Morning Report: Jerome Powell appears on 60 Minutes

Vital Statistics:

S&P futures4,115-5.4
Oil (WTI)60.471.15
10 year government bond yield 1.67%
30 year fixed rate mortgage 3.27%

Stocks are flattish this morning on no major news. Bonds and MBS are flat.

We kick off earnings season this week, with the big banks starting the show. We will get some important economic data with the Consumer Price Index on Tuesday, Industrial Production on Thursday and Housing starts on Friday.

Fannie Mae and Freddie Mac will stop purchasing loans under the GSE patch starting on July 1. This means they will no longer accept loans with debt-to-income ratios above 43%. This is interesting given that the CFPB has proposed extending the patch to October 2022.

Fed Chairman Jerome Powell went on 60 Minutes yesterday and talked about the state of the economy. Here is the transcript. Nothing was said that could be considered market-moving, although he did discuss the Fed’s thinking regarding inflation as the economy improves:

SCOTT PELLEY: What the Fed has done traditionally is use economic models to predict inflation and then raise interest rates, tap the brake if you will, before inflation happens. Is that what you’re planning on doing?

JEROME POWELL: No, it’s not. And really, what we’ve done is we’ve updated our understanding of the economy and therefore, our policy framework to the way the economy has evolved. The economy has changed. And what we saw in the last couple of cycles is that inflation never really moved up as unemployment went down.

We had 3.5% unemployment, which is a 50-year low for much of the last two years before the pandemic. And inflation didn’t really react much. That’s not the economy we had 30 years ago. That’s the economy we have now. That means that we can afford to wait to see actual inflation appear before we raise interest rates. Now, we don’t want inflation to go up materially above 2% and go back to, you know, the bad, old inflation days that we had when you and I were in college back a long time ago. But at the same time, we do have the ability to wait to see real inflation. And that’s what we plan on doing.

Overall, the Fed is sticking with its base case scenario that the second half of 2021 will be exceptionally strong, perhaps the strongest in 30 years. That said, there are still about 9 million fewer people working than there were pre-pandemic and a lot of small businesses have closed. It will take time for those people to find jobs and new businesses to emerge to replace the closed ones.

Powell has changed his thinking even over the course of his term regarding tapering and getting off the zero bound. The labor market index is roughly at the same place today as it was in 2013 when Powell began urging the Fed to reduce purchases of Treasuries and MBS. As the article notes, we are going to see a spike in inflation simply because prices during the lockdown days of 2020 were artificially low. Of course that doesn’t tell the whole story; supply chain bottlenecks are driving prices higher as well, although those should be temporary. Ultimately people’s perception of inflation is largely driven by prices at the gas pump, and the summer driving season begins soon.

Morning Report: Inflation spikes

Vital Statistics:

S&P futures4,084-4.4
Oil (WTI)59.43-0.45
10 year government bond yield 1.68%
30 year fixed rate mortgage 3.26%

Stocks are flattish this morning after a dull overnight session. Bonds and MBS are down.

Inflation at the wholesale level jumped last month, according to the Producer Price Index. The headline number rose 1% month-over-month and 4.2% year-over-year. Ex-food and energy, it rose 0.7% MOM and 3.1% YOY.

The FOMC minutes from Wednesday mentioned that the early days of COVID presented some unusually weak price readings, which will create exaggerated year-over-year comparisons this year. While the Fed focuses on the Personal Consumption Expenditures index instead of CPI / PPI it appears we are seeing this effect here as well. Regardless, bonds don’t like the number and the 10 year tacked on about 5 basis points of yield this morning.

Fannie Mae sent out a letter yesterday regarding non-owner occupied properties. It said:

Effective June 1, all whole loans secured by investment properties must be purchased against the Investment Property commitments in Pricing & Execution-Whole Loan® (PE-Whole Loan). Loan Delivery will allow whole loans for investment properties to only be delivered against a 30yr or 15yr investment property PE-Whole Loan commitment. If an investment property loan is delivered against another commitment type (e.g. 30-Year Fixed Rate, 30-Year Fixed Rate – 110k Max Loan Amount, etc.) a fatal edit will occur.

Essentially, Fannie will limit its purchases of investment properties (and presumably second homes) by rationing its commitments to people. No idea what pricing will look like or anything like that, but that is the latest out of Fannie. I have heard that Freddie is telling lenders they may have to repurchase excess NOO loans if they over-deliver.

Higher borrowing costs are not deterring demand for second / vacation homes, according to Redfin. “The Palm Springs housing market is incredibly busy, with an influx of vacation-home buyers from Los Angeles and San Francisco,” said local Redfin agent Nisa Sheikh. “Many of them are tech workers who can do their jobs remotely, and they enjoy the weather and lifestyle here in the desert. People don’t want to vacation in a hotel room right now, and many of my buyers are planning to turn their second homes into Airbnb rentals and earn some extra income when they’re not in town.”

Redfin noted that home price appreciation was higher in seasonal towns versus non-seasonal towns. Redfin noted that second-home mortgage locks were up 128% in March, which I think was driven by people trying to get in loans before Fan and Fred impose their NOO limits. Look at the price appreciation: 19%.

Morning Report: Dovish FOMC minutes

Vital Statistics:

S&P futures4,08010.4
Oil (WTI)59.17-0.65
10 year government bond yield 1.66%
30 year fixed rate mortgage 3.28%

Stocks are higher this morning despite another disappointing unemployment filing number. Bonds and MBS are up.

Initial Jobless Claims increased to 744,000 last week. Despite the improvement in the BLS Employment Situation report, this drip, drip, drip of initial claims is worrisome.

The FOMC minutes were pretty dovish. I was interested in what drove the significant upward revision in GDP forecasts, and they primarily based it on vaccination progress, in addition to some economic reports. The stimulus measures were mentioned as well, but essentially the optimism in the economy is based on the progress made in battling COVID.

“Participants observed that the pace of the economic recovery had picked up recently and that the economy continued to show resilience in the face of the pandemic. They noted encouraging developments regarding the pandemic, including significant declines in the number of new cases, hospitalizations, and deaths over the intermeeting period as well as a pickup in the pace of vaccinations. In light of these developments as well as the extent of the recent fiscal policy support, participants significantly revised up their projections for real GDP growth this year compared with the projections they submitted last December. They noted, however, that economic activity and employment were currently well below levels consistent with maximum employment.”

In terms of consumer spending, the Fed noted that consumption had risen this year, however spending on services has been weak. They mentioned the high consumer savings rate and expect that this represents pent-up demand that will be released later in the year as social distancing restrictions are removed.

They noted that the labor market improved recently, however there is a lot of work to do in order to get back to normalcy.

“Participants observed that labor market conditions had improved recently, as payroll employment registered strong gains in February and the unemployment rate fell to 6.2 percent. Even so, payroll employment was about 9.5 million jobs below its pre-pandemic level, and labor market conditions for those in the most disadvantaged communities were viewed as lagging behind those of other households. Moreover, participants noted that employment in the leisure and hospitality sector was still down substantially from its pre-pandemic level despite a sharp rebound in February. Participants generally expected strong job gains to continue over coming months and into the medium term, supported by accommodative fiscal and monetary policies as well as by continued progress on vaccinations, further reopening of sectors most affected by the pandemic, and the associated recovery in economic activity. However, participants noted that the economy was far from achieving the Committee’s broad-based and inclusive goal of maximum employment.”

Finally, they discussed the increased inflation numbers. It turns out that the 2%+ PCE inflation forecast for the rest of the year is being driven primarily by exceptionally weak inflation numbers in the spring and summer of 2020. As things return to normalcy, the year-over-year comparisons will be exaggerated. In other words, a 2.3% or 2.4% PCE reading should be nothing for the bond market to freak out over.

Overall, the minutes were interpreted as dovish, particularly the sentence that the economy was “far from” achieving the goal of maximum employment.

The MBA’s Mortgage Credit Availability Index improved last month, driven by improvement in low FICO and high LTV products. I wonder if this was driven by the announcement by the GSEs that they will begin limiting these products and bankers are trying to get these loans done before the window closes. We are still way below where we were pre-COVID, however.

The Biden Administration is planning to help ease the housing shortage by providing incentives to local governments to permit apartment buildings in areas zoned for single-family residences only. Essentially, if local governments ease zoning restrictions, they will get grants from the Federal government for building schools, etc. This is being trumpeted by the Administration as “all carrot, no stick” however that doesn’t mean that HUD won’t be back suing local governments under the AFFH argument. Ultimately this comes down to how much the local governments need the money.

Speaking of the Biden Admin, he is “willing to negotiate” on the higher corporate tax rate. It sounds like he is getting some push-back from people in his own party on this.

Morning Report: Commercial real estate cap rates fall

Vital Statistics:

S&P futures4,060-3.4
Oil (WTI)59.05-0.29
10 year government bond yield 1.66%
30 year fixed rate mortgage 3.29%

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

We will have a lot of Fed-speak today, and the FOMC minutes will be released at 2:00 pm today. The minutes should be an interesting read, and could have the potential to move markets if there are any surprises.

Mortgage applications fell 5% last week as purchases and refis fell by the same amount. Last week contained Passover and Good Friday, which probably depressed the numbers as well. Still, the mortgage market is struggling with higher rates, which are depressing refinancings, and tight inventory which is limiting purchase activity.

Residential real estate is not the only sector that is seeing a flood of investment dollars; commercial real estate is as well. Cap rates (which represent the investor’s anticipated income margin) have hit all-time lows in the net-lease retail and industrial space, according to the Boulder Group. This means that that either (a) rents are depressed and about to go up, or (b) properties are expensive. I found it surprising that cap rates would be the lowest ever coming out of a pandemic, especially in retail.

Industrial rates make sense; the pandemic exposed the issues with companies running lean and mean inventory levels. This is partially why we are seeing just about every commodity in short supply. But retail? Perhaps a consumer spending bet, but I am surprised by that. Mall vacancies rose at a record record pace to hit 11.4%.

Zillow put out its first quarter Population Science Survey which tracks homeowner’s intentions regarding their properties. 14% of homeowners expect to sell in the next 2-3 years. The main reasons to move include the desire for more space, easier commute, and having a home office.

Morning Report: Home prices rise 10%

Vital Statistics:

S&P futures4,061-6.4
Oil (WTI)59.841.22
10 year government bond yield 1.68%
30 year fixed rate mortgage 3.33%

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

Home prices rose 10.4% YOY in February, according to CoreLogic. “Homebuyers are experiencing the most competitive housing market we’ve seen since the Great Recession. Rising mortgage rates and severe supply constraints are pushing already-overheated home prices out of reach for some prospective buyers, especially in more expensive metro areas. As affordability challenges persist, we may see more potential homebuyers priced out of the market and a possible slowing of price growth on the horizon.” I think the slowing of price growth is probably a given, since double digit price growth is generally unsustainable. That said, professional money is flooding the single family sector, and a lot of new construction will be build-to-rent. With inventory at record lows, it will take years to get supply and demand back into balance. Note every state is seeing high single digit + appreciation except one: New York.

The MBA is urging the CFPB to adopt the new QM rule without delay.

“MBA supports the General QM Final Rule’s pricing construct, which, compared to the
alternatives considered, strikes the best balance between ensuring consumers’ ability to
repay and ensuring access to responsible, affordable mortgage credit. Loan price is a holistic
measure, capturing the borrower’s credit score, income, debts, assets, debt-to-income (DTI)
ratio, and other strongly correlated indicators of a borrower’s risk of default. The Bureau’s
analysis of loan performance data demonstrates that loan price is a strong proxy for a
borrower’s ability to repay. Specifically, the Bureau’s analysis indicates that for loans within a
given DTI ratio range, those with higher rate spreads consistently had higher early
delinquency rates, and loans with lower rate spreads had relatively low early delinquency

Loans in forbearance fell again last week to 4.9% of servicer portfolios. “The share of loans in forbearance decreased for the fifth straight week, and new forbearance requests dropped to their lowest level since March 2020,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “The share of loans in forbearance also decreased for all three investor categories. “More than 21 percent of borrowers in forbearance extensions have now exceeded the 12-month mark. Of those that exited forbearance in March, more than 21 percent received a modification, indicating that their income had declined and they could not afford their original mortgage payment.”

There were 7.4 million job openings at the end of February, according to the JOLTS jobs report. This was an increase of 268,000 from the end of January. Hires were 5.7 million while separations were 5.5 million. The quits rate was unchanged at 2.3%.

Morning Report: The CFPB warns servicers about foreclosures

Vital Statistics:

S&P futures4,03227.4
Oil (WTI)59.84-1.62
10 year government bond yield 1.74%
30 year fixed rate mortgage 3.33%

Stocks are higher this morning after Friday’s strong jobs report. Bonds and MBS are down small.

The upcoming week is pretty data-light, as is typical after the jobs report. The main thing will be the FOMC minutes on Wednesday and then inflation data on Friday. The FOMC minutes will be interesting to see just how much faith the Fed is putting into the stimulus spending.

Speaking of stimulus, the Biden Admin is trying to sell its $2.5 trillion infrastructure plan both to Republicans and the country at large. The sticking point will be the increase in corporate taxes to pay for the plan, and so far it looks like he isn’t even getting buy-in from his own party on that.

Pension funds are getting into the single-family rental business. “You now have permanent capital competing with a young couple trying to buy a house,” said John Burns, whose eponymous real estate consulting firm estimates that in many of the nation’s top markets, roughly one in every five houses sold is bought by someone who never moves in. “That’s going to make U.S. housing permanently more expensive,” he said. Again, when you look at mid single-digit cap rates, and then tack on double-digit price appreciation for the underlying assets, you have an asset class that has better characteristics than most other investment options out there.

The CFPB wants servicers to be ready for the wave of foreclosures once the moratoriums expire. “There is a tidal wave of distressed homeowners who will need help from their mortgage servicers in the coming months. Responsible servicers should be preparing now. There is no time to waste, and no excuse for inaction. No one should be surprised by what is coming,” said CFPB Acting Director Dave Uejio. “Our first priority is ensuring struggling families get the assistance they need. Servicers who put struggling families first have nothing to fear from our oversight, but we will hold accountable those who cause harm to homeowners and families.”

Morning Report: The economy added 916,000 jobs in March

Vital Statistics:

S&P futures4,02717.4
Oil (WTI)61.242.02
10 year government bond yield 1.70%
30 year fixed rate mortgage 3.32%

Stocks are higher this morning after a robust payroll number. Bonds and MBS are flat.

The economy added 916,000 jobs in March, according to BLS. The unemployment rate slipped from 6.2% to 6%. Average hourly earnings were down 0.2% MOM but up 4.2% on a YOY basis. The labor force participation rate ticked up 0.1% to 61.5%.

Looking at the Establishment Survey, 780k payrolls were in the private sector and 136k were in government. Leisure and hospitality added 280k jobs, while education / health added 101k. Construction jobs increased 110k.

On the Household side, the employment-to-population ratio ticked up from 57.6% to 57.8%. A year ago, the ratio was 59.9%. The employment population ratio is still lower than it was during the Great Recession, and the last time it was at this level was mid-1983, as the economy was coming out of the Volcker-driven recession of 1981-1982. In other words, the labor market still has a lot of work to do to get back to even a semblance of normalcy.

The Wall Street Journal has an article on how hard it is to get a mortgage loan if you have low credit scores. It pretty much glosses over the effect that forbearance has on lenders and is completely oblivious to the plight of servicers. FHA insurance reimbursements are particularly miserly, which is why FHA servicing basically became worthless last year. While FHA limited advancements to only four months, the servicer always has to eat the first two payments. So, those first two payments are generally going to be higher than the value of the servicing in the first place.

It also doesn’t mention the new high risk limits for loans going to Fan and Fred. The article postulates that as easy refi activity dries up, lenders will start moving lowering credit score requirements. Perhaps, but as long as forbearance and foreclosure moratoriums are in place, I think lenders will continue to avoid FHA.

Residential real estate brokerage company Compass went public yesterday, albeit in a scaled-back offering. The initial price talk was 36 million shares at a price of $23 to $26, however the company ended up selling 25 million at $18.50.

Morning Report: Manufacturing Improvement the best in decades.

Vital Statistics:

S&P futures398721.4
Oil (WTI)60.741.62
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.34%

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

With the expiration of the Supplemental Liquidity Ratio issue, perhaps some of the selling pressure in the bond market will abate.

Initial Jobless Claims rose to 719k last week. While the economy has been adding jobs overall, the drip, drip, drip of these high unemployment claims have been a drag on confidence. Separately, outplacement firm Challenger and Gray reported companies announced 30,600 job cuts last month.

Construction spending fell 0.8% in January, according to the Census Bureau. Residential construction spending fell 0.2% MOM, however it was up 21% on a YOY basis. Given the COVID-19 effects on commercial real estate, it isn’t a surprise to see lower spending in areas like office properties and retail.

Things are picking up in the manufacturing sector, with the ISM Purchasing Managers Index rising to 64.7%. This is the highest reading since 1983. New orders and production drove the increase, and it is clear that manufacturing companies are re-building inventories. Bottlenecks in the supply chain remain, and the list of commodities in short supply is pretty extensive. Every commodity is up in price. In fact, the supplier deliveries number, which measures how long it takes suppliers to fill orders, is the highest since 1973, at the end of the OPEC oil embargo.

These sorts of numbers have people thinking about inflation, and it is true that all commodities are up in price. Are we on the cusp of another 1970s inflation repeat? Certainly some of the pieces are there. Massive government spending? Check. Commodities in short supply? Check. Massive monetary stimulus? Yep. Lousy productivity? You bet. These factors are driving the argument that we are about to see inflation return.

Here are some reasons why it isn’t going to return. Most of these supply bottlenecks are COVID-19 related, and therefore are temporary. As manufacturers restock inventories (this is the driver of that ISM number), these bottlenecks will abate. In fact, logistics REIT Prologis thinks the inventory restocking will take years, as manufacturers realized that a “lean and mean” corporate framework makes companies vulnerable to shocks like we saw with COVID. This applies to workers and inventory. Eventually, these commodity supplies will restock, delivery times will decrease, and then final demand will be the driver.

The 1970s inflation issue was driven by energy, particularly oil. The reason why oil stayed so high was because things like fracking weren’t invented yet. High oil prices seeped into almost every other goods price. US factories, which were built during the Industrial Revolution, were aged and inefficient. Capacity Utilization rates were in the high 80% range, so any additional production was expensive. Foreign competition was nascent as Japan was only beginning its rise and China was a Communist country that supplied us nothing.

Inflation is “too much money chasing too few goods” and the “too few goods” part of this is going to prove temporary, IMO. You aren’t going to see inflation until you have massive consumer spending. In the 1970s, the Boomer generation, which knew nothing but 1950s and 1960s prosperity began consuming with a vengeance, which lasted through the 1990s. Today’s Millennials came of age in the Great Recession, and I have to imagine they will be more frugal than their parents.

Final demand is going to be an interesting question. So far, it appears that people are taking their stimulus checks and saving them – meaning they are either paying off debt or putting it in the bank. That is most certainly not inflationary. The labor market isn’t conducive to massive wage inflation either, given that we are a surplus of workers with a low labor force participation rate. It will take time for those folks to get hired.

I suspect the Fed’s forecasts will be about right: we will see an uptick to something like 2.2% this year as supply chain bottlenecks create a temporary bout of inflation. As inventories restock, we go back to the 1.8%-ish PCE reading to which we are accustomed.

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