Morning Report: The era of low mortgage rates is over 5/18/18

Vital Statistics:

Last Change
S&P futures 2713 -5.75
Eurostoxx index 394.37 -1.42
Oil (WTI) 71.39 -0.08
10 Year Government Bond Yield 3.09%
30 Year fixed rate mortgage 4.69%

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

Slow news day. with no economic data.

The Wall Street Journal has declared the era of low mortgage rates is over. What does this mean for the industry? For the industry overall, it means a tougher fight to keep purchase business, but it also could depress home sales as a combination of higher home prices and higher rates make moving up too unaffordable. NAR estimates that the effect of a 100 basis point increase in mortgage rates can reduce sales by 8%. Mortgage rates have been on a tear this year, increasing 62 basis points since the end of 2017. The 10 year yield has increased by the same amount, and usually mortgage rates don’t move up in a 1:1 ratio with Treasuries. I wouldn’t be surprised to see mortgage rates fall if Treasury yields stall out here.

I suspect that “convexity selling” has been driving the moves in rates. Mortgages have a quirky characteristic called negative convexity. Negative convexity explains why a GN mortgage with an expected duration of 7 years will pay a higher yield than a Treasury with a duration of 7 years. Neither one has credit risk, but they have different interest rate risk. MBS investors (say mortgage REITs or hedge funds) will buy mortgages and hedge interest rate risk by selling Treasuries. As interest rates rise, they can get balanced by either selling MBS (which pushes mortgage rates up) or by buying Treasuries (which pushes interest rates up). Whenever you see big moves in rates during a short period of time, you are often seeing convexity hedging exacerbating the move, which is why you will see a retracement in rates after the re-hedging activity finishes. We saw a big move this week as Treasuries broke the 3.1% level. Mortgage rates have shot up as well.

Do credit cycles drive the business cycle or is it the other way around? Historically, business cycles have driven credit cycles. In other words, business dries up, making debt harder to service, which causes banks to retrench and raise cash. The last two cycles however, the credit cycle drove the business cycle. Credit tightened up first, and then the economy rolled over. Is this a new trend? My guess is that it probably isn’t, as the last two economic booms were driven by bubbles in stocks (late 90s) and residential real estate (mid 00s). This time around, asset prices are high, but we don’t have anything comparable to the stock market or real estate bubbles this time around. Your major macro credit risk is that the Fed overdoes it, not that a bunch of debt backed by garbage assets implodes.

Everyone loves ETFs these days. They have low fees, provide instant diversification, and are liquid. In the fixed income market however, the liquidity is probably a bit of an illusion. Corporate bond issuance has soared since the bottom of the cycle in 2012, yet the amount of market-making capacity has been shrunk by 80-90%. The issue for ETF investors is that they expect to have liquidity in these instruments, but in a crisis the underlying assets of these bond funds will experience a tremendous shock. Why? Because Dodd-Frank’s Volcker Rule has essentially ended market-making as a business for banks. Market-making activity means that when everyone wants to sell, the banks who issued these bonds would usually step in and act as the buyer of last resort. This time around, that won’t happen and ETFs will trade at huge discounts to their supposed net asset value. There is no such thing as a financial free lunch, and investors are going to discover the downside of low fees, tight spreads and marginal cost commissions the next time the credit cycle turns.

35 Responses

  1. Trump makes a comment, media pounces, gets it wrong, and it is somehow Trump’s fault…

    Liked by 1 person

  2. JFC.

    WASHINGTON — President Trump accused the F.B.I. on Friday, without evidence, of sending a spy to secretly infiltrate his 2016 campaign “for political purposes” even before the bureau had any inkling of the “phony Russia hoax.”
    In fact, F.B.I. agents sent an informant to talk to two campaign advisers only after they received evidence that the pair had suspicious contacts linked to Russia during the campaign.

    So, Trump “accused… without evidence” an action that actually happened? And the problem with the first two paragraphs, according to the NYT, was that Trump was guessing about an event that was actually true? Not that Obama was spying on his political opposition?

    If I’m reading this right, the CIA and FBI sent an undercover agent into the campaign of the Republican Party. I’m supposed to feel all patriotic about it?

    Yesterday, I was told only a nut would think the US government would spy on its opposition party, today it’s “Hell yes I ordered the code red!”

    I’m the most cynical person I know and this blows my mind.

    Over the past two days, Mr. Trump has used speculative news reports about the informant, mostly from conservative media, to repeatedly assail the Russia investigation.

    How dare he read something other than the bullshit fed to him!

    I didn’t vote for Trump but I honestly wish I would have.

    The call and response in this article is fucking amazing!

    “Reports are there was indeed at least one FBI representative implanted, for political purposes, into my campaign for president,” he wrote on Twitter on Friday. “It took place very early on, and long before the phony Russia Hoax became a ‘hot’ Fake News story. If true — all time biggest political scandal!”

    No evidence has emerged that the informant acted improperly when the F.B.I. asked for help in gathering information on the former campaign advisers, or that agents veered from the F.B.I.’s investigative guidelines and began a politically motivated inquiry, which would be illegal.

    It’s obvious no why the Justice Department is fighting Nunes tooth and nail.

    It’s time for Sessions to unrecuse himself.

    The fact that this all occurred on foreign soil, so Brennan could run it shouldn’t go unnoticed.

    I predict they planted more than one government spy in the campaign.


    • Good McCarthy follow-on today.

      “The fons et origo of the counterintelligence investigation was the suspicion — which our intelligence agencies assure us is a fact — that the Democratic National Committee’s server was hacked by covert Russian operatives. Without this cyber-espionage attack, there would be no investigation. But how do we know it really happened? The Obama Justice Department never took custody of the server — no subpoena, no search warrant. The server was thus never subjected to analysis by the FBI’s renowned forensics lab, and its evidentiary integrity was never preserved for courtroom presentation to a jury.

      How come? Well, you see, there was an ongoing election campaign, so the Obama Justice Department figured it would be a terrible imposition to pry into the Democrats’ communications. So, yes, the entire “Russia hacked the election” narrative the nation has endured for nearly two years hinges on the say-so of CrowdStrike, a private DNC contractor with significant financial ties to the Clinton campaign.”


      The Obama Justice Department and FBI investigated Flynn — including an ambush interview — on the theory that his discussions with Kislyak and other diplomats violated the Logan Act. Currently codified as Section 953 of the federal penal code, this statute purports to criminalize “any correspondence or intercourse” with agents of a foreign sovereign conducted “without authority of the United States” — an impossibly vague term that probably means permission from the executive branch. The Logan Act is patently unconstitutional, but no court has had the opportunity to invalidate it because, to borrow a phrase, no reasonable prosecutor would bring such a case. As our Dan McLaughlin has explained, the Act dates to 1799, a dark time for free-speech rights during the John Adams administration. Never in its 219-year history has it resulted in a single conviction; indeed, there have been only two indictments, the last one in 1852.


      Incidentally, in the ambush interview, Flynn, without counsel and apparently unaware that he was being questioned as a suspect, was grilled about what was said in a conversation with Kislyak. There was no intelligence need to do this because the FBI had a recording of the conversation. The agents who questioned Flynn, including counterespionage specialist Peter Strzok, determined that Flynn did not lie to them.
      He was later prosecuted by the special counsel for lying to the FBI.

      McCarthy is a NeverTrumper.

      Liked by 1 person

      • Hillary losing this election is like the Globetrotters losing to the Generals. How she lost with the entire deep state throwing the race for her and all the media cheerleading her is beyond me…

        Liked by 1 person

        • If she was so incompetent that she couldn’t win, even with a level of US government spying against her opponent unheard of in American history, how can any rational person be upset she lost? What kind of fuckup of an Adminstration would she have had?

          Liked by 1 person

  3. NY Times has a series on evictions and rent control. The anti-free market bias that permeates the entire series is impressive and not concealed at all.

    I’ve come to the conclusion that the narrative style from fiction that Tom Wolfe, Hunter S. Thompson and others brought to journalism has resulted in worse journalism in terms of informing the reader. All of the “public impact” stories are now written to drive the narrative that the author is trying to push, not dispassionately examine the issue.

    Liked by 1 person

    • Journalists always cite their desire to “change the world” and to “have an impact on society”. It seems to me that you cannot achieve those goals by merely dispassionately reporting the facts.

      Liked by 1 person

      • You can, but they don’t just want to improve things or have a positive impact, they have a fictional utopian vision and a strong moral code, and they want that imposed. Or manifested, anyway. There is no emotional satisfaction in improvement that doesn’t in some way involve imposing their individual vision for humanity on the populace at large.

        I think that’s why ideologues despise pragmatists and people who ask data-based questions about what would work best, what is a mutually agreeable goal, what is the best fact-driven approach towards the achievement of that goal even if that approach is emotionally unsatisfying.

        A broad, constant, fact-checked, non-biased, non-ideological reportage would both have an impact on society and change the world for a better, but ultimately their goal is to advance their own personal agendas and achieve notoriety within their ideological tribe (and the enjoy the emotional benefits thereof).


    • All of the “public impact” stories are now written to drive the narrative that the author is trying to push, not dispassionately examine the issue.

      Everything has a side. They pick that side, and then they argue for that side. There is never serious treatment of the objections of critics. Nor they discuss the very real drawbacks of the sides they are advocating for. Or question the general assumption. Why should their be affordable housing in New York City? Maybe a better government intervention would be finding jobs in places with low cost of living, and then buying these people bus tickets to move out of the city.


    • Now I’m reading the story. OMG. The new owners sins that are designed to push out rent-regulated tenants:

      Fresh construction! Improving the building! A hole accidentally punched through the ceiling by a clumsy (no doubt union) construction worker! Security cameras!

      Continuing to read, it sounds like the city made providing low-income housing a money-losing proposition, so gave all landlords an incentive to only provided high-income housing. And then are surprised that low income housing has disappeared.

      City regulators do not investigate whether an owner who has illegally gutted apartments

      Is this a euphemism for the city making remodeling/improving apartments illegal?

      to investigate complaints of illegal construction

      Illegal because they are not supposed to improve the property?

      In 1996, the entire building was regulated, with a mixture of rent-stabilized and rent-controlled units. The average price of stabilized units was about $870 per month, adjusted for inflation

      So, the same price as a nice-ish apartment, probably about twice the size, in Memphis at the time. How in the world could a rental management company stay in business in New York City at those prices in 1996 without massive subsidy?

      19 units lost to the free market

      Christ. On a cracker.

      Jean Tremont is paying less than $700 a month for an apartment in NYC and complains that he isn’t getting Jacuzzi tubs and wine fridges when already the rental company has to be losing money on his apartment. I was paying for a $700 for a townhouse in a crappy part of Memphis in 1993.

      Why does this guy need to live in New York at all? I like San Diego but I’m never going to live there because it’s way too frickin’ expensive for me.

      Enough. Just one final thing: gentrification is fucking IMPROVEMENT. It’s taking run-down areas that are often economically struggling or falling apart or suffering from crime, etc., and making them better. It’s just improvement. The same people who complain about cities expanding, building new suburbs, building malls at the edge of the city, are the same people complaining when areas are improved within old, crappy urban neighborhoods. WTF do they want?


      • And some of those neighborhoods mentioned (Nolita, West Village) are swanky addresses. I demand rent controlled apartments in Gramercy Park.

        When I first moved to the City, I did sublet rent-controlled apartments for my first 4 years there. Shared a 3 bedroom place in Styvesant town that cost $1,100 a month…

        Liked by 1 person

  4. Worth a read:

    and Krugman goes all in with “treason”, which looks a lot like investigative journalism.

    Liked by 1 person

  5. Interesting:

    “Barack and Michelle Obama are becoming television and film producers for Netflix
    by Steven Zeitchik
    May 21 at 12:43 PM”


  6. I laughed

    Liked by 1 person

  7. Interesting that this is viewed as crazy talk:

    “Trump could order the department to comply with congressional demands, although that would spark significant backlash in federal law enforcement, and it is possible that Justice Department officials might resign in protest or refuse the order and force Trump to fire them.”


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