All Things in Moderation

Vital Statistics:

Stocks are lower this morning after Apple and Amazon both missed earnings expectations. Bonds and MBS are down.

Personal incomes fell 1% in September, according to the Bureau of Economic Analysis. The drop in government assistance as extended unemployment benefits expired was the big driver. Wages and salaries rose by $80 billion while unemployment benefits fell by $255 billion. Consumer spending rose by 0.6%.

The Personal Consumption Expenditures index (PCE) rose by 0.3% MOM and 4.4% YOY. Ex-food and energy, it rose 0.2% MOM and 3.6% YOY. This is higher than the Fed’s preferred level, however the central bank (and Treasury) still consider the current spate of inflation to be temporary.

The Employment Cost Index rose 3.7% YOY as companies are raising wages in order to attract employees. One thing to keep in mind is productivity and wages. We saw 3Q GDP come in at 2%, while employment costs are rising much faster. This would imply falling productivity (output increasing slower than wage growth). Increasing productivity is the key to higher living standards, and when productivity is low, you generally see inflation and stagnation. Which is kind of where we are now.

To that point, Treasury Secretary Janet Yellen is peddling the idea that the Administration’s big spending package will be anti-inflationary because it will include subsidies for healthcare and childcare.

Pending Home Sales fell 2.3% last month, according to NAR. “Contract transactions slowed a bit in September and are showing signs of a calmer home price trend, as the market is running comfortably ahead of pre-pandemic activity,” said Lawrence Yun, NAR’s chief economist. “It’s worth noting that there will be less inventory until the end of the year compared to the summer months, which happens nearly every year.”

The hottest markets were Jacksonville, Tampa, Nashville and Denver. Pending Home sales dropped almost 19% YOY in the Northeast, while they declined mid-to-high single digits everywhere else.

Despite some of the disappointing economic data, the Fed Funds futures are increasing bets that interest rates rise next year. The December 22 Fed Funds Futures seem to be coalescing around 2-3 rate hikes next year. This is a huge jump from a month ago.

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Vital Statistics:

Stocks are flattish this morning despite a disappointing GDP print. Bonds and MBS are up.

Economic growth slowed to 2% in the third quarter, according to the Bureau of Economic Analysis. This was well below expectations, and seems to confirm that the economy is slowing down. The Chicago Fed National Activity Index earlier this week confirmed that the economy is growing below trend.

Initial Jobless Claims fell to 281,000. This is close to getting back to normalcy, however we are still elevated compared to pre-COVID.

New Home Sales fell 18% YOY to a seasonally-adjusted annual rate of 800,000. At the end of September, there were 379,000 units in inventory, which represents a 5.7 month supply. The median sales price rose 19% YOY to $408,800.

Durable Goods orders fell 0.4% in September. Ex-transportation, they rose 0.4%. Core Capital Goods (a proxy for capital expenditures) rose 0.8%. I wonder if the labor shortages are encouraging businesses to invest more in productivity-enhancing technology.

Mortgage applications rose 0.2% as purchases rose 4% and refis fell 2%. “Mortgage rates increased again last week, as the 30-year fixed rate reached 3.30 percent and the 15-year fixed rate rose to 2.59 percent – the highest for both in eight months. The increase in rates triggered the fifth straight decrease in refinance activity to the slowest weekly pace since January 2020. Higher rates continue to reduce borrowers’ incentive to refinance,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase applications picked up slightly, and the average loan size rose to its highest level in three weeks, as growth in the higher price segments continues to dominate purchase activity. Both new and existing-home sales last month were at their strongest sales pace since early 2021, but first-time home buyers are accounting for a declining share of activity. Home prices are still growing at a rapid clip, even if monthly growth rates are showing signs of moderation, and this is constraining sales in many markets, and particularly for first-timers.”

Zillow is pausing its iBuying program. The problem is that it has a backlog of inventory has swollen its balance sheet. Zillow’s program basically allowed homeowners to sell their property to the company, which then would make any repairs, stage and sell the home. This was popular in many communities where bidding competition was fierce, and a non-contingent offer could help carry the day. Zillow would charge a fee of something like 7.5% for this service.

Shortages of labor and materials are making it harder for the company to flip and sell their homes, and debt has been building up to finance the activity.

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Stocks are higher this morning as earnings continue to come in. Bonds and MBS are flat.

Home Prices rose 18.5% YOY, according to the latest FHFA House Price Index. “Annual house price gains remained extremely high in August but the pace of month-over-month gains continues to decelerate,” said Dr. Lynn Fisher, FHFA’s Deputy Director of the Division of Research and Statistics. “This does not mean house prices are at risk of declining—far from it, they continue to climb at a double-digit pace in all regions—but it does suggest we may have seen the peak in annual gains for the time being.”

Based on that home price appreciation gain, we should see 2022 conforming loan limits around $650k. Of course the FHFA might not increase it by that much. Next month’s report will be the one FHFA uses to set the new limit.

The share of loans in forbearance fell to 2.28% last week, according to the MBA. “Following two weeks of rapid declines, the share of loans in forbearance dropped again, but at a reduced rate. As reported in the past, many servicers process forbearance exits at the beginning of the month, therefore it is not surprising to see the pace of exits slow again mid-month,” said Mike Fratantoni, MBA’s Senior Vice President and Chief Economist. “The composition of loans in forbearance is evolving. More than 25% of loans in forbearance are now made up of new forbearance requests and re-entries, while many other homeowners who have reached the end of 18-month terms are successfully exiting into deferrals or modifications.”

Separately, Treasury distributed about $2.8 billion worth of rental aid in September. While the eviction moratoriums issued by the Center for Disease Control have expired, many states still prohibit foreclosures and evictions.

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Vital Statistics:

Stocks are higher this morning as earnings continue to come in. Bonds and MBS are down.

The upcoming week has a lot of important economic data. We will get new home sales and the FHFA House Price index on Tuesday, the advance estimate of third quarter GDP on Thursday, and personal incomes / outlays on Friday.

The FHFA House Price Index will cover August, and the new FHFA limits will be based on the third quarter numbers. We are seeing a lot of lenders start to accept loans based on the expected new limits. Given the pace of home price increases, the new limit will be around $650k or so.

The Street is looking for GDP growth to come in around 2.7%. This is a deceleration from the first half of the year, and it definitely looks like shortages are beginning to show up in the numbers. The Chicago Fed National Activity went negative last month, which indicates the US economy is grew below trend in September. This index is a meta-index of about 85 indicators, so it is a pretty broad based look at the economy.

Jerome Powell pretty much confirmed that tapering will begin this year: “I do think it is time to taper,” Mr. Powell said Friday. “I don’t think it is time to raise rates.” He went on further to discuss the economy: “We think we can be patient and allow the labor market to heal,” he said. But at the same time, “no one should doubt that we will use our tools to guide inflation back down to 2%” if it looked like more persistent inflationary pressures were taking root, Mr. Powell added.

Despite the repeal of limits on non-owner occupied properties, the private label market is still going strong. IMO, this was the ultimate rationale for the limits in the first place. The private label market disappeared in the aftermath of the 2008 financial crisis, which meant that something like 90% of all mortgage production was backed by the taxpayer. Mick Mulvaney ended up forcing the issue by creating a need for it.

One thing to keep in mind: while there is probably a contingent of the far left that likes the fact that the taxpayer backs the vast majority of mortgages, most housing professionals are uncomfortable with it. What happens if the the government says “yes, the FHFA House Price Index is up 20% YOY, but we don’t want to be subsidizing every loan below $650k.” If the limits get raised by something below 14%, then a lot of these wholesalers who are betting on the FHFA price index might find themselves caught short.

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Vital Statistics:

Stocks are higher this morning after troubled Chinese property developer Evergrande made an interest payment last night ahead of the default deadline. Bonds and MBS are up.

Globally, we are seeing improved sentiment based on the Evergrande situation, however manufacturing activity in Europe is down to an 8 month low as shortages are clogging up the system. European manufacturers are able to pass along price increases relatively easily, so you have falling GDP and rising inflation. The German Bund yield is trading at a 2.5 year high of negative 9 basis points, which is part of a global move higher in yields.

Existing home sales rebounded 7% MOM in September, according to NAR. This was still down a couple of percent on a YOY basis however. “Some improvement in supply during prior months helped nudge up sales in September,” said Lawrence Yun, NAR’s chief economist. “Housing demand remains strong as buyers likely want to secure a home before mortgage rates increase even further next year.”

Depleted inventory remains the biggest issue for the housing market and is largely responsible for the upward pressure in prices. Inventory fell 13% YOY to 1.27 million units, which represents a 2.4 month supply at the current sales pace. A balanced market is generally considered to be around 6 month’s worth. The average home sold in just 17 days.

The median home price rose 13% to $352,800, and all-cash sales accounted for 23% of transactions. First time homebuyers are being squeezed by professional investors and institutional money which is flooding into the residential rental space. With cap rates around the mid single-digits and double digit home price appreciation, the returns in this strategy dwarf every other asset out there.

Yesterday’s Treasury Inflation Protected Securities (TIPS) auction was strong, and is useful as a market-driven look at inflationary expectations. The way these work is the face value of the bond increases by the Consumer Price Index during the life of the bond. You can therefore compare it to a corresponding Treasury and calculate the expectations for inflation going forward. This is called the “breakeven” inflation rate, which means if inflation rises above the breakeven rate, you are better off in the TIPS bond. If it doesn’t you are better off in the Treasury.

If you take a look at yesterday’s auction, the breakeven inflation rate rose to 2.94% for the next 5 years. This is pretty much an all-time record. Note TIPS are a relatively new security and weren’t around during the high inflation 70s and 80s.

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Vital Statistics:

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

Initial Jobless Claims fell to 290k last week, which was lower than expected. We are still well above pre-COVID levels however.

The economy grew at a “modest to moderate” rate in September, according to the Federal Reserve Beige Book, which is a report by all of the regional Fed banks on the economy. The overall punch line is that growth is slowing and supply chain issues and a lack of labor are pushing up prices.

On the overall economy, they said: “Economic activity grew at a modest to moderate rate, according to the majority of Federal Reserve Districts. Several Districts noted, however, that the pace of growth slowed this period, constrained by supply chain disruptions, labor shortages, and uncertainty around the Delta variant of COVID-19.”

On the labor market, they observed: “Employment increased at a modest to moderate rate in recent weeks, as demand for workers was high, but labor growth was dampened by a low supply of workers….Firms reported high turnover, as workers left for other jobs or retired….The majority of Districts reported robust wage growth. Firms reported increasing starting wages to attract talent and increasing wages for existing workers to retain them. Many also offered signing and retention bonuses, flexible work schedules, or increased vacation time to incentivize workers to remain in their positions.”

And on inflation: “Most Districts reported significantly elevated prices, fueled by rising demand for goods and raw materials. Reports of input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Price pressures also arose from increased transportation and labor constraints as well as commodity shortages. Prices of steel, electronic components, and freight costs rose markedly this period. Many firms raised selling prices indicating a greater ability to pass along cost increases to customers amid strong demand. Expectations for future price growth varied with some expecting price to remain high or increase further while others expected prices to moderate over the next 12 months.”

What does all of this mean? For the Fed, the issue of inflationary expectations is critical. Once the population expects higher prices in the future, it tends to create a self-reinforcing cycle. Consumers accelerate purchases in order to avoid paying more in the future. This exacerbates supply shortages. Workers demand bigger cost-of-living wage increases which bumps up labor costs. Economists call this the wage-price spiral and this was a big component to the 1970s inflationary period.

There are many similarities between the 1970s and today: commodity price increases, shortages, profligate government spending and extremely easy monetary policy. As long as the economy is strong, people grudgingly accept it. The problems begin when the economy slows, because fiscal / monetary policy have reached the point of diminishing returns. Economists call this “pushing on a string” which means that further stimulus doesn’t create growth – it just creates inflation.

Jimmy Carter referred to it as “malaise.” Economists called it stagflation. Regardless of what you call it, I suspect it will be the template going forward. The government spent a crap-ton of money stimulating the economy over the past year and a half, the Fed has cut interest rates to 0% and has been buying MBS and Treasuries to support the economy. In return, economic growth is “modest to moderate,” which is Fed-speak for “meh.”

The Fed and the government have been conducting a stealth experiment in modern monetary theory over the past year and a half. Investors should ignore any gaslighting out of the media that offers MMT as a potential solution, as if we aren’t already there. We are. And we should get the verdict on that experiment soon.

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Vital Statistics:

Stocks are higher this morning as the numbers out of the banks continue to be strong. Bonds and MBS are down.

Housing starts rose 7.4% YOY to 1.55 million, according to Census. Building Permits were flat YOY at 1.59 million. To put the housing starts number into perspective, we are at the same level we were in 1959, when the government first started keeping track. Mind you, the US population has increased by something like 85% since then.

The NAHB Housing Market index improved in September. Homebuilder sentiment has been strong for the past several years as tight inventory conditions give them pricing power.

Separately, mortgage applications for a new home fell 16.2% in September, according to the MBA. “New home sales purchase activity was weaker in September, and the average loan size rose to another record high, as homebuilders continue to grapple with rising building materials costs and labor shortages. The survey-high average loan size of $408,522 is evidence of higher sales prices from these higher costs, as well as the shift in new construction to larger, more expensive homes,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “The estimated pace of new home sales decreased 3.5 percent last month after a strong August reading, but the two-month sales pace is at its strongest since January 2021.”

Mortgage applications fell 6.3% last week as refinances fell 7% and purchases fell 5%. “Refinance applications declined for the fourth week as rates increased, bringing the refinance index to its lowest level since July 2021. The 30-year fixed rate has increased 20 basis points over the past month and reached 3.23 percent last week – the highest since April 2021. The 15-year fixed rate increased to 2.54 percent, which is the highest since July,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity declined and was 12 percent lower than a year ago, within the annual comparison range that it has been over the past six weeks. Insufficient housing supply and elevated home-price growth continue to limit options for would-be buyers.”  

Demand for second homes jumped during the pandemic, according to Redfin. This was probably due to rapidly falling rates and a desire for people to leave crowded urban areas. The decline after March 2021 corresponds with the temporary limits on second homes and investor loans from the GSEs and it looks like demand is back on the upswing.

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Vital Statistics:

Stocks are higher this morning as good numbers are being reported by the banks. Bonds and MBS are down.

Retail Sales rose 0.7% MOM, which was well above the consensus. Ex-vehicles and gas, they rose 0.7% as well. This report covers the back-to-school shopping season, which is a good indicator of what the holiday season will look like. That said, we have no problem with demand right now, the problem is supply. Higher gas prices were a big factor in the increase, as they are up 38% YOY.

“Services spending may see some renewed strength over the next couple of months, as virus cases continue to drop back,” Capital Economics senior U.S. economist Andrew Hunter wrote. “But with goods shortages likely to persist, and the resulting surge in prices eating into real incomes, we expect consumption growth to remain subdued.”

The supply issues are also evident in import and export prices. Import prices rose 9.2% on a YOY basis, while export prices rose 16%.

Jerome Powell is still expected to be re-nominated to run the Fed, however he is getting some pushback from the hard left, particularly Elizabeth Warren. If he isn’t the nominee, Lael Brainard, who was nominated by Barack Obama, seems to be the next best bet. Brainard is considered more dovish than Powell, however that probably doesn’t matter all that much – after all the FOMC is a committee and decisions are usually arrived by consensus and voting.

“You could see a different path of monetary policy with a Brainard-led Fed” that pushes back initial interest rate hikes and follows with a shorter tightening cycle, said Paul Herbert, Managing Director at Harbor Capital Advisors, who expects Powell to be renominated but is preparing to hold shorter duration bonds for longer in the case of a Brainard-led Fed.

Consumer sentiment slipped in October, according to the University of Michigan Consumer Sentiment Survey. The numbers are well below September’s numbers and October 2020’s. The survey blames the debate in DC over the stimulus bill and the debt ceiling, but IMO that stuff probably doesn’t resonate with the typical US citizen.

If you look at consumer sentiment surveys historically, they have historically correlated (negatively) with gasoline prices, and I suspect that is what is driving the numbers. If gas prices rise, people’s mood sours. That said, the Delta variant of COVID is probably playing a part too.

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Vital Statistics:

Stocks are higher this morning as earnings season begins in earnest. Bonds and MBS are up.

The FOMC minutes pretty much confirmed what we already knew – that that the Fed will begin its tapering process shortly – either at the November or December meeting.

In the discussion of the economy, the job market and inflation seem to have differing views. The Fed participants thought that employment would continue to accelerate, and that the labor force participation rate would increase. So far, that is not happening. The Fed is not sure why this is happening, but it offered explanations like COVID resurgence, school and childcare.

On the inflation front, there is some concern that the identifiable COVID bottlenecks are translating into higher inflationary expectations, although the consensus seems to be that inflation will moderate back to 2% or so once these bottlenecks have worked out.

Overall, the explanation for the worker shortage seems to be largely boilerplate, and it seems unsatisfying. The Great Resignation seems to be something different, and so far no one seems to have a good explanation for it. Much of it is falling down ideological lines.

Initial Jobless Claims fell to 293,000 last week. We are still elevated, however we are well above pre-COVID levels.

Inflation at the wholesale level came in below expectations, however the numbers are still pretty high. The producer price index rose 0.5% MOM and 8.6% YOY. Ex-food and energy, it rose 0.2% MOM and 6.8% YOY.

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Vital Statistics:

Stocks are flattish this morning after the consumer price index came in higher than expectations. Bonds and MBS are up.

Prices at the consumer level rose 0.4% MOM and 5.4% YOY. Both numbers were a touch above expectations. Ex-food and energy, they rose 0.2% MOM and 4.0% YOY. FWIW, the Fed will dismiss the current numbers as “transitory” however that term is living on borrowed time. If we don’t see the numbers come down by next summer, then the Fed will probably have to act.

Mortgage applications were up marginally last week as purchases rose 2% and refis fell by 1%. “Mortgage rates reached their highest level since June 2021, but application activity changed little this week. An increase in home purchase applications offset a slight decline in refinances,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The increase in purchase applications was welcome news, but was primarily driven by a 2 percent gain in conventional purchase applications, which kept the average loan size elevated.”

JP Morgan reported earnings this morning. QOQ, numbers were flat, however they rose 28% on a YOY basis. It looks like a big part of the increase in earnings was driven by credit reserve releases. Net income was $11.7 billion, and credit release reserves were $2.1 billion.

Mortgage banking volume rose smartly to $41.6 billion compared to $29 billion a year ago. The increase was driven primarily by a 116% uptick in correspondent volume. Servicing was marked up to 3.85x. The stock is down a couple of percent so far today.

New Rez purchased Genesis Capital, a fix-and-flip / business purpose originator from Goldman Sachs. “The acquisition of Genesis adds a new complementary business line to our Company and advances our ability to create and retain additional strong housing assets for our balance sheet,” said Michael Nierenberg, Chairman, Chief Executive Officer and President of New Residential. “We are excited to work with the seasoned Genesis team and add business purpose lending to our suite of products, furthering our connectivity with a new subset of borrowers. We see the acquisition of Genesis as a great opportunity that supports our growing single-family rental strategy and one that allows us to capture additional unmet demand from our Retail and Wholesale origination channels.”

Mortgage credit availability increased 1.5% last month, according to the MBA. “Last month’s expansion was driven by a 4.5 percent increase in the conventional index, while the government index slightly decreased,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Even with increases in seven out of nine months thus far in 2021, total credit availability is still around 30 percent less than it was in February 2020 before the pandemic.”

Post-COVID, we are back to real estate bust levels of mortgage availability.

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