All Things in Moderation

Vital Statistics:

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

Slow news day.

Builder sentiment fell somewhat last month, but is still strong, according to the NAHB.

Mortgage Applications increased 4% last week as purchases rose 3% and refis rose 4%. This is a bit of a surprise given that bond yields moved up aggressively on stronger economic data and speculation that China would reduce its Treasury purchases. The 30 year fixed rate mortgage rose 10 basis points to 4.33%.

The deadline to fund the government is fast approaching, and it looks like we will only get another temporary (one-month) deal. The deal won’t include anything on immigration, however it will fund the Children’s Health Insurance Program for 6 years, and delays some Obamacare taxes. Bond Traders are not so sanguine on a deal, and are selling Treasuries maturing in early March.

Rising input costs are the biggest challenges to homebuilding. 84% of all builders surveyed said that rising labor costs and rising material costs are going to be a problem this year. High land prices are also an issue. Affordable housing is one of the nation’s biggest problems right now, and it is extremely difficult to build at price points that are affordable for the entry-level homebuyer.

Industrial Production rose 0.9% in December and manufacturing production rose 0.1%. Capacity Utilization jumped to 77.9% from 77.3%. Utilization is still relatively low, and indicates that we still have plenty of unused capacity. High utilization rates (85%-ish+) are usually associated with increasing inflation.

Bitcoin is now trading below $10,000. Easy come, easy go.

Filed under: Economy, Morning Report | 31 Comments »

Vital Statistics:

Stocks are higher this morning as on overseas strength. Bonds and MBS are up small.

Not a lot of market-moving data this week, however we do get housing starts and the FHFA House Price Index. Bank earnings will dominate the releases this week.

The Empire State Manufacturing Survey came in a little weaker than expected, but was still pretty strong. Employment-related indicators (number of workers and average workweek) decelerated a touch, however the inflation indicators (both prices paid and prices received) increased. The bond market seems to be taking the inflation data in stride.

The big thing this week will be a continuing resolution to keep the government open. The government will shut down if a budget deal isn’t reached by Friday. Democrats are holding out over immigration. Republicans are weighing another short-term funding measure that will last until mid-February.

So far, it looks like the meta-issue for 2018 will be inflation. Numerous companies have announced wage increases in response to the tax bill, and some states have raised the minimum wage. Commodity prices remain firm (especially food and energy). In order to really get inflation, we need wage inflation and so far we haven’t really seen a lot in the BLS numbers. That said, with all the company announcements over raises this could be the year.

Dallas Fed President Robert Kaplan believes we are going to “overshoot full employment” and he thinks we will need to see 3 rate hikes this year. His personal GDP forecast is 2.75% growth. “The history of overshooting full employment in this country has not been a happy one,” he added. “Normally, what happens is you get an overheating, the Fed has to play catch up, and what happens then is you tend to often have a recession.” Historically (post-Great Depression) that has been the case: the economy grows, inflation starts, and the Fed causes a recession to beat back inflation. That model probably works 90% of the time, but post-bubble economies are different, and have longer (and shallower) recoveries. The excesses of the bubble years may have been worked off, however the psychology of the bust instills a risk-aversion on the part of the business community that isn’t necessarily conducive to inflation. Japan has been trying to create inflation since the early 90s and they still haven’t been able to do it. The US isn’t necessarily Japan, however the Japanese experience shows that the usual economic playbook goes out the window after asset bubbles.

The black swan for US inflation? The bursting of the Chinese real estate bubble. This will be a drag on overall global growth and commodity demand.

Filed under: Economy, Morning Report | 19 Comments »

Filed under: Economy, Morning Report | 69 Comments »

Vital Statistics:

Stocks and bonds are lower this morning on news that China may slow or halt its purchases of Treasuries.

Bonds are currently trading at 2.58% after Chinese officials recommended slowing or halting purchases of US Treasuries. Driving this decision are the relative attractiveness of US Treasuries and the possibility of a trade war. Between the Fed tapering their purchases of Treasuries, and potential disinvestment of the Chinese, Treasuries are heavy. Ultimately, this is about the trade deficit, which is the difference in value between what we import from China and what we export to China. The deficit is simply filled in by Treasury purchases. While a trade war is probably just saber-rattling, a drop in trade will probably mean a drop in the trade deficit, which means less demand for Treasuries. Ultimately, the US would prefer the Chinese to buy less Treasuries since that would mean they are buying more goods and services.

Note that the recent peak in the 10 year was 2.62% in March this year. We are close to breaking through support, which would probably trigger at least some technically-driven selling. We have a 10 year bond auction this afternoon at 1:00 pm EST. If we get a lousy bid / cover ratio that could be the catalyst to break through that level.

We have a lot of Fed-speak today, with Charles Evans, Robert Kaplan and James Bullard speaking.

Mortgage Applications rose 8.3% in a holiday-shortened week, as purchases rose 5% and refis rose 11%. The average contract rate for the 30 year conforming rate rose a basis point to 4.23%.

Import prices rose 0.1% MOM and 0.3% YOY, while export prices fell 0.1% MOM and rose 2.6% YOY.

Lennar reported fourth quarter earnings of $1.29 a share which missed analyst expectations. An undisclosed “one-time strategic transaction” was delayed until the first quarter, which apparently drove the miss. Revenues increased 12%, while deliveries were up 5% in units. Backlog was up 17% in units and 23% in dollars. Gross margins fell by 90 basis points to 22.4%. Lennar is also in the process of buying CalAtlantic, and that deal should close in February.

The National Association of Homebuilders projects that 653,000 new homes will be sold in 2018, an increase of 5.4% from 2017. This won’t be enough to meet demand. Lack of labor and land are the limiting factors, as well as government regulations. It seems that “urban villages” are the flavor du jour, with apartments and walkable developments that mix commercial and residential.

Filed under: Economy, Morning Report | 16 Comments »

Vital Statistics:

Stocks are higher this morning on good economic data out of Europe. Bonds and MBS are down.

Small Business Optimism slipped slightly in December, capping the strongest year in the index since the early 80s. Hiring was sluggish in December, with a lack of qualified workers being the biggest problem in construction and manufacturing. Compensation is trending up as well, as a net 23% of small businesses intend to raise compensation this year.

Job openings were little changed in November, according to the JOLTs survey. This was a slight drop from October, and a touch below expectations. Openings increased for retail, and fell for government, transportation, and utilities. The quits rate was unchanged at 2.2%. Until we start seeing the quits rate move up, we probably won’t be seeing broad-based wage inflation.

Volatility in the bond market has hit a 52 year low, according to a Bank of America / Merrill Lynch report. This is not surprising: volatility in the stock market is also at record lows. Volatility is generally a sign of stress in the system, and it tends to fall during periods of stronger growth.

The drop in bond market volatility has major implications for the mortgage market as well, and helps explain a bit of why mortgage rates are behaving the way they are. While the 10 year has been steadily moving higher over the past few months, mortgage rates have been relatively stable. While mortgage rates do tend to lag Treasuries, something else has been going on, and that something has been low volatility.

30 year fixed rate mortgages have an embedded option in them, which is the right of the borrower to prepay their mortgage without penalty at any time. That right to prepay is worth something, and that value explains the yield differential between government backed mortgage debt and Treasuries. The value of the prepayment option is determined largely by the volatility of the bond market – when volatility rises, the right to prepay is worth more, and when volatility falls, it is worth less. So, when the market is stable, investors bid up mortgage backed securities as the value of that option falls, which translates into tighter MBS spreads and lower mortgage rates. In fact, the difference between a 30 year fixed rate mortgage and an adjustable rate mortgage is driven by the value of that prepayment option and risk-shifting between borrower and lender. When volatility is low, the borrower is paying less for that option and 30 year fixed rate mortgages will be more attractive than ARMS. When volatility is high, ARMS will be much cheaper. During periods of low volatility, it makes sense to scoop up that prepay option on the cheap and take out a 30 year fixed rate mortgage. When volatility is high, you will end up getting a much lower initial rate with the ARM. Co-incidentally, the economic backdrop (stronger growth, accelerating inflation, and a Fed raising short term rates) also favors the 30 year fixed over ARMS.

Filed under: Economy, Morning Report | 32 Comments »

Vital Statistics:

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

Should be a relatively quiet week, data-wise. The only potential market moving report will be inflation data on Friday. We will have a lot of Fed-Speak this week however.

The National Association of Realtors thinks we could be in for a construction boom in 2018. Much of the action will be in non-residential, mainly office building, lodging and logistics. Residential is a mixed bag – we have had a boom in apartment construction, but single family is still weak. The biggest problem for construction is labor, and many construction workers are aging out of the workforce. In 2017, a net 190,000 construction workers entered the job market, which is lower than the three year average of 284,000. This means construction firms are going to need to raise wages. One thing is for sure: if we do in fact see a construction boom in 2018, the Fed’s 2018 estimate of 2.5% growth is going to be too low. It also means the Fed will probably raise rates a little faster than expected.

The Fed Funds futures are currently pricing in a 61% chance of a 25 basis point hike in March. Despite the weak payroll number on Friday, the futures upped their probability of a hike.

One market-based measure of inflation – the TIPS spread – broke 2% for the first time in 9 months. TIPS (Or Treasury Inflation Protected Securities) increase the principal amount of the note by the annual consumer price inflation number, so they act as a hedge (at least in theory) against inflation. The 2% break-even yield is important as that is the Fed’s inflation target.

Republicans and Democrats are still far apart on a spending deal to keep the government open. Democrats want something done on DACA, while Trump wants funds allocated to a southern border wall. We are still far enough out that much of what we are seeing may just be posturing, but there is a possibility we could be looking at a government shutdown. Loan officers who need 4506-T tax transcripts should keep this in mind. The deadline is January 19.

Delinquencies rose in November, according to Black Knight Financial Service’s November Mortgage Monitor. You generally see an increase in November due to seasonality, but this year also includes the effects from the hurricanes in Texas and Florida. The report also checked in on negative equity. We still have homes more than 15% below their peaks in the areas hit hardest by the housing bubble (inland CA, Las Vegas, Florida, parts of the Northeast). The map below shows the current state of affairs:

Filed under: Economy, Morning Report | 9 Comments »

Vital Statistics:

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

There is some labor data this morning. Initial Jobless Claims came in at 250k last week, while job cuts in December were 32,423 in December, according to outplacement firm Challenger, Gray and Christmas. This is the lowest year for job cuts since 1990. Finally, the ADP employment report showed 250,000 jobs created in December, which came in well above the consensus number of 188,000. Tomorrow’s jobs report is looking for 190,000. Mark Zandi, chief economist of Moody’s Analytics, said, “The job market ended the year strongly. Robust Christmas sales prompted retailers and delivery services to add to their payrolls. The tight labor market will get even tighter, raising the specter that it will overheat.”

Regarding Zandi’s comment about overheating: there are certainly labor shortages, and perhaps the slew of year end bonuses given out by employers are signaling wage growth ahead. So far, wage growth has been faster than the official inflation estimates, but not by much.

There was nothing earth-shattering in the FOMC minutes, (the bond market didn’t move at all on the release) however the prospect of tax reform did cause some members to take up their estimates for interest rates going forward. The FOMC did expect tax reform to boost growth this year, which accounts for the increase in their GDP forecast for 2019 to 2.5% from 2.1%. They consider the labor market to be generally strong, especially for unskilled entry-level workers, where we are seeing some wage growth. Some firms are coping with a tight labor market by raising wages, while others are using more flexible working arrangements. Some are spending money on productivity-improving technology in lieu of raising compensation.

Regarding the Fed Funds rate, we are seeing a wider dispersion in terms of opinion:  While most members were comfortable with the projected path of rates, both hawks and doves expressed concern: “A few participants indicated that they were not comfortable with the degree of additional policy tightening through the end of 2018 implied by the median projections for the federal funds rate in the December SEP. They expressed concern that such a path of increases in the policy rate, while gradual, might prove inconsistent with a sustained return of inflation to 2 percent, or that the level of the federal funds rate might already be near its current neutral value. A few other participants mentioned that they saw as appropriate a pace of additional policy tightening through the end of 2018 that was somewhat faster than that implied by the December SEP median forecast. They noted that financial conditions had not materially tightened since the removal of monetary policy accommodation began, that continued low interest rates risked financial instability in the future, or that the labor market was increasingly tight.”

The wider dispersion of opinion on the part of the FOMC is new and will be something to monitor, especially since we have a new FOMC Chairman.

We tend to take FICO scores for granted. They have been around forever, everyone pretty much understands them, and we have all sorts of data from which to backtest loan performance versus FICO. Now, some lenders are pushing FHFA to allow scores from Experian, Equifax, and Transunion for conforming loans. These alternative scoring methods tend to be a little more forgiving than FICO (which comes from Fair Issac). The FHFA is considering the suggestion, however there is always the fear that credit scoring companies could create a “race to the bottom” by becoming more lenient. The non-FICO companies launched VantageScore, which supposedly can grade 30 million more people than FICO can. Of course having competing credit score companies can open up lenders to charges of discrimination, particularly if they use different scores for different borrowers.

Filed under: Economy, Morning Report | 10 Comments »

Vital Statistics:

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

We will get the FOMC minutes this afternoon at 2:00 pm. We might see some volatility if they contain any surprises, so just be aware if you are locking around then.

Mortgage applications fell 3% last week as purchases rose 1% and refis fell 7%.

Manufacturing improved in December, according to the ISM Manufacturing Report. New Orders and Production drove the increase, while employment fell. This was the second highest reading for 2017. Manufacturing firms reported difficulties finding qualified workers, and 44% reported increasing starting pay to attract workers. The 2017 average of 57.6 in the index historically corresponds with a 4.5% increase in GDP. The December reading would be associated with over 5% growth. That said, manufacturing doesn’t have the impact on the economy it used to have, but that is still impressive growth.

Despite Twitter tensions with North Korea (which rattled the chattering classes), North Korea and South Korea improved communications. While the tiff between Kim Jong Un and Trump make for bit of a sideshow, the markets (stocks, bonds, currencies) do not take it as any sort of serious threat or possibility.

Construction spending increased in November by 0.8% MOM and 2.4% YOY. Private residential construction rose 1.1% MOM and over 7% YOY.

Framing lumber prices are up 43% YOY, in the CME futures. Traders are looking for prices to eclipse their bubble highs this Spring. This should bump up prices for new construction in 2018. For all of the handwringing over tax reform’s effect on house prices, simple supply and demand will keep them supported, at least for 90% of the market. If the growth in the economy ever translates into faster wage growth, expect that supply and demand imbalance to increase even further.

Economic confidence was positive in 2017, according to Gallup’s economic confidence index. Note the index began in 2008, so the only track record we have is of the crisis / post-crisis days.

Congress is working to come up with some sort of long-term spending solution to keep the lights on. Republicans want increased defense spending, while Democrats want non-defense spending to have the same increases that defense does. Surprisingly, both parties seem to want to increase defense spending. Republicans are going to need Democrats to reach a deal, as some on the right will balk at the higher spending levels. While there has been talk that Democrats might demand some sort of immigration measure in exchange for a vote, so far they haven’t drawn that line in the sand. At least as of now, nobody is talking about a government shutdown. Remember the last time government shut down, originators couldn’t get tax transcripts out of the IRS which delayed some closings. It is something to stay ahead of.

Filed under: Economy, Morning Report | 14 Comments »