All Things in Moderation

Vital Statistics:

Stocks are higher this morning as we round out the third quarter. Bonds and MBS are down.

The government looks like it will do a temporary move to avoid a shutdown, however the potential for a shutdown remains until the debt ceiling is raised. Generally speaking these sorts of things are nothing more than political theater. That said, we have had temporary shutdowns in the past and it was hard to get 4506-Ts out of the IRS. Plan accordingly.

Pending Home Sales rose 8.1% in August, according to NAR. “Rising inventory and moderating price conditions are bringing buyers back to the market,” said Lawrence Yun, NAR’s chief economist. “Affordability, however, remains challenging as home price gains are roughly three times wage growth. The more moderately priced regions of the South and Midwest are experiencing stronger signing of contracts to buy, which is not surprising,” Yun continued. “This can be attributed to some employees who have the flexibility to work from anywhere, as they choose to reside in more affordable places.”

I suspect the theme of the real estate market going forward will be the flow of people to areas that have become too cheap to ignore.

Initial Jobless Claims rose to 361,000 last week. The continuing high unemployment claims remain a mystery given the plethora of job openings out there.

The final revision to second quarter GDP was inched up to 6.7%, as consumption rose a hair. Estimates for third quarter GDP have been decreasing. The current Atlanta Fed GDP Now estimate is sitting at 3.2%. The much-ballyhooed 2H acceleration doesn’t seem to be playing out.

Jerome Powell addressed the inflation situation yesterday. “It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse,” he added. “We see that continuing into next year probably, and holding up inflation longer than we had thought.”

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Vital Statistics:

Stocks are lower this morning as investors fret about energy costs. Bonds and MBS are down.

Loans in forbearance fell under 3% last week, according to the MBA. They estimate that 1.5 million borrowers are still in forbearance. Fannie and Freddie loans decreased by 3%, while Ginnies rose.

Home prices rose 19.2% YOY in July, according to the FHFA House Price Index. “Record appreciation rates for the U.S. continued in July,” said Dr. Lynn Fisher, FHFA’s Deputy Director of the Division of Research and Statistics. “Although the monthly pace of increase slowed in most Census Divisions in July, four areas experienced year over year growth rates in excess of 20 percent and all saw annual gains in excess of 15 percent.”

With 19% appreciation, we could be looking at new conforming limits for 1 unit properties in the mid 600k next year.

Separately, the Case-Shiller Index rose close to 20%. Get a load of these numbers: Phoenix up 32%. San Diego up 28%. S&P thinks that this could simply be a case of current transactions “borrowing” from future transactions, which would imply a pricing slowdown going forward.

“We have previously suggested that the strength in the U.S. housing market is being driven in part by a reaction to the COVID pandemic, as potential buyers move from urban apartments to suburban homes. July’s data are consistent with this hypothesis. This demand surge may simply represent an acceleration of purchases that would have occurred anyway over the next several years. Alternatively, there may have been a secular change in locational preferences, leading to a permanent shift in the demand curve for housing. More time and data will be required to analyze this question.”

I wonder how much the Evergrande situation in China (and its bursting real estate bubble) will have fallout for the big West Coast cities like Vancouver and San Francisco. When you have this sort of financial crisis, you never sell what you want to, you sell what you can.

Lael Brainard discussed the economy and the Fed’s thinking. I have to say this statement puzzled me: “Many forecasters have downgraded consumer spending in the second half of the year, as Delta has limited the acceleration in services spending that had been anticipated to help offset the drag on activity from fiscal support shifting from being a tailwind to a headwind.” Congress is working on a $3.5 trillion spending package. I know a trillion doesn’t mean what it used to, but characterizing that as a “headwind” seems odd.

That said, I can see where this is going. I expect the chattering classes will soon exhume the term “austerity” which is about the most loaded economic term out there. “Austerity” officially means a decline in stimulus, however it is often conflated with contractionary fiscal policy. If the US runs a $1 trillion deficit and the deficit narrows to $900 billion in the following year, that is officially “austerity.” That doesn’t mean the government is tightening. It doesn’t mean the government is trying to slow the economy. Deficit spending is still highly stimulative to the economy and is still a “tailwind.” Austerity is Newspeak for “the government isn’t spending enough on my priorities.”

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Vital Statistics:

Stocks are lower as we round out the third quarter. Bonds and MBS are down.

The upcoming week won’t have much in the way of market-moving data, however we will have a lot of Fed-Speak. We will get plenty of real estate data, with pending home sales, Case-Shiller and FHFA. Although Friday is October 1, the jobs report will come out next week.

The bond market is back in sell-off mode, and there wasn’t too much in the way of US news to drive it – the FOMC statement was a nonevent, and everyone pretty much knew that tapering was slated to begin this year. The sell-off seems to be global, and German yields have risen over the past few days by 13 basis points to negative 0.2%. Angela Merkel is not going to run again, and it looks like Germany is going to be run by the left.

We are seeing commodity shortages all over Europe, especially in the energy markets. Natural gas prices in Europe are up 150% over the past 6 months. Gas prices in the US are up over 100% over the same period. The US is exporting liquefied natural gas to Europe, but that should increase prices over here. With gas prices so high, people can expect to see big increases in electricity bills this winter.

There is a lot going on legislatively this week between the infrastructure bill, the 3.5 trillion stimulus bill and the debt ceiling. The infrastructure bill is probably fine, the stimmie bill is going to have to go on a diet, and there is plenty of jawboning over the debt ceiling. Democrats want Republican fingerprints on the debt ceiling bill, but Republicans are resisting.

Durable goods orders rose 1.8% last month, which was well above the Street consensus forecast. Ex-transportation they rose 0.2%. Core Capital Goods orders rose 0.5%, which was above expectations as well.

The increase in core capital goods is a good proxy for business capital spending. CAPEX spending has been depressed for a while, however I suspect that the current labor shortage is driving the increase. While labor availability can come and go, technology is always there, getting cheaper and better. This is the fatal flaw in the logic of engineering a labor shortage.

Democrats are looking at a 20-year FHA loan that will be subsidized enough that the payments will be the same as a 30 year FHA. It will be called the LIFT program, for Low Income First Time Homebuyers. The idea is that it will go to first generation, first time homebuyers who make more than 120% of the area median income. Separately, they are looking at more down-payment assistance programs. Former MBA head Dave Stevens said: “In Congress right now, and I would guess the White House, they would like to see both Maxine Waters down payment assistance bill and this one make its way to the reconciliation process,” added Stevens. “If you could get a modest amount of dollars for both Chairwoman Waters’ piece of legislation as well as for the LIFT bill, you get some really good dollars targeted for first time homebuyers.”

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Vital Statistics:

Stocks are lower this morning on overseas weakness. Bonds and MBS are down.

Home equity rose 29% in the second quarter to $2.9 trillion, according to CoreLogic. This works out to be a $51,500 gain per homeowner. The number of homes with negative equity (surprised they still exist anymore) fell to 1.2 million homes.

New Home Sales rose 1.5% MOM to a seasonally-adjusted annual rate of 740,000. This is down big (24%) compared to a year ago. This was above expectations, however.

The Conference Board Index for Leading Economic Indicators rose in August.

“The U.S. LEI rose sharply in August and remains on a rapidly rising trajectory,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “While the Delta variant—alongside rising
inflation fears—could create headwinds for labor markets and the consumer spending outlook in the near term, the trend in the LEI is consistent with robust economic growth in the reminder of the year. Real GDP growth for 2021 is expected to reach nearly 6.0 percent year-over-year, before easing to a still-robust 4.0 percent for 2022.”

This is interesting since the GDP forecasts are falling, at least if you look at the 2020 forecasts from the FOMC meeting this week. The Atlanta Fed’s GDP Now index has been trending downward for some time, and Street strategists have been taking down growth estimates. Given what we have heard out of FedEx and Nike, third quarter earnings will be soggy for a lot of companies. So what the heck is going on?

I think the issue is that the Conference Board’s LEI inputs are mainly measuring demand, and the issue for the economy right now is supply. Demand is strong for cars, however chip shortages have reduced inventories. Lots of people want to eat out at a restaurant, but restaurants are short-staffed.

Since GDP is a function of actual transactions, you need both supply and demand. For much of the post-bubble period demand was the issue. People lost a lot of their net worth in the housing market, and they used any extra cash to pay off debt. Since spending is the biggest portion of GDP, the policy levers were used to encourage spending. Today, the issue isn’t demand, it is supply. Unfortunately for DC politicians, they are still fighting the last war.

Ultimately the question becomes whether this is a short-term phenomenon or something longer term. If it is short term, it will work itself out and be forgotten in a year or two. If it is long term, then we will start seeing persistent inflation. And the lesson from the 1970s is that inflationary expectations are hard to control once they start.

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Vital Statistics:

Stocks are higher this morning after the Fed maintained interest rates. Bonds and MBS are down.

The FOMC statement was pretty much in line with expectations. The Fed noted that the economy had continued to strengthen, although some of the industries hit hardest by the disease have seen their recoveries slow down. The Fed is sanguine with letting inflation run hot in the near term, in order to bring the average up to their target. On the subject of tapering, here is what they had to say:

Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals. If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.

The economic projection for GDP was lowered from 7% to 5.9% for 2021, which was the biggest change in the projections. 2022 GDP was bumped up from 3.3% to 3.8%, while inflation and unemployment projections for 2021 were increased.

The dot plot showed the FOMC basically coming into agreement with the Fed Funds futures. A few additional members saw a rate hike in 2022, and we are now more or less seeing a 50 / 50 chance of a rate hike next year.

Overall, I think the takeaway is that the first reduction in asset purchases probably happens this year, and the Fed views this current deceleration in growth as a temporary blip that will add to growth next year.

Initial Jobless Claims ticked up to 351k last week as the Great Resignation continues. As we saw in FedEx’s numbers yesterday, labor shortages are taking a toll on profitability. FedEx’s woes probably translate to a whole host of other businesses too. Third quarter earnings may disappoint for a lot of companies.

The Fed’s plans may also be moot given the Evergrande situation in China. Evergrande is a distressed property developer in China that has something like $300 billion in liabilities. While the government so far hasn’t made moves to bail out the company, the reverberations may still impact the Chinese real estate market, especially residential real estate.

As we saw in Japan in the late 80s, and the US during the bubble, burst residential real estate bubbles are something that develop a life of their own, and it is hard to manage the fallout. I read somewhere that real estate accounts for 29% of China’s GDP, compared to about 6% in the US, and real estate assets account for 40% of Chinese household assets. When that bubble bursts, it will be ugly.

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Vital Statistics:

Stocks are higher this morning as fears over an Evergrande contagion fade. Bonds and MBS are flat.

The Fed decision is due at 2:00 pm today. No changes in interest rates are expected, although there is the possibility we could see an announcement regarding decreased asset purchases (tapering). We will also get a press conference and new projections.

FedEx reported earnings this morning which came in lower than expected. Check this statement out in the press release:

First quarter operating results were negatively affected by an estimated $450 million year over year increase in costs due to a constrained labor market which impacted labor availability, resulting in network inefficiencies, higher wage rates, and increased purchased transportation expenses. This was partially offset by higher package and freight yields, increased international export express shipments and a favorable net fuel impact. In addition, while commercial ground and U.S. domestic express package volume increased year over year, continued supply chain disruptions have slowed U.S. domestic parcel demand compared to the company’s earlier forecast.

The stock is down 7% this morning. I wonder if this is going to be a theme when companies start reporting third quarter numbers in about a month.

Mortgage applications rose 4.9% last week as refis increased 7% and purchases rose 2%. “There was a resurgence in mortgage applications the week after Labor Day, with activity overall at its highest level in over a month, and purchase applications jumping to a high last seen in April 2021,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Housing demand is strong heading into the fall, despite fast-rising home prices and low inventory. The inventory situation is improving, with more new homes under construction and more homeowners listing their home for sale. Despite this week’s increase, purchase applications were still 13 percent lower than the same week a year ago.”

Existing home sales fell 2% in August, according to the National Association of Realtors. Existing home sales came in at an annualized pace of 5.9 million, which was down on both a month-over-month and year-over-year basis. “Sales slipped a bit in August as prices rose nationwide,” said Lawrence Yun, NAR’s chief economist. “Although there was a decline in home purchases, potential buyers are out and about searching, but much more measured about their financial limits, and simply waiting for more inventory.”

The median home price rose 15% to $356,700, as inventory remains an issue. Speaking of inventory, we had a 2.6 month supply of unsold homes, which is well below a balanced market, which has about 6 months’ worth. First time homebuyers slipped to 29% which is another indication that people are getting priced out of the market.

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Vital Statistics:

Stocks are rebounding after yesterday’s Evergrande-related sell off. Bonds and MBS are flat.

The FOMC meeting begins this morning. The decision will be released tomorrow at 2:00 pm.

While no change in rates are expected at this week’s FOMC meeting, the consensus seems to be that Jerome Powell will give the market the official heads up that the bank will start reducing bond and MBS purchases. Given the Evergrande issue, the Fed has to make sure that it doesn’t freak the markets out too much. If the dot plot shows rates rising in late 2022, then that could be a problem. So far, the Fed Fund futures have a better-than 50% chance of a rate hike by the end of 2022.

Housing starts rose to 1.62 million in August, which came in above expectations. This is up 3.9% compared to July and is 17% above a year ago. Starts increased in the Northeast, South and Midwest, but declined in the West. Building Permits also rose to 1.73 million. This is up 6% on a MOM basis and 13% on a YOY basis.

Banks are beginning to consider “blue-lining” or refusing to lend to flood-prone areas. Since we have national flood insurance, and government-guaranteed loans I suspect this is more for show than anything else. The term itself (reminiscent of redlining) kind of gives away the game. That said, there is a no-bid risk for VA loans, so that could conceivably be a factor.

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Vital Statistics:

Stocks are lower this morning on fears of a hard landing in China. Bonds and MBS are up.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The markets don’t see any changes in the Fed Funds rate, however we could see some further language about reducing bond purchases. Aside from the FOMC announcement, we will get housing starts and new home sales.

The NAHB Housing Market Index improved a point in September to 76. This is a sentiment indicator for homebuilders.

Fears are increasing that the Chinese government is going to let property developer Evergrande fail. Evergrande is the most indebted property developer in the world, with something like $300 billion in liabilities. “Everyone is looking at Evergrande and saying ‘has the time come for a major default in that area, and then the potential for contagion into the broader property sector?’” said Edward Park, chief investment officer at Brooks Macdonald. “It’s an imminent risk now rather than being a theoretical risk as it has been for the past few years.”

The consensus so far seems to be that Evergrande won’t be a “Lehman-type moment,” in reference to the 2008 decision to let Lehman fail, which supposedly caused the 2009 financial crisis. The hope is that a collapse in Evergrande would be limited to the real estate sector and not impact financial sector (and therefore the overall economy) too much.

I suspect this is probably not going to happen. People who insist that Lehman and “subprime” blew up the economy in 2009 have it backwards. The issue was not the financial sector – that was the symptom. The issue was a real estate bubble – which was the disease. Real estate is such a leveraged product that if real estate prices fall by a meaningful amount, equity can be wiped out in a hurry. Real estate bubbles are therefore the Hurricane Katrinas of banking and the contagion spreads fast. When real estate bubbles burst, they throw shrapnel everywhere.

Managing a burst real estate bubble can be done – Japan did it. While there were a few developer and bank failures over the course of the decades that followed, Japan managed to prevent the economy from entering a Great Depression style tailspin. What was the cost? Little-to-no GDP growth from 1989 onward, and a debt-to-GDP ratio of 2.4x.

What does this mean for the US? I suspect the punch line is that we will see a flight to the US dollar and US Treasuries, and that will prevent rates from rising too much. If the Chinese economy hits a hard landing, they will try and export their way out of it, so import prices will fall and that should keep inflation from getting out of hand.

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Vital Statistics:

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

Initial Jobless Claims came in at 332k last week, which was above expectations. It is still a mystery why we are seeing such elevated numbers in the tightest job market I can remember.

Retail sales rose 0.7% in August, when the Street was looking for a 0.8% decline. Ex-vehicles and gasoline, they rose 2%, which was well above expectations. August and September are the back-to-school shopping months and this bodes well for the holiday shopping season at the end of the year.

The retail sales number is great news for those who were looking for an acceleration into the end of the year. Consumption is 70% of the US economy. Still, the labor market remains a headwind, especially if it lasts longer. Consumers may be willing to spend, but if the goods aren’t there to begin with then the sales won’t happen.

Consumer sentiment fell slightly in the preliminary reading from the University of Michigan.

Home sales fell in August, according to Redfin. Prices still increased 16%, however. “When it comes to home prices in this market, what goes up stays up,” said Redfin Chief Economist Daryl Fairweather. “That’s especially true in the Sun Belt; home prices are up more than 20% from last year in Austin and Phoenix. Even with these steep increases, homes in these areas are still relatively affordable, so these and other hot migration destinations are going to continue to attract homebuyers from the coasts. As workers change jobs en masse and enhanced unemployment benefits come to an end, we could see even more households relocate for affordability in the coming months.”

Chinese developer Evergrande is on the brink of default, with something like $300 billion in debt. We have known forever that China has a real estate bubble, similar to what the US went through in the 1920s and Japan went through in the 1980s. If this is indeed the end of the Great Chinese Real Estate Bull Market then the country is probably due for a Great Depression style event. IMO, this is a byproduct of decades of rapid growth. Eventually, more and more marginal projects get built and the debt crisis creates a collapse.

As far as the banking system goes, I don’t think that the US banking system has much exposure here. We can pretty much guarantee that any bailout for Chinese banks won’t extend to foreign banks, but I suspect this might be an overseas hedge fund event. I don’t see any sort of reverberation into the US markets, however I do think that this event will be bullish for US bonds. When financial markets hit credit-related stress, the first asset everyone wants is US Treasuries. We saw good demand in the 30 year auction earlier this month, and that could portend strong demand going forward.

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Vital Statistics:

Stocks are higher this morning after inflation data came in lower than expected. Bonds and MBS are flat.

Prices at the consumer level rose 0.3% MOM and 5.3% on a YOY basis. This monthly increase was the lowest since January. Ex-food and energy, they rose 0.1% MOM and 4% YOY. Higher energy prices have been the big driver for the index, however food has also been a big factor as well. Interestingly, owners equivalent rent (which is a function of housing prices) rose only 0.3% MOM and 2.6% YOY. While this number is an artificial construct, it should generally correlate with housing prices. According to just about every real estate index, prices are rising in the high teens percent.

Small business sentiment increased 0.4% in August, according to the NFIB Small Business Sentiment Index. “As the economy moves into the fourth quarter, small business owners are losing confidence in the strength of future business conditions,” said NFIB Chief Economist Bill Dunkelberg. “The biggest problems facing small employers right now is finding enough labor to meet their demand and for many, managing supply chain disruptions.”

Biden is expected to nominate Mike Calhoun to run FHFA. It sounds like the left is not happy with him due to his Wall Street contacts. Supposedly he is in support of he utility model for Fannie Mae and Freddie Mac.

The share of mortgages in forbearance fell 15 basis points to 3.08% last week. “The share of loans in forbearance decreased by 15 basis points last week, as forbearance exits jumped to their fastest pace since March. The fast pace of exits outweighed the slight increase in new forbearance requests and re-entries,” said Mike Fratantoni, MBA’s Senior Vice President and Chief Economist. “Servicer call volume jumped last week as summer came to an end and many borrowers reached the end of their forbearance terms. We anticipate a similarly fast pace of exits in the weeks ahead, which should lead to increased call volume and a further decline in the forbearance share.”

The housing market is beginning to cool off, according to Redfin. Redfin agents reported that 59% of all sales involved bidding wars last month. “Sellers are still pricing their homes very high, but a lot of buyers have had enough and are no longer willing to pay the huge premiums they were six months ago. Instead of 25 to 30 offers on turnkey homes, we’re now seeing five to seven,” said Nicole Dege, a Redfin real estate agent in Orlando, FL, where the bidding-war rate dropped to 57.5% in August from 78.9% in July. “Buyers are getting a bit more selective. I have one seller who recently put his four-bedroom single-family pool house on the market, but the roof was shot. He had to lower his asking price to $423,000 from $427,000 and agree to spend around $7,000 to replace the roof in order to attract bidders. Six months ago, he would have easily been able to sell that home as-is without dropping the price.”

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