All Things in Moderation

Vital Statistics:

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

Volatility in the Treasury market is back to March and April of 2020. While this volatility isn’t as bad as the 2013 taper tantrum, we should still expect volatility in the interest rate market as the Fed begins its tapering process. FWIW, MBS spreads are still super-tight, which means the mortgage backed securities market is sanguine about the process. I have received some emails from NQM lenders saying that conditions in the NQM securitization market are deteriorating, and there is the possibility that this could start flowing through to other markets.

The Evergrande situation in China has the potential to affect financial markets outside of China. There is so much leverage in the system that financial distress gets transmitted quite quickly. Don’t forget in 2008, pain in the subprime market (which theoretically should have been contained in the hedge fund / investment bank community) ended up making it impossible for retailers to borrow money in the commercial paper market to fund inventory for the holiday shopping season. This is why I keep harping on this situation.

Mortgage delinquencies fell for the fifth straight quarter, according to the MBA. Delinquency rates fell by 59 basis points on a quarterly basis and 277 on an annual basis to 4.88% of all loans outstanding. “For the fifth consecutive quarter, the mortgage delinquency rate declined, commensurate with a decline in the U.S. unemployment rate over the same time period,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “The improvement was driven entirely by a decline in later-stage delinquent loans – those loans that are 90 days or past due, but not in foreclosure. By the end of the third quarter, many borrowers were approaching the 18-month expiration point of their forbearance terms and were being placed in permanent home retention solutions, such as modifications and loan deferrals.”

Consumer sentiment fell again, according to the University of Michigan Consumer Sentiment Survey. This is the lowest level in a decade. The index hit 66.3, which goes back to 2011 levels. Consumers cited inflation as the prime reason, along with a belief that government policy will be unable to address it. FWIW, consumer sentiment surveys tend to mirror gasoline prices, but the inflation issue is something we haven’t dealt with for a long time.

On the issue of policy responses, the government has 3 options. First, they can hope that things eventually work out. That is Plan A, and is what the Biden Admin is pursuing. The second option is for the Fed to tighten, which will probably cause a recession since GDP growth is around 2%, and productivity is highly negative. The third option is price controls, which is probably going to be pursued as well. It will start with fire and brimstone speeches alleging profiteering and price gouging. Next year is an election year, so expect Plan C to be utilized.

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Vital Statistics:

Stocks are lower this morning after the inflation numbers came in hotter than expected. Bonds and MBS are down.

The Consumer Price Index rose 0.9% MOM and 6.2% on an annual basis. Ex-food and energy, it rose 4.6%. This was the highest reading in 30 years. Energy prices drove the month-over-month increase, but we are seeing increases across the board. Aside from energy, meat / poultry / fish and used cars were up big.

Mortgage Applications rose 5.5% last week as purchases rose 3% and refis rose 7%. “Although overall activity remains close to January 2020 lows, homeowners acted on the decrease in rates,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Refinance activity was up 7 percent overall, with gains in both conventional and government refinances. Additionally, the average loan balance for a refinance application was the highest in a month.”

Initial Jobless Claims came in at 267k last week. We are still pretty elevated compared to pre-pandemic numbers.

United Wholesale reported third quarter numbers yesterday. Originations rose 16% YOY and 6% QOQ to $63 billion. Gain on sale margins came in at 94 basis points, an improvement from the 81 bps in Q2 but much lower than the 318 from a year ago. For the fourth quarter, they are guiding for gain on sale margins to come in between 85 and 105 basis points and for production to fall by around 11%.

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Vital Statistics:

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

Inflation at the wholesale level rose 0.6% MOM and 8.6% YOY. Ex-food and energy, they rose 6.8% on a YOY basis. About a third of the increase was due to higher gasoline prices. The producer price index is upstream of the consumer price index, which means it will percolate down to the consumer level. While the history of the PPI doesn’t go back as far as the CPI, we are seeing record inflation.

Small business optimism slipped again, according to the NFIB Small Business Optimism Index. This is the lowest overall reading since March of this year. “The Optimism Index decreased slightly in October by 0.9 points to 98.2. One of the 10 Index components improved, seven declined, and two were unchanged. The NFIB Uncertainty Index decreased 7 points to 67. Owners expecting better business conditions over the next six months decreased 4 points to a net negative 37 percent. Owners have grown pessimistic about future economic conditions as this indicator has declined 17 points over the past three months to its lowest reading since November 2012.

You can see the increase in prices below, which corroborates the PPI:

Mortgage credit availability increased in October, according to the MBA. “Credit availability inched forward in October, but the overall index was 30 percent lower than February 2020 and close to the lowest supply of mortgage credit since 2014,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Within the subindexes, a 4 percent increase in the jumbo index was essentially offset by a 6 percent drop in the conforming index. There was an increase in the supply of jumbo ARM and non-QM products, which drove most of the increase in the jumbo index. On the conforming side, there was a pullback in ARMs, higher LTV loans, and lower credit score products.

Home prices rose 18% in September, according to CoreLogic. They see home price appreciation moderating to only 2% over the next year, however. The flight out of urban areas into the suburbs and exurbs continued, however CoreLogic sees that trend reversing over the next year.

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Vital Statistics:

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

The upcoming week will be relatively data-light as is typical in the week after the jobs report. We will get inflation data with the Producer Price Index tomorrow and the Consumer Price index on Wednesday.

Jerome Powell will be speaking today and tomorrow at Jackson Hole. Note that the bond market will be closed on Thursday for Veteran’s Day.

Fannie and Freddie made $5.3 billion from the adverse market fee. The proceeds from the fee are expected to partially cover the losses Fan and Fred are eating from the foreclosure moratorium. The FHFA anticipates that the moratorium will cost the GSEs between $7 and $8 billion over the next couple of years.

Chinese high-yield bondholders have lost about a third on their investment this year as the property developers begin to default on their debt. FYI, the Chinese stock market is flattish on the year. As a general rule, when the bond market and the stock market disagree on the future the bond market usually has it right.

Chinese media claims that Evergrande has made all of its interest payments. It looks like offshore investors have not received a November 6 interest payment.

Rocket reported that it originated $88 billion in the third quarter. This was an increase from the second quarter, and roughly flat on a YOY basis. Gain on sale margins rose from 2.8% in the second quarter to 3.05% in the third. I guess they see the market getting more competitive in the fourth quarter. Guidance for gain on sale margins are expected to come in between 2.65% and 2.95%.

Jerome Powell and Lael Brainard met with Joe Biden presumably to discuss who will lead the Fed when Powell term expires soon. Brainard is viewed as more dovish than Powell. Whoever gets the nod might end up being the G William Miller of this generation. Miller was nominated by Jimmy Carter to run the Fed in 1978, and lasted a little over a year before getting kicked upstairs to run Treasury.

During this time period, the inflation rate rose from about 6.5% in March of 1978 to almost 12% in August of 1979 when he was replaced. Below is a chart of the last inflation cycle, which pretty much lasted from 1965 to 1980.

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Vital Statistics:

Stocks are higher after the payrolls number came in above expectations. Bonds and MBS are up.

The economy added 531,000 jobs in October, according to the BLS. The unemployment rate fell 0.1% to 4.6% and the employment-population ratio increased by 0.1%. The labor force participation rate was flat at 61.6%. Average hourly earnings increased at a 4.9% clip. Interestingly, the average workweek fell by 0.1 hours, so that sort of jives with the drop in productivity we saw yesterday.

The end of mortgage forbearance has increased the number of affordable homes on the market, according to Redfin. “The end of forbearance has forced many lower-income Americans to put their homes up for sale and become renters,” said Redfin Chief Economist Daryl Fairweather. “This has caused the number of affordable homes on the market to surge, helping replenish inventory amid an acute housing shortage. It’s a rain storm after a long drought, but the drought isn’t over yet.”

On the other side of the coin, luxury home sales are beginning to slip after spiking during COVID. Home prices are still up mid-teens.

Zillow’s exit out of iBuying caused competitor Opendoor to rally 19% yesterday. I guess it is one less competitor, but do they really have a better real estate price forecasting model than Zillow?

Analyzing repeat sales and comps is complex, but it isn’t splitting the atom or anything. And market movements (like what happened with Zillow) are impossible to predict. The bottom line is that investing in real estate is a highly leveraged business, and leverage and volatility don’t mix.

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Vital Statistics:

Stocks are higher this morning after the Fed announced its tapering policy yesterday. Bonds and MBS are flat.

As expected, the Fed announced that it will start reducing its MBS and Treasury purchases as it unwinds its COVID support. It will reduce its Treasury purchases by $10 billion per month and MBS purchases by $5 billion per month and should complete this process by summer next year.

The reaction in the bond market was muted. Rates ticked up 3 or 4 basis points and we are back to pre-meeting levels this morning.

The Fed Funds futures became slightly more dovish, with investors trimming their bets on the extreme rate hike scenarios. The consensus seems to be that we will see two rate hikes next year.

Initial Jobless Claims feel to 269,000 last week. It appears that we are getting closer to pre-COVID numbers, but we still need about a 22% reduction to get back to pre-COVID normalcy. Separately, companies announced 22k job cuts last month, according to Challenger, Gray and Christmas.

Productivity fell by 5% in the third quarter, as output increased 1.7% and unit labor costs rose 8.3%. This is an awful report. There is no way to sugar-coat it. Output (i.e. GDP growth) is tepid, while costs are rising. This translates into inflationary non-growth, aka stagflation. The Fed has a tough line to walk here.

The Fed is betting that the supply chain issues are in fact temporary, and it needs that to be the case in order to stick the landing. If the supply chain issues translate into persistent inflation, then we are pretty much in a replay of the late 1970s. Inflation picks up -> Fed tightens -> Economy goes into recession -> Fed eases to boost economy -> Inflation rises faster. Inflation spirals higher while the economy vacillates between mild recessions and mild recoveries.

This set of affairs ended up causing what was then known as the “misery index” which was the sum of inflation, unemployment and interest rates. They only thing that will break that cycle is that the supply chain issues work themselves out and inflation returns to its normal 2% level. If so, then the Fed can take its time raising rates. Otherwise we could be in for a bumpy ride over the next year.

In the 1960s, it was hip amongst macro-economists to try and “fine tune” the economy. The hope was that fiscal and monetary policy could engineer out the business cycle and create a permanent prosperity. Guys like Paul Krugman were raised on that mindset. From the mid 1960s through the late 1970s, left-Econ ran the show. Fiscal policy through “guns and butter” and new entitlements was exceptionally loose. The government closed the gold window, which ended any discipline with interest rates. Rates rose and nearly killed the banking system as depositors fled the banks, which were limited by law to cap deposit rates at 5%. Eventually the whole thing devolved into stagflation, and Econ in general began to realize there are limits to economic engineering.

Fast forward to today: we are in a very similar position. Left Econ has run the show since 2008. Government spending has soared, and the Fed has been running an unprecedented experiment in the financial markets, trying to manage the economy by purchasing trillions of Treasuries and mortgage backed securities. While it is possible that government (fiscal and monetary) policy can extricate itself from the economy, it looks like the powers-that-be might have engineered the same result as the 1970s.

The parallels are there.

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Vital Statistics:

Stocks are lower as we await the decision out of the Fed. Bonds and MBS are flat.

The Fed decision is set for 2:00 PM EST. While no one expects the Fed to raise rates, the consensus seems to be that the Fed will begin to reduce its purchases of Treasuries and mortgage backed securities.

The economy added 517,000 jobs in October, according to the ADP Employment Survey. Leisure / hospitality and transportation had the biggest gains. The Street is looking for 400,000 payrolls in Friday’s jobs report.

“The labor market showed renewed momentum last month, with a jump from the third quarter average of 385,000 monthly jobs added, marking nearly 5 million job gains this year,” said Nela Richardson, chief economist, ADP. “Service sector providers led the increase and the goods sector gains were broad based, reporting the strongest reading of the year. Large companies fueled the stronger recovery in October, marking the second straight month of impressive growth.”

Mortgage applications decreased 3.3% last week as purchases fell 2% and refis fell 4%. “Mortgage rates decreased for the first time since August, as concerns about supply-chain bottlenecks, waning consumer confidence, weaker economic growth and rising inflation pushed Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Most of the decline in rates came later in the week, which is likely why refinance applications declined to the lowest level since January 2020, and the overall share of activity fell to the lowest since July 2021. Government refinance applications fell for the sixth straight week, as it becomes evident that an increasing number of borrowers have already refinanced.”

Zillow was down 16% yesterday after reporting disappointing Q3 results and announced that it will wind down its iBuying Homes segment. The company’s third quarter results included a $304 million writedown for homes bought in the third quarter that are worth less than current selling prices. The company expects another $265 million in writedowns in the fourth quarter. It will also lay off a quarter of the workforce in the iBuying segment.

Zillow was able to convert only about 10% of its bids into actual sales. Zillow kept its fee a secret, but it was more or less around 7.5%. Since the typical home seller is mainly responsible for the two realtor’s commissions of 3%, many must have considered the extra 1.5% to not be worth the hassle of letting Zillow handle the staging and final maintenance.

Given the rapid home price appreciation over the last year, it is hard to see how they lost money on buying homes, unless they really missed the seasonality aspect of home prices. Regardless, this is the first data point that indicates that home price appreciation is slowing.

New York State has extended CRA requirements to non-banks. I do wonder if redlining is really a thing in this age of “push button, get mortgage.”

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Vital Statistics:

Stocks are flattish this morning as the Fed begins its 2-day FOMC meeting. Bonds and MBS are up small.

Manufacturing decelerated in October, according to the ISM Manufacturing Survey. We saw a big decline in the index for new orders, while the Prices Index rose substantially. “Business Survey Committee panelists reported that their companies and suppliers continue to deal with an unprecedented number of hurdles to meet increasing demand. All segments of the manufacturing economy are impacted by record-long raw materials lead times, continued shortages of critical materials, rising commodities prices and difficulties in transporting products. Global pandemic-related issues — worker absenteeism, short-term shutdowns due to parts shortages, difficulties in filling open positions and overseas supply chain problems — continue to limit manufacturing growth potential. However, panel sentiment remains strongly optimistic, with four positive growth comments for every cautious comment. Panelists are fully focused on supply chain issues in order to respond to the ongoing high levels of demand.”

The biggest complaint has been the inability to get products out of China. Rolling blackouts are exacerbating the problems. The report has some individual responses from companies in different industries. Many see the shortages continuing through 2022.

Home prices rose 18% in September, according to CoreLogic. CoreLogic sees the home price appreciation slowing to 2% over the next year, however. “The pandemic led prospective buyers to seek detached homes in communities with lower population density, such as suburbs and exurbs. As we head into 2022, we expect some moderation in the current pattern of flight away from urban cores as the pandemic wanes.”

Construction spending fell 0.7% MOM in September, according to the Census Bureau. Residential construction fell 0.4% MOM and rose 7.8% YOY.

The number of loans in forbearance fell again last week to 2.15%, according to the MBA. “For the first time since March 2020, the share of Fannie Mae and Freddie Mac loans in forbearance dropped below 1 percent,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “A small decline for this investor category was matched by similarly small declines for Ginnie Mae and portfolio/PLS loans. Forbearance exits slowed at the end of October to the slowest pace since late August. With so many borrowers having reached the end of their 18-month forbearance term, we expect a steady pace of exits in November.”

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Vital Statistics:

Stocks are higher this morning ahead of a big week for data and earnings. Bonds and MBS are down.

In terms of economic data, we will get the ISM numbers this week, along with productivity and the jobs report on Friday. The Street is looking for 400k jobs, unemployment to fall to 4.7%, and a 4.8% increase in average hourly earnings.

The Federal Open Market Committee meets on Tuesday and Wednesday. No changes are expected to the Fed Funds rate, however the consensus seems to be that the Fed will announce its first reduction in the pace of Treasury and MBS purchases.

MBS spreads are still pretty tight compared to history, and especially compared to the 2013 taper tantrum. I think the difference today is certainty; in 2013 the menu of options for the Fed was much wider. In other words, the markets in 2013 thought the Fed could actually sell their portfolio of Treasuries and MBS into the market. We now know that they probably won’t even let it run off naturally. The Fed will probably reduce its purchases by $10 billion a month and will go into maintenance mode – in other words re-investing maturing principal payments back into the market – by summer.

Speaking of MBS spreads, mortgage REITs Annaly and AGNC Investment reported increases in book value for the third quarter. This is a far cry from 2013, where book values were cut in half and the mortgage REITs cut their dividends big time.

Troubled Chinese property developer Evergrande made another interest payment on Friday, which prevented a default. Another troubled Chinese developer (Yango Group) has asked international bond holders to swap its dollar bonds into a new bond. Yango bonds are trading around 20 cents on the dollar, and the cascade of Chinese real estate companies heading into troubled waters signals we might be witnessing the start of an epic real estate bust.

IMO, this will send another deflationary wave around the globe. It is worthwhile to distinguish between deflation and inflation. Inflation is “too much money chasing too few goods.” It is a monetary and supply issue. It describes the current setup in the US right now.

Deflation is a credit issue, and it happens when asset prices are falling. This makes anyone who borrowed a lot of money insolvent. This is what China is experiencing. Entire cities were built “on spec” and it looks like they will never get filled. Whoever lent money for those projects will probably get nothing on that investment. This means banks will have to start writing down assets and liquidating what they can. The Chinese government will try and manage the crisis, but this one will be epic.

The playbook for countries in this sort of spiral is to devalue the currency. The first thing FDR did (after confiscating everyone’s gold) was to change the gold / dollar exchange rate. We saw the same thing in the Asian Tiger crisis in the late 90s. China manages the exchange rate, and since it has capital controls, it can pretty much set it wherever it wants.

That means Chinese investors are going to pile into Treasuries since they will immediately reap a huge gain on that investment when the yuan devalues. It will also cut the prices of Chinese goods entering the US which could help the inflation issue.

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