All Things in Moderation

Vital Statistics:

Stocks are higher this morning after a strong GDP report out of China. Bonds and MBS are up.

There isn’t much in the way of market-moving events this week with a sparse economic calendar and the Fed is in the quiet period ahead of their FOMC meeting next week.

Inflation at the consumer level remains below the Fed’s target as the consumer price index was flat MOM and up 1.6% YOY. Ex-food and energy, it was up 0.1% MOM and 1.7% YOY.

Retail sales disappointed, falling 0.2% MOM. The prior month was revised upward however from a drop of 0.3% to a drop of 0.1%. The Street was looking for 0.1% gain. The control group fell 0.1% versus expectations of a 0.4% gain.

Industrial production rose 0.4% MOM while manufacturing production rose 0.2% and capacity utilization ticked up to 76.6%. Improvements in the mining sector accounted for the rise.

Business inventories rose 0.3% as autos increased. Inventory will amount to a slight positive in the Q2 GDP report. The inventory-to-sales ratio is at 1.38, which is elevated compared to historical norms and would ordinarily be associated with a downturn in the economy.

The Empire State Manufacturing Survey fell to 9.8 last month, but is still reasonably strong.

Earnings season gets into full gear this week, with a lot of the big banks reporting.

Wells Fargo reported better-than-expected earnings last week. The stock was down about 2% on the news, despite the earnings beat as improvements in credit quality were offset by high expenses. Mortgage origination was down 11% YOY to $56 billion, while applications fell 13% and the size of their pipeline fell 28%. Nonconforming loans rose by $7.3 billion, while second mortgages fell. Mortgage banking revenues fell 19%, however which indicates margin compression.

Mortgage banking revenues at JP Morgan and Citi also fell by 26% and 52% respectively.

Defaults are soaring for subprime auto loans, as the sector has hit new post-crisis highs. While subprime auto loans are not going to have the impact on the economy that subprime mortgages did, this is a tell that all is not necessarily well in consumer-lending land. Despite the aggressive underwriting in auto loans, mortgage credit remains tight as a drum. The auto loan issue is yet another one of the unintended consequences of Fed policy: many of the biggest investors in this sort of paper are pension funds, insurance companies, etc, who have to hit a return bogey and cannot earn enough in government and investment grade paper to meet their actuarial obligations. Many of the state pension funds are solvent only if you squint at the asset return assumptions.

Mortgage credit eased a touch in June, according the the MBA Mortgage Credit Availability Index. Conforming and non-conforming credit eased while government credit tightened.

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Vital Statistics:

Stocks and bonds are sporting their rally caps on Janet Yellen’s prepared testimony in front of Congress.

The big event of the day will be Janet Yellen’s semiannual testimony in front of the House Financial Services Committee. Expect the focus to be on the tightness of the labor market and why we have yet to see any real wage inflation. Both sides will also try and get her to agree with their viewpoints on banking regulation. Here are her prepared remarks.

The statement that jumped out to me was this: “That expectation is based on our view that the federal funds rate remains somewhat below its neutral level–that is, the level of the federal funds rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel. Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.” That is a dovish statement, and bonds took off, especially the long end of the yield curve. This sentiment was echoed by Lael Brainard as well.

The Fed Funds futures reacted to the remarks by assigning a 91% probability of no move in September and assigning a 53% chance of no move in Decsember. These are about 9-10 basis points higher than they were last week.

Minneapolis Fed President Neel Kashkari is skeptical that the economy is close to overheating, and he believes that wage growth will happen once labor is scarce. The fact that wages aren’t really increasing leads him to believe there is still plenty of slack in the labor market, despite some shortages in certain skills.

Donald Trump Jr. met with a Russian lawyer last year who supposedly had dirt on Hillary Clinton. Turns out the info mainly concerned the Ziffs and was tangentially related to the Clinton Foundation. Interpretation of the gravity of this is predictably falling along partisan lines. PIMCO is warning that this could affect markets since it makes bipartisan consensus less likely in DC, but that ship has sailed. Note stocks went out on their highs yesterday, which indicates the stock market assigns zero import to the latest “bombshell.”

Mortgage Applications fell 7.4% last week as purchases fell 3% and refis fell 13%. The index does include an adjustment for the 4th of July holiday, however many people took off on the Monday prior. Interest rates did rise on the back of a European bond sell-off, which hurt production.

RBS reached a settlement with the FHFA for $5.5 billion related to toxic MBS securities from the go-go days.

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Vital Statistics:

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

Job openings fell slightly in May to 5.7 million, according to the BLS. The number of hires increased by 430k to 5.5 million. The quits rate increased to 2.2 million. The quits rate is a key indicator that carries a lot of weight with the Fed. An increase in the quits rate usually is an indicator of future wage inflation. The quits rate is back to pre-crisis levels.

Small business optimism declined in June, according to the NFIB. We are still higher than we were pre-election, but some of the optimism is fading as it looks like tax reform and healthcare reform are not going to happen. Employment-related indicators ticked down, but are still very strong. 85% of all respondents that tried to hire reported that there were few or no candidates with the required experience. Rising compensation will draw more people into the workforce, however that will be a slow process. Note that much of the drop in the labor force participation rate has been due to people aging out. The first big question is whether these people want back into the workforce or are content to stay retired. The second big question is whether ageism will keep these people out.

Consumers are becoming more optimistic according to the New York Fed. Nearly 35% of all respondents said they are better off now than they were a year ago, and they are less worried about losing their jobs. Consumers also said they expect to spend about 3.3% more in the coming year than they did last year.

Are appraisers going to be replaced by artificial intelligence and / or algorithms like Zillow’s Z-estimates? Some people think so. Zillow has been tweaking its model to take into account more than just the comps – now it will include things like interior amenities. This may happen out of necessity: the regulators raised the barriers to entry so high that the pipeline of new people entering the profession is almost nothing (In 2005, 1,200 people entered the profession. Now it is 100). The average age of an appraiser is 58 and there simply isn’t a stream of replacements. Freddie Mac is now willing to accept model-generated appraisals for some refis and is asking FHFA for permission to use more. It kind of begs the question of why the government then thinks appraisers need to have so much education and apprenticeship time if it is willing to accept modeled values to begin with.

Mortgage performance improved last month according to CoreLogic. 4.8% of all mortgages were 30 days down in April compared to 5.3% the year prior. That said, early stage delinquencies (30 – 60 days down) ticked up to 2.2% from 2% the year before. 60-90 day DQs were roughly flat YOY. Some of the drop in performance is coming from the energy-intensive states like Alaska and North Dakota. Now that oil cannot seem to get out of its own way, we may start seeing more trouble in the oil patch.

The CFPB has released a new rule making it easier for class-action suits against lenders. Financial firms will be restricted in their ability to use mandatory arbitration clauses to protect themselves against lawsuits. Under the Congressional Review Act, Congress has 60 days to overturn the new rule. The OCC has asked the CFPB for their data, and Republican Jeb Hensarling has already come out against it.

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Vital Statistics:

Stocks are higher this morning after a decent jobs report. Bonds and MBS are down.

Jobs report data dump:

• Nonfarm payrolls up 222,000
• Unemployment rate 4.4%
• Labor Force Participation rate 62.8%
• Avg weekly earnings up .2% MOM and 2.5% YOY

Overall, it is a decent report. The payroll number was a bit higher than expectations. The wage numbers are certainly nothing to get the Fed worried about inflation, although we still aren’t making much headway on bringing the long-term unemployed back into the labor force. Bringing those folks back into the workforce is the key (along with improving housing construction) to improving the economy from “meh” to “boom.”

The bifurcation in the employment market between those with jobs and those without is evident in what recruiters are saying: It is the hottest market in memory for some headhunters and things are definitely candidate-driven. Companies have been loath to give raises for over a decade, but they may be forced to in order to attract / retain talent.

Ray Dalio and Jeffrey Gundlach believe the top is in for the bond market (in other words, rates are going higher) and that stocks are vulnerable. Being short bonds is probably one of the biggest fast-money / wiseguy trade on the Street right now. Note however that notwithstanding the pop in yields over the past week or so, most of these guys are lugging a losing position.

Federal Reserve Governor Jerome Powell called the current US housing system unsustainable, and pointed directly at Fannie and Fred. Here is the problem: US mortgage rates are artificially low, and that is due to government subsidies. The 30 year fixed rate mortgage is a distinctly American phenomenon. In the US, the taxpayer bears the credit risk and the lender bears the interest rate risk. Loans are guaranteed by the government, which means the lender gets paid even if the borrower stops paying. The 30 year fixed rate means the borrower has no interest rate risk – it doesn’t matter where rates go, their rate stays the same. Everywhere else, the lender bears the credit risk and the borrower bears the interest rate risk (because everywhere else the rate floats with interest rates after a certain time period). Without the government backing, no lender would make loans at the rates Fannie and Fred can offer. His point is that real estate prices are based on subsidized borrowing rates and that makes the real estate market more susceptible to downdrafts. Nothing is going to change however – the US residential real estate finance market has been largely the same since the New Deal and there really is no replacement for it. Just remember this any time someone blames 2008 on the “free market.” There is nothing, absolutely nothing “free market” about the US residential real estate market. There hasn’t been since the Great Depression.

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Vital Statistics:

Stocks are down this morning along with overseas markets. Bonds and MBS are down as European bond markets sell off.

The German Bund is getting whacked this morning after a lousy French auction and is up 10 basis points in yield to 55 bps. The Bund yield is at the highest level since early 2016, and this is pulling yields higher globally.

The FOMC minutes didn’t reveal anything market-moving. The Fed still plans to raise interest rates gradually, and there is some disagreement between members over when and how to begin balance sheet normalization (which is their term for letting bonds mature and not re-investing the proceeds). It looks like they will gradually reduce reinvestment activity, not stop all at once. The proposed idea would be to reduce reinvestment of Treasuries by $6 billion a month and increase that in increments of $6 billion every 3 months until they hit $30 billion. For MBS, it will be $4 billion a month, increasing in $4 billion increments every 3 months until they hit $20 billion a month. The FOMC members were divided over timing, with some wanting to move in Q3, while others want to begin in Q4.

The September Fed Funds futures didn’t move in response to the minutes, but the December futures did move more towards a higher probability of a rate hike. December is pricing in a 42% chance of no changes, a 47% chance of a 25 bp hike and a 10% chance of a 50 bp hike.

The overall economic outlook was positive, however residential investment “appeared to be slowing after increasing briskly in the first quarter.” The Fed suspects that weather, along with homebuyers getting ahead of expected interest rate increases drove the bump in Q1. The staff also noted that the market seems to be handicapping a smaller chance of fiscal expansion.

Mortgage Applications increased 1.4% last week as purchases 3% and refis fell 0.4%. The refi share continues to decline and the ARM share is ticking up slightly, however it is still in the single digits.

The ADP payrolls number came in lower than expected, at 158,000 versus expectations of 180,000. The consensus for tomorrow’s payroll number is 170,000. Note that lately the ADP number has been a lousy predictor of the BLS numbers.

Employers are hanging on to their employees, according the Challenger and Gray Job Cuts report. While job cuts continue in retail, overall they remain low, at 31k. Note that these numbers come from press releases, where companies announce job cuts they expect to make. They aren’t actual job cuts. Meanwhile, initial jobless claims ticked up slightly to 248k.

Redfin has filed for an IPO. For those keeping score, Blue Apron has been an unmitigated disaster, trading at $8.31 a share after going public last week at $10.

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Vital Statistics:

Stocks are up small after the long weekend. Bonds and MBS are down.

At 2:00 pm we will get the minutes from the June FOMC meeting. There is the always the possibility of market movement from these things, so just be aware. Here are the things the markets will be looking for.

Construction spending was flat MOM in May and up 4.5% YOY. Private residential construction was up 11% YOY.

Manufacturing continues to accelerate, according the ISM PMI report, which hit a 3 year high. The index level would historically correspond with a 4.6% increase in GDP. The average for the first half of the year would correspond to a 4.1% increase in GDP. Of course manufacturing doesn’t have the share of GDP it used to, but it is a good indication that things are getting better.

Bond yields have been backing up, largely on overseas events. Bonds in Europe are selling off and dragging US yields higher on the relative value trade. The current projections for the upcoming FOMC meetings have become slightly more in favor of rate hikes, but we are still looking at no change at the July meeting, and only a 18% chance of a hike in September. The markets are also looking to the September meeting for more clarity regarding balance sheet reduction.

Home Price appreciation continues to accelerate, as the CoreLogic home price index rose 1.2% MOM and is up 6.6% YOY. Rental inflation rose 3.1%, so the increase in home prices is a bit of a double-edged sword. Those who already own homes are getting the benefit of home price appreciation while the first time homebuyer is squeezed.

Upcoming changes that will affect mortgage credit. Tax liens and civil judgements will be expunged from credit reports, which could amount to a 20 point increase in FICOs for some people. Second, Fannie Mae is increasing the DTI ratio from 45 to 50 in order to take into account high levels of student loan debt.

HUD is recommending that Fannie Mae tweak upward its affordable housing goals for 2018-2020. Most goals are unchanged, but a couple were pushed up slightly.

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