All Things in Moderation

Vital Statistics:

Stocks are marginally higher this morning after the second revision to fourth quarter GDP came in as expected. Bonds and MBS are flat.

Fourth quarter GDP increased at 2.5%, which matched Street expectations. The price index was revised downward a touch and consumer spending was revised upward. For the year, GDP increased at 2.3% versus 1.6% for 2016. Inflation is picking up, as the price index rose 2.5% versus 1.7% in the third quarter. Excluding food and energy, the index was up 1.9%, compared to 1.3% in the third quarter.

The Chicago PMI decelerated last month, but still came in at a strong 61.9. The number was below estimates however.

Pending Home Sales fell 4.7% in January, according to NAR. This is down 3.8% YOY and the lowest since October 2014 after the Taper Tantrum. Despite higher rates and smaller inventory, traffic was up YOY in January, except for the Northeast, which could have been weather-driven.

Jerome Powell spooked the bond markets yesterday during his testimony in front of the House. He acknowledged that inflation is accelerating and that the economy has improved since the meeting in December, and that statement pushed bond yields higher. He said he didn’t want to “prejudge a new set of projections,” referring to the dot plot at the March meeting. Powell will testify in front of the Senate tomorrow.

The Fed Funds futures didn’t really do much in response: The March futures are now handicapping an 87% chance of a hike and the consensus is still for 3 hikes this year.

Mortgage applications increased 2.7% during the holiday-shortened week, with the refi index falling 1% and the purchase index increasing 6%. The average contract rate was 4.64%, unchanged from the prior week.

The NAR and ATTOM weigh in on the real estate outlook for 2018. Unsurprisingly, they expect the inventory issue to continue, and homebuilders to modestly ramp up production while constrained by labor shortages. They point out also that the churn of move-up buyers has largely collapsed post-crisis. The average tenure (or amount of time that someone has lived in their home) has doubled since the crisis, from just over 4 years to 8 years. This lack of churn depresses the number of homes available on the market. I wonder if the churn was simply an issue related to underwater homeowners – short sales are tough to do. Second, as the foreclosure inventory is largely worked through, with the exception of the Northeast and a few other states, distressed homes are drying up. I suspect the professional investors who bought these homes will want to ring the register at some point, but that will be a function of interest rates and home price appreciation.

Lowe’s missed Street estimates and is down 8% pre-open. It looks like this is a company-specific problem and doesn’t reflect on the home improvement market. The Despot beat earnings recently.

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Vital Statistics:

Stocks are down small on no real news. Bonds and MBS are down as well.

Durable Goods Orders fell 3.7% in January MOM, but rose 6.8% YOY. Ex-transportation, they fell 0.3% MOM and rose 6.9% YOY. Core Capital Goods (a proxy for business capital expenditures and expansion) fell 0.2% MOM and is up 6.3% YOY.

In other economic news, the trade deficit widened to 74 billion, while retail inventories rose 0.8%. Wholesale Inventories rose 0.7%.

Home prices rose 6.3% YOY in December to close out 2017 up 6.3% overall. House price inflation will be subject to a bit of a push-pull effect: Strong demand and limited supply will provide support for home prices, while increasing interest rates will reduce affordability and should have a dampening effect on home price inflation. That said, by historical standards, these mortgage rates are still extremely low, and affordability is still extremely high, at least on a long-term basis when you use monthly payment as a percentage of income.

The FHFA House Price Index rose 0.3% and it is up 6.5% for the year.

Fed Chairman Jerome Powell testifies in front of Congress this morning at 10:00 am. Here are his prepared remarks. Nothing in the remarks jumps out at me as anything all that new, although Powell argues that the stability of the labor force participation rate over the past few years is a sign of strength, not weakness. Yes, baby boomers are retiring but their kids are entering the workforce so it should balance out. Below is a chart of the labor force participation rate going back to WWII. Note the steady rise beginning in the 1960s. That is the baby boom entering the workforce, and the secular change of more women entering the workforce. About half of those gains have been given back in the Great Recession. I think he is saying that the labor force participation rate should be trending even lower due to demographic factors, and that the stability of the past few years is evidence that the labor market is strong. Perhaps.

The Fed has always had a simple model of unemployment and inflation called the Phillips Curve. It basically says that unemployment will start driving inflation if it gets low enough. Historically economists have thought that unemployment levels in the low 4s would trigger it. So far we have seen some wage inflation in some skilled areas, but nothing widespread. Most of the inflation we have been seeing has been commodity push inflation driven by food and energy prices. These things often reverse, as higher prices invite new supply. Or in other words, the cure for high prices is high prices.

You are beginning to see a new theory in academia – that the slow growth in wages is not due to a supply / demand issue, but is evidence of an antitrust problem, or at least a market failure. Hard to see how heavyweights like Wal Mart and McDonalds are colluding for low wage labor, but that;s what they believe, and they think the cure is a higher minimum wage, more unions, and exerting more oversight over the bigger employers. Occam’s Razor says that labor-replacing technology is probably the driver, but that’s no fun.

Toll Brothers reported better-than expected earnings this morning, showing that there is still plenty of strength in the luxury sector of the market. Orders rose 19% in units, and ASPs rose 6.8% to $826k.  Margins are falling however, as increasing input and labor costs push against price hikes.

Surprising stat: 35% of homebuyers bid on a home before seeing it in person. The young buyer is more likely to do this: almost half of Millennial buyers bid before seeing.

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Vital Statistics:

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

No economic data today, but we do have a lot of Fed-Speak.

Speculative short positions in US Treasuries are at a record. This means in plain language, that a lot of speculators are making the same bet: that interest rates are going higher. In practice, crowded trades like this often will behave in a perverse manner, especially when you get data points that don’t support the prevailing view.  Right now, the Street thinks inflation is rising and they are negative on Treasuries. Any data point that supports that view will probably have a muted effect, while any data point that doesn’t support that view will probably have an outsized reaction. To give an example: Say next week’s GDP number comes in higher than expected – maybe 3%, with an increase of the GDP deflator (inflation) at 2.8%. Bonds might sell off from something like 2.9% to 2.92%. However, if GDP comes in light (say 2%), and the GDP deflator comes in at 2% as well, we could see bonds rally from 2.9% to 2.85%. These sorts of movements are generally short-lived (lasting a morning or a day), but they do provide opportunities to lock at good prices if you are nimble. Big picture, rates are going higher, however since there are so many speculative bets against Treasuries at the moment, it will provide some opportunities to lock in at good rates if you are quick.

Lenders are loosening requirements to get a mortgage, particularly for first time homebuyers. We are seeing a modest drop in overall credit scores, and a slight increase in LTV and DTI ratios. This indicates a move towards low down payment loans. As rates increase, the credit box will almost invariably increase as lenders fight for fewer and fewer loans. Some lenders are also changing the way they treat student loan debt, even excluding it altogether if a parent is making the payments.

Who is the biggest mortgage lender out there? If you said Wells Fargo, you would be correct for all of 2017. However the biggest lender in the 4th quarter was Quicken.

HUD is providing foreclosure relief for victims of the 2017 hurricanes in Texas and Florida. Homeowners affected by these disasters (and some others) may be able to get a loan that covers their mortgage payments for a year, payable upon sale of the property or a refinance.

How much do you have to make to be in the top 1% these days? Just shy of half a million. To be in the top 10%? Just under 150k.

This weekend is Buffetapalooza, or the annual shareholders meeting for Berkshire Hathaway in Omaha. It has been called a Woodstock of Capitalism, where shareholders dance with the Froot of the Loom guys, eat See’s candy and have dinner at Warren’s favorite steakhouse. The climax will be his letter to shareholders, which is usually chock full of folksy advice for investors, along with observations on the economy and the state of affairs politically. Warren is the second-biggest corporate holder of short term Treasuries and is probably itching for a deal. That said, I think the last big deal he did was several years ago when he bought Precision Castparts.

There is a rumor going around that the Fed will begin holding press conferences after all FOMC meetings, not just the Mar, Jun, Sep and Dec meetings. That could be a setup to begin making interest rate changes at these meetings as well. As of now, the markets expect them not to. Don’t forget, press releases after a FOMC meeting is relatively new. Historically the Fed wanted to be opaque, as they believe that their policy is more effective if it is a surprise to the markets. Greenspan was known for changing interest rates between meetings.

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Vital Statistics:

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

The FOMC minutes were surprisingly upbeat on the economy, which pushed up bond yields yesterday afternoon. The part that got everyone’s attention:

“A number of participants indicated that they had marked up their forecasts for economic growth in the near term relative to those made for the December meeting in light of the strength of recent data on economic activity in the United States and abroad, continued accommodative financial conditions, and information suggesting that the effects of recently enacted tax changes—while still uncertain—might be somewhat larger in the near term than previously thought. Several others suggested that the upside risks to the near-term outlook for economic activity may have increased. A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate.” (emphasis mine)

Separately, Bullard and Quarles cited the strength in the economy and the need to continue to raise interest rates.

This language caused some strategists to increase their forecast to 4 hikes this year from 3. Surprisingly, the Fed Funds futures reacted in an opposite manner on the minutes, but reversed course later to become unchanged on the day. The 10 year treasury sold off throughout the day, and hit 2.94% in the late afternoon.

Part of the movement in bonds is being driven by Europe. European governments have been increasing their bond issuance at the same time the European Central Bank is decreasing its demand for paper. The market for government bonds is a global market, and if there is excess supply, it will hit interest rates across the board. This is why you will sometimes see bonds move lower without any particular catalyst. The catalyst may exist, however it is something overseas that the US business press is either ignoring or covering lightly.

Initial Jobless Claims fell to 222,000 last week. We remain at lows not seen since the Vietnam War and the days of the military draft. Still have yet to see widespread wage inflation however. Until that happens, the Fed will go slowly.

The Index of Leading Economic Indicators improved in January, increasing 1%. It will be interesting to see if February’s number is affected by the recent stock market volatility.

Interesting map from GeoFred which shows the economic growth in different parts of the country. The thing that jumps out at me is how bad the NY-NJ-CT area is. I guess the fact that that area is somewhat levered to the financial industry is an issue, although I wonder how much of it is due to people who have been fleeing high taxes, though if that was the case you would expect to see it in CA as well and you don’t.

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Vital Statistics:

Stocks are flattish this morning on no real news. Bonds are lower after a tough auction yesterday.

Mortgage Applications fell 6.6% last week as purchases fell 6% and refis fell 7%. Higher mortgage rates are beginning to bite.

Existing Home Sales fell 3.2% in January, according to the National Association of Realtors. Lawrence Yun, NAR’s Chief Economist said: “The utter lack of sufficient housing supply and its influence on higher home prices muted overall sales activity in much of the U.S. last month. While the good news is that Realtors® in most areas are saying buyer traffic is even stronger than the beginning of last year, sales failed to follow course and far lagged last January’s pace. It’s very clear that too many markets right now are becoming less affordable and desperately need more new listings to calm the speedy price growth.” The median home price rose 5.8% to $240,500. Inventory rose, however it still remains extremely tight at 3.4 month’s worth of supply. The rise in prices and scant inventory may be scaring away the first time homebuyer which dropped to 29% of sales. Historically, that number has been closer to 40%.

The FOMC minutes from the January meeting are scheduled to be released at 2:00 pm EST today. Investors noted a slight change in the January FOMC statement, where the need for “gradual adjustments” in interest rates was changed to “further gradual adjustments” in interest rates. They hope to get more clarity on what message the Fed intends to send with that change of language, however we probably will have to wait until the March meeting when the Fed releases their new dot plot of expected interest rate movements. As of now, the consensus seems to be a total of 3 hikes this year, at least according to the Fed Funds futures. New York Fed Chairman William Dudley said in an interview that the statement was meant to reflect further strength in the economy.

Homeowners will be able to deduct mortgage insurance premiums on their 2017 returns thanks to a last-minute change in the budget. Borrowers must have adjusted gross income below $100k and the insurance must apply to their principal residence. No word on whether this will continue, and it will probably be a moot point anyway as taxpayers with AGIs under 100k will probably be better off taking the standard deduction most of the time. The tax liability on principal forgiveness also was extended for another year. This would apply to homeowners who get principal forgiven in loan modifications, short sales, and foreclosures. The tax code treats forgiven debt as ordinary income, and the people who go through mods or foreclosures are usually in such financial trouble to begin with that the last thing they need is an additional tax bill.

The Supreme Court yesterday declined to hear a lawsuit brought by Fannie Mae shareholders which challenges the government’s sweep of all of Fannie’s profits into the Treasury. This isn’t the end of the road for the investors however – they have one more claim pending in the U.S Court of Federal Claims in DC. Fannie Mae stock is down about 5% pre-open.

Merger mania in the mortgage banking space continues. Mr. Cooper has been bought by WMIH in a cash and stock transaction worth $3.8 billion in cash, stock and assumed debt. Mr. Cooper and WMIH are the new monikers for old stalwarts Nationstar (or IndyMac) and Washington Mutual. Separately, Flagstar has bought the mortgage warehousing operations of Santander Bank.

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Vital Statistics:

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

Inflation at the wholesale level came in higher than expected as the Producer Price Index rose 0.4% MOM and 2.7% YOY. Ex-food and energy, the index was up 0.4% / 2.2% and the core rate was up 0.4% / 2.5%. The US dollar is weaker on the data, which adds to inflationary pressures. I suspect at some point dollar weakness will feed higher rates, but we aren’t there yet. Treasuries look like they want to test the 3% level we reached after the taper tantrum. The 10 year yield hit 2.94% overnight, so we aren’t all that far away. Goldman is forecasting 3.5% on the 10 year within the next 6 months on monetary tightening. Other strategists are raising their forecast for Fed tightenings as well, based on the additional stimulus of the budget deal and tax cuts.

FWIW, after the inflation data, the Fed Funds futures are now predicting a 83% chance of a hike at the March meeting, and sentiment is coalescing for a total of 3 hikes this year, to take the Fed Funds rate to 2.0% – 2.25%.

In other economic data, Initial Jobless Claims rose to 230k last week, while the Philly Fed rebounded to 25.8. The Empire State Manufacturing survey slipped. Industrial Production fell a tenth of a percent while Manufacturing Production was flat. Capacity Utilization fell 20 basis points to 77.5%. So, between the higher than expected inflation data and weaker manufacturing data, bonds are pretty much flattish.

Donald Trumps proposed 2019 budget contemplated an 18% cut in HUD’s budget, with the cuts largely coming from the end of the Community Development Block Grant program. At the end of the day, this budget is a messaging document and has 0% chance of becoming law as-is.

Builder Sentiment was flat in February according to the NAHB.

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Vital Statistics:

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

Consumer prices rose 0.5% MOM and are up 2.1% YOY, according to the Consumer Price Index. Apparel drove the increase. Ex-food and energy the index was up 0.3% and 1.8%. These numbers are a little higher than what the Street was looking for, and bonds sold off about 5 basis points on the report. Between the CPI and the higher-than-expected wage inflation in the jobs report, Treasury investors are getting nervous about inflation.

The Fed Funds futures are predicting a 78% chance of a 25 basis point hike next month. For the year, there is about a 1/3 chance of two hikes and a 1/3 chance of 3 hikes. with the final 1/3 split between 1 and 4.

Goldman’s inflation forecast is for a 1.8% increase in the core PCE. Despite upward creeping inflation, this is still below the Fed’s target rate.

Mortgage Applications fell 4% last week as purchases declined 6% and refis declined 2%. On the back of the jobs report, Treasury yields rose and mortgage rates hit the highest level in 4 years. The typical 30 year mortgage rate rose to 4.57% from 4.5%.

Retail Sales were down 0.3% in January and were flat YOY. Weak auto sales were behind the change. The control group was flat.

Fannie Mae reported earnings of $2.5 billion for 2017, after taking a $9.9 billion hit on deferred taxes based on the tax law. Adding back the $9.9 billion noncash charge gives the company net income of about $12.4 billion, about the same as 2016. The stock has a market cap of $10.7 billion, meaning it is trading at a P/E below 1. Arguably, the stock shouldn’t exist in the first place, and it only trades due to the vagaries of government accounting.

About 130 mortgage bankers sent an open letter to Congress stressing the need for GSE reform. The letter laid out their preference for a guarantor-based system over an issuer-based system. Essentially the difference would be that the guarantor-based system would be most similar to the current one, where someone like Fannie and Freddie do not originate mortgages, but guarantee than and issue securities. The issuer-based system would rely on a few large aggregators to secure the government guarantee and issue securities. The smaller bankers would probably be at some sort of competitive disadvantage under an issuer-based system and would be better off under a guarantor-based system.

Federal Reserve Chairman Jerome Powell’s prepared remarks at his swearing-in ceremony. “While the challenges we face are always evolving, the Fed’s approach will remain the same. Today, the global economy is recovering strongly for the first time in a decade. We are in the process of gradually normalizing both interest rate policy and our balance sheet with a view to extending the recovery and sustaining the pursuit of our objectives. We will also preserve the essential gains in financial regulation while seeking to ensure that our policies are as efficient as possible. We will remain alert to any developing risks to financial stability.”

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