All Things in Moderation

Vital Statistics:

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

We will get the minutes from the July FOMC meeting at 2:00 pm EST. Given the dramatic change in the Fed’s posture over the past several months, there is a possibility that it could be market-moving.

The Trump Administration floated the idea of a payroll tax cut and a capital gains tax cut in order to stimulate the economy. Note that a payroll tax cut would require Congressional approval, which means there is a less than 0% chance of this happening ahead of the 2020 election.

Mortgage applications fell 0.9% last week as purchases fell 4% and refis rose 0.4%. The MBA mentioned how much mortgage rates have underperformed the Treasury market: “In a week where worries over global economic growth drove U.S. Treasury yields 13 basis points lower, the 30-year fixed mortgage rate decreased just three basis points. As a result, the refinance index saw only a slight increase but remained at its highest level since July 2016,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The small moves in rates and refinancing are potentially signs that lenders may be approaching capacity constraints as they continue to deal with the largest wave of refinance activity in three years. The refinance share of applications, at almost 63 percent, was also at its highest level since September 2016.” Turn times are certainly getting longer from correspondent lenders as this refi wave caught the entire industry off guard.

What is driving the underperformance of MBS versus Treasuries? Capacity constraints are one big possibility – as firms use up their operational excess capacity, they will increase margins. The other issue is that the inverted yield curve is wreaking havoc on MBS investors, who borrow short and lend long. The big agency mortgage REITs  (Annaly Capital and American Capital Agency) cut their dividends recently. Two Harbors also cut their dividend. This is a warning sign that the mortgage REIT sector is losing money as rising prepayment speeds kill the value of their portfolios. Since mortgage REITs are probably deleveraging in response, that means they are either selling MBS or at least cutting back their purchases. That lack of demand means that mortgage rates will be higher than you would expect. So, if you are running scenarios and wondering why you can’t get par pricing at X%, that is a big reason why.

McMansion builder Toll Brothers reported better than expected earnings last night. That said, most numbers were down on a YOY basis – earnings, revenues, contracts, margins. Despite the mediocre numbers, the stock is up pre-market. Douglas C. Yearley, Jr., Toll Brothers’ chairman and chief executive officer, stated: “In our third quarter, we had strong revenues, gross margin, and earnings. While our third quarter contracts were down modestly, we are off to a good start in our fourth quarter. Low mortgage rates, a limited supply of new and existing homes, and a strong employment picture are providing tailwinds. We are focused on measured growth through geographic, product and price point diversification, and capital-efficient land acquisitions. We continue to expand the buyer segments that we serve with homes now ranging in price from $275,000 to over $3 million. Our balance sheet remains strong and our book value continues to grow. With ample liquidity, moderate leverage, and limited near-term debt maturities, we have the flexibility to execute on our balanced capital allocation strategy.”

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