All Things in Moderation

Vital Statistics:

Stocks are up on the last trading day of the year. Bonds and MBS are flat.

Yet another slow news day.

Should be a dull day for bonds as the market closes at 2:00 pm EST. There is no economic data or Fed-speak either.

Oil has topped $60 a barrel, which is higher than it has been for the past 3 years, but is pretty low in the grand scheme of things. It is something to watch, however as oil prices are a drag on the economy when they get too high. The US has so much capacity however that whenever prices rise, additional supply can come on line in a hurry. The US is pretty much insulated from OPEC any more.

What is the value of all US homes in the US? Almost $32 trillion, or more than 1.5x US GDP.  Over the past year, they have increased in value by almost $2 trillion. This increase is more than 3x the rate of inflation.

As inflation rises, we should expect to see US bond yields rise. That said, global sovereign bond markets do influence each other, and the spread between US Treasuries and German Bunds has risen to more than 2%. Relative value trading (i.e. investors swapping out of more expensive German bonds into cheaper US Treasuries) should act as a bit of a drag on US interest rates. The bigger question will be whether global growth pulls up Euro yields or whether the US yield curve continues to flatten.

See you all in the new year!

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Vital Statistics:

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

Very slow news day.

The Chicago PMI came in at a very strong 67.6 as production and new orders hit multi-year highs. Employment was disappointing however as businesses struggle to find qualified employees.

Initial Jobless Claims came in at 245k last week ahead of the Christmas holiday. Surprised it is that high.

Some the biggest fixed income managers lay out their trades for 2018. Blackrock says to move up in credit quality. Note that they are neutral on everything. U.S. municipal bonds, U.S. credit, emerging markets and Asian fixed income, and an underweight position on Treasuries, European sovereign debt and European corporate bonds. They don’t like anything, really. Fidelity says global growth is going to become inflationary, so buy TIPS (Treasury inflation protected securities) and emerging market debt. Goldman is betting against the crowd, favoring yield curve steepeners as opposed to the biggest trade on the Street, which is betting on a flatter yield curve. The theme seems to be inflation will return, and that means higher rates next year. The elephant in the room is the Fed, and the fear that increasing short term rates will torpedo the recovery.

Easy come, easy go. Bitcoin continues to give back gains after it hit a record last week. It is down 28% from its highs on fears that South Korea might close one of its exchanges. Here is the fundamental issue with Bitcoin: governments despise it, and while they might not be able to kill it directly, they can attack everything that supports it. While there are a few retailers that accept Bitcoin, understand that they don’t hold it. They immediately exchange it into dollars.

Tax reform has some people in high tax jurisdictions rushing to pre-pay their property taxes ahead of the change in 2018. Note the IRS will only allow this if they are assessed and paid in 2017. So if your local government can’t get the assessments out in time, it doesn’t matter if you prepay.

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Vital Statistics:

Stocks are higher this morning on no real news. Bonds and MBS are up as well.

Home prices rose 0.7% MOM in October and are up 6.4% YOY, according to the Case-Shiller Home Price Index. Seattle, Las Vegas, and San Diego led the charge with 12.7%, 10.2%, and 8.1% gains respectively. Inventory fell to 3.4 month’s worth of supply, although some of that is probably seasonal. With home prices accelerating so fast out West, renting could be more attractive than buying in some MSAs.

Manufacturing continued to be strong in in December according to the Richmond and Dallas Fed.

Pending home sales rebounded in November, according to NAR.  This is the first YOY gain since June, and is being driven by a strong economy. There might have been some hurricane elements at play however.

What trade worked in 2017 (aside from Bitcoin and the stock market?) Credit risk transfer securities issued by Fannie and Fred. These are meant to offload some of the credit risk that the GSEs hold on their balance sheets. They take the first losses when borrowers default. The subordinate tranches of these securities made over 11% last year. outstripping high yield bonds and MBS by a wide margin. If there is more of an appetite for these securities, it will go a long way in helping establish the framework for competition to Fannie and Fred.

The current state of affairs over who runs the CFPB: Mick Mulvaney (appointed by Trump) or Leandra English (appointed by outgoing director Richard Cordray).

Tax reform will probably cause more migration from the high-cost states like NY, NJ, CT, IL, and CA to cheaper states like NC and TX. These states are hit with the double-whammy of high housing costs and high state taxes. The difference probably isn’t going to be enough to cause a massive migration, however it could nudge those who are on the fence.

Bond funds have been seeing outflows since tax reform has passed and investors are making changes to their asset allocations. Bond funds saw a withdrawal of $3.3 billion in the week ending Dec 20, which may account for the big increase in the 10 year’s yield that week. It isn’t just US Treasuries – the German Bund yield is up big this year as well. As investors become more constructive on the economy, they are shifting to emerging market sovereign bonds, which pay more and are more levered to global economic growth and out of Treasuries and Bunds, which are largely looked at as safe haven assets. Developed market stock funds also saw outflows as investors rang the register after a great year.

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Vital Statistics:

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

This should be a relatively quiet day as bonds close early heading into the long holiday weekend.

Durable Goods orders increase 1.3% MOM / 8.2% YOY in November, coming in below analyst estimates. A surge in aircraft orders drove the increase. Core capital goods orders (a good proxy for business capital expenditures) rose 8.1% YOY.

Personal incomes rose 0.3% in October, slightly below the Street estimate of 0.4%. Consumer spending was better than expected, rising smartly at 0.6%. Inflation remains nowhere to be found, with the core PCE up 0.1% MOM and 1.5% YOY. The low inflation numbers certainly give the Fed some breathing room, although tax reform will probably push them to be more aggressive. Especially since 9 companies so far have announced wage increases based on tax reform.

The Fed Funds futures are currently handicapping a 5% probability of no hikes in 2018, a 21% probability of a single 25 basis point hike, a 35% chance of 50, a 27% chance of 75, and a 10% chance of 100.

Bitcoin is crashing right now, down 25% from yesterday. I was asked how Bitcoin would affect the real estate market.  My view was that Bitcoin is simply so volatile that I cannot imagine both a buyer and seller being comfortable quoting a house in bitcoin. I just don’t see someone trying to sell their house for 25 bitcoin. Second, the financing has to be in dollars as no banks lend in bitcoin yet, and I cannot imagine what the interest rate for a bitcoin loan would be. So no, it may be accepted by your local store, however it is more of a novelty at this point. Will that change? Who knows? Will Bitcoin be dominant cryptocurrency or will it be like Classmates.com or MySpace – early adopters that got crushed later on by Facebook?

Bloomberg takes a look at the state of housing entering 2018. Tight inventory, builder confidence, and a growing economy point to a strong housing market next year. On the other side of the coin, the drop in the mortgage interest deduction could hurt homes at the top end, while the larger standard deduction may lower the incentive to buy versus rent for many at the lower end of the income scale. IMO, the negatives are marginal compared to the positives.

Don’t forget, housing’s contribution to GDP is way, way below historical levels. If 2018 is the year homebuilding finally breaks out, it will have an ousized effect on GDP growth. Labor shortages might be the bottleneck, but as wages rise, they attract new workers so that state of affairs doesn’t last long. Swinging a hammer pays a lot more than slinging burgers.

90 day delinquencies spiked in November, according to Black Knight Financial Services. 85% of the spike is attributed to the hurricanes, so it doesn’t really tell us anything about the state of the economy.

Finally, happy holidays to all!

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Vital Statistics:

Stocks are up this morning after tax reform is passed. Bonds and MBS are flat.

Hot on the heels of tax reform is legislation to keep the lights on. The House is set to vote on a stopgap measure to keep the government open for another month. This will prevent the Senate from attaching too many things to the bill. It also gives the government some breathing room after the new year to hash out a longer-term funding deal.

In response to the tax cuts, 5 big corporations (Comcast, AT&T, Boeing, Fifth Third, and Wells Fargo) all announced they were either raising pay or paying bonuses to workers. Could this be the start of broader wage growth?

House prices rose 0.5% in October, according to the FHFA House Price Index. September’s 0.3% increase was revised upward to 0.5%. On a YOY basis, prices rose 6.6% nationally. The East South Central region (TN, KY, MI, and AL) rose 8.2%, which was a particular strong showing. As usual, the West and Mountain states led the charge, while the Upper Midwest and the East Coast brought up the rear.

The final revision for third quarter GDP came in at 3.2%. The prior estimate was 3.3% as consumer spending was revised down a tenth of a percent to 2.2%. The GDP price deflator was unchanged at 2.1%.

In other economic data, Initial Jobless Claims rose to 245k last week, while the Philly Fed Manufacturing Index rose. The Chicago Fed National Activity Index gave back some of October’s hurricane-related gains. The Index of Leading Economic Indicators rose 0.3%. Overall, all of these reports were strong readings and show the economy with some momentum heading into 2018.

The chickens are coming home to roost for subprime auto lending. Some big private equity firms got into the business, hoping to generate huge returns from auto loans paying in the high single digits. Unfortunately, the default rates have soared for these loans, and auto sales have cooled off and they can’t exit the business. No, it isn’t a canary in the coal mine for the US economy as a whole.

Realtor.com weighs in on the hottest and coldest real estate markets of 2017. In the top 20, the hottest are unsurprising – the Bay Area. However there are a few surprises, like Detroit, Fort Wayne, and Stockton.

This reminds me of the late 90s, when companies discovered you could get a multiple by adding .com to your corporate moniker. Long Island Iced Tea company jumps fivefold after renaming itself Long Blockchain and committing to looking for a way to make money in blockchain and fintech. Not that they have any business in it, or expertise, but they will look into the idea.

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Vital Statistics:

Stocks are higher as Congress begins the voting for tax reform. Bonds and MBS are down.

The House is expected to vote on tax reform this afternoon around 1:30. Depending on the procedural machinations, the Senate will vote either tonight or tomorrow. Bob Corker and Susan Collins are supposedly on board, so this should be done.

Housing starts increased to 1.3 million in November, according to Census. This is up 3.3% MOM and 13% YOY. Building Permits came in at 1.3 million as well. The increase in starts was driven by single-family, not multi, and hit a 10 year high. Note that tax reform’s pass-through treatment will be good news for landlords and could encourage more multi-fam construction. We didn’t see any jump in multi-fam permits last month, so maybe the change is too recent to influence behavior yet.

Minneapolis Fed Head Neel Kashkari argues that we should not be raising interest rates yet. Neel was one of 2 dissenters at the last FOMC meeting, preferring to maintain the current level of rates.  His argument is that inflation remains below the Fed’s target rate of 2% and there is still slack in the labor market. He also is worried about what the flattening yield curve is saying. IMO he has a point – we want the labor market to keep bringing back the long-term unemployed, however we are hardly going to a tightening posture. On a scale of 1 – 10, where 1 is easy and 10 is tight, we are going from a 1 to a 2. Real interest rates are still negative, and the Fed is still buying Treasuries and MBS albeit at a reduced pace. What would a 10 on that scale look like? The early 1980s, when Paul Volcker tightened to quell inflation and took the Fed Funds rate from 9% to 19%. We are in a different economic scenario than the late 70s, but some historical perspective is helpful.

New mortgage loan credit risk increased in the third quarter, according to CoreLogic’s Housing Credit Index. The increase in risk was driven by an increase in the share of condo / multi-fam loans. Credit scores improved, while DTIs fell. We are back in the pre-bubble range of credit risk.

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Vital Statistics:

Stocks are up this morning on optimism over tax reform. Bonds and MBS are down small.

This should be a quiet week as people prepare for the holidays, however we will get a lot of economic data. The biggest one will be personal incomes and outlays on Friday.

Homebuilders are more optimistic now than they were during the bubble years, according to the NAHB Homebuilder Sentiment Index.

Congress worked on making smallish changes to the tax bill over the weekend. Marco Rubio held out for an increased child tax credit. The state and local tax deduction was supposedly widened to $10k. Another change involves tax breaks for real estate pass-throughs, which caught one wavering Republican Senator – Bob Corker – by surprise. Since it looks like John McCain will not be voting on the plan this week, Republicans need Corker’s vote. It is a fluid situation, to say the least.

The New York Fed took up its estimate for Q4 GDP to 4%. We will get the final revision to third quarter GDP on Thursday.

One of the biggest trades on the Street right now is the yield curve flattening trade, where investors bet the difference between long-term rates and short-term rates will decrease. There are many reasons to put on the trade, but the most common one is that the yield curve tends to do this during tightening cycles, and people are making the bet that history will repeat itself. The side effect of this trade is a whole lot of articles claiming that the changes in the yield curve are predicting a recession going forward. Given that the NY Fed just took up its Q4 GDP estimate up to 4%, a recession doesn’t seem to be on the horizon. But here is the bigger issue: What information is the yield curve transmitting when it is being influenced by global central banks? Yes, before the Fed was buying (and holding) 4.5 trillion worth of bonds, the yield curve was probably providing useful information. But now? I would argue that all of this central bank buying is distorting the signals the curve might be sending. And therefore I would caution against reading too much into it.

Freddie Mac weighs in on the housing market and makes its predictions for 2018. Big picture: the economy is getting better, Millennials are beginning to buy, and increased homebuilding should alleviate the big inventory problem. That said, cuts in the mortgage interest deduction and increasing supply should dampen home price appreciation. Basically the current housing market is great and that should continue, albeit at a somewhat slower level. FWIW, I suspect the demand for housing is only going to get bigger, and will dwarf whatever homebuilding is being done.

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Vital Statistics:

Stocks are higher after a relatively dovish FOMC statement. Bonds and MBS are down small after rallying hard after the announcement yesterday.

As expected, the Fed raised rates a quarter of a percent yesterday and released their economic forecasts. This was Janet Yellen’s last hurrah. The vote was 7-2 with two dissenters: Evans and Kashkari, who both wanted to maintain the current Fed Funds rate. Bonds rallied on the FOMC decision, largely due to the dot plot, which showed virtually no change from September, despite a big upward revision in the Fed’s 2018 GDP forecast, which went from 2.1% to 2.5%. Their forecast for unemployment was revised downward from 4.1% to 3.9%, while their forecast for core inflation remained unchanged at 1.9%. It was a Goldilocks report for the markets. You can see the dot plot comparison below, with the central tendency right around 2%.

Note that the Fed Funds futures are currently predicting 1-2 hikes next year through November (we don’t have December 2018 Fed Funds futures yet). So, the market is somewhat more dovish than the FOMC is, but they are pretty close. Note that one of the big trades on the Street right now is a bet that the Fed will blink and only raise rates 1-2 times next year. The other big trade that is happening right now: yield curve flattening trades, where traders bet that the difference in yield between the 2 year and the 10 year will decrease.

Initial Jobless Claims fell to 225k last week. This is just off the post-crisis low of 223k, and you would have to go back to the early 1970s to find similar readings. The job market is pretty strong, provided you are employed. The long-term jobless still are with us, although it remains to be seen how many will (or even want to) re-enter the workforce. That untapped reservoir is probably one big reason why wage inflation continues to be muted.

Retail Sales came in way stronger than expected, pointing to a strong holiday shopping season. The headline number was up 0.8%, as was the control group, which was a big jump from October, and above the highest point in the consensus range. The S&P SPDR Retailer ETF (XRT) is up about .63% in an otherwise flattish market early.

The ECB maintained interest rates at current levels and cut their QE buying in half. Central bank demand for sovereign debt is being cut back globally. FWIW, we aren’t really seeing that much of an impact in yields (Probably as people pile into curve flatteners, as described above). The German Bund is down with Treasuries.

The NAR points out that the median age of renters is rising – it rose to 40 from 38 a year before. Given that the relative attractiveness of buying compared to renting is about as big as it ever has been, what gives? It is mainly empty-nest Boomers who are choosing to go with rentals, which means no more home maintenance.

Bill Gross warns that the Fed really has to stop hiking rates once the Fed Funds rate gets around 2 – 2.25% or else it runs the risk of hurting the housing market. “A lot [of mortgages] are variable, floating-rate mortgages. And to the extent that the Fed has already raised interest rates by 75 to 100 basis points and is expect to raise by another 50 to 100 that affects the average monthly payments.” He is correct on the ARM part of it, and with the Fed raising short term rates, while long-term rates stay in place, it is the time to refinance out of an ARM and into a 30 year fixed rate mortgage. While he does draw upon 2005 – 2006 as a comparison, we were in a bubble then. It really isn’t similar to today, where inventory is so tight we probably won’t see any price decreases. If anything, we are seeing bidding wars.

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