the economy feel better.

Further to the above, Axios has a cool moving graph that demonstrates the malaise in the jobs market over the past decade. It plots the number of jobs on the vertical axis and wages on the horizontal axis. You can see in some professions where both the number and the wages have been falling.

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Vital Statistics:

Stocks are up this morning as global central banks remain easy. Bonds and MBS are up small.

The Index of Leading Economic Indicators jumped 0.6% in June, which is forecasting an acceleration in the economy going forward.

Initial Jobless claims fell to 233k, which is a 9 week low. The last time we were at similar levels was the early 1970s, when the Vietnam War was still raging. I have plotted initial jobless claims (left axis) versus wage inflation (right axis). You can see the inverse correlation, and it also suggests that with claims this low, we should be seeing wage inflation. Of course inflation has an influence as well, and the late 60s / 70s were characterized by inflation. However, pressures seem to be building, and we are seeing wage inflation at the lowest end of the spectrum – low wage workers.

Bill Gross looks at the shape of the yield curve and warns investors not to read too much into it, since the curve is being manipulated by central bankers worldwide. The chart below shows the difference in yield between the 10 year bond and the 3 month T-bill. That difference has historically been somewhat predictive of recessions, especially when it has inverted. While the current spread is nowhere near zero, the trend is certainly heading that way. Does that mean a recession is imminent? His point is that we are really in an apples-to-oranges comparison with QE. Global central bank buying of sovereign debt is pushing that spread downward, and the relevant question is where would the yield curve be without the Fed’s (and other global central banks’) buying?

He does make the point that Corporate America is more leveraged than before, however with rates so low, the debt service (actual interest paid) is much less than it was historically. You see that in households too. Total debt has risen past the old highs, however the debt service (interest paid as a percent of disposable income) is close to the lows.

The NYC luxury real estate market is soft, and many luxury sellers in Greenwich, CT are pulling the plug on sales. Of the homes in this market ($4.5 million+) days on market was 319, up by over 100 days. Some sellers have had to cut their price by 60% to entice a buyer. FWIW, I see very little building in this area of the country – only a handful of spec homes have been built, and they haven’t sold yet.

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Vital Statistics:

Stocks are higher this morning as the ECB starts its two day meeting. Bonds and MBS are flat.

Bonds staged a strong rally yesterday after the Senate was unable to repeal and replace Obamacare. Obamacare repeal was to be the source of funds for infrastructure spend and tax reform, and this failure largely means the rest of the Trump reflation trade is pretty much dead.

Mortgage applications rose by 6.3% last week as purchases rose 1% and refis rose 13%. Treasury yields fell last week on dovish comments by Janet Yellen.

Housing starts rose to 1.22MM and building permits rose to 1.25 million. Starts were up 8.3% MOM and 2.1% YOY. Activity rebounded in the Northeast and the Midwest while falling in the South. The West was unchanged. This is a strong rebound after a terrible May. Tariffs on framing lumber are increasing home construction costs, just as the first time buyer re-enters the housing market. Historically starts have averaged around 1.5 million a year, which largely explains the current housing shortage. In reality, we should be closer to 2 million a year, which is typical for a post-recession rebound.

CNBC discusses the pros and cons of a 30 year mortgage versus a 15 year mortgage. Yes, the payments on a 30 year will be lower, but the interest paid over the life of the loan will be much higher. One thing worth remembering: you tend to get a decent drop in rate for moving from a conforming 30 year to a 15 year. That pickup is much, much smaller on a FHA or VA loan, due to the illiquidity of 15 year TBA. The one thing the article doesn’t really touch on is inflation. US Treasuries are priced as if inflation is never, ever coming back – if you are buying Treasuries at 2.27%, you are really betting that “this time is different,” which are the 4 most dangerous words in investing. If you can borrow money for 30 years at under 4%, you will almost assuredly see inflation running hotter than that at some point during the mortgage’s life. The world’s central bankers are on a mission to create inflation. Eventually they will succeed.

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Vital Statistics:

Stocks are lower this morning after healthcare reform fails. Bonds and MBS are up small.

We are in the summer doldrums, with not much in the way of news or movement. Monday was so dull it felt like a 3 day weekend in the markets.

Obamacare repeal (and the lower spending that ensued) was going to be the source of funds for infrastructure spend and tax reform. So that pretty much sticks a fork in the Trump reflation trade. This should send rates lower, at the margin. Don’t forget the 10 year was trading below 1.9% before the election. Economists now see an even risk of overshooting and undershooting their GDP forecasts, the highest since the election.

The Fed Funds futures aren’t really reacting to the news yet, with September futures pricing in only an 8% chance of a hike and the Dec futures pricing in a 47% chance of a hike.

The Senate is considering a last-ditch attempt to simply repeal Obamacare without a replacement and then try and create a healthcare plan from scratch.

Import prices fell 0.2% in June and are up 1.5% YOY. Export prices are down 0.2% as well and up 0.6% YOY.

Homebuilder confidence slipped in July, according to the NAHB. “Our members are telling us they are growing increasingly concerned over rising material prices, particularly lumber,” said NAHB Chairman Granger MacDonald, a home builder and developer from Kerrville, Texas. “This is hurting housing affordability even as consumer interest in the new-home market remains strong.”

The House Appropriations Committee approved a bill to reform the CFPB. The biggest change will be to bring the agency under the normal appropriations umbrella, although there will be language regarding payday lending and mandatory arbitration.

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