All Things in Moderation

Vital Statistics:

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

The upcoming week will be dominated by the jobs report on Friday. The consensus is that January’s numbers will look a lot like December, with payroll growth of only 200k. The unemployment rate is expected to remain at 3.9%, however average hourly earnings are forecasted to increase at a 5.2% clip.

Aside from the jobs report, we will also the ISM data, construction spending, and productivity numbers. We don’t have much in the way of Fed-speak.

The construction spending report will be interesting given that lumber prices are back on the march, and skilled labor is still scarce.

Goldman is now forecasting 5 rate hikes this year, based on Friday’s employment cost index. The March Fed Funds futures are fully onboard with a rate hike, and markets are pricing in a 20% chance of a 50 basis point hike.

Look at the table below to get an idea of just how much the consensus has changed. At the end of the year, the market considered the March meeting to be a toss-up between no change and a 25 basis point hike. There has been a sea-change in opinion.

While the economic information that is transmitted by interest rates is highly distorted, it is interesting to watch the behavior of the yield curve, which is the difference between longer-term rates and shorter-term rates. As of right now, the 10-year is trading at 1.8%, while short term rates are zero. The consensus for the December meeting is a Fed Funds rate between 125 and 150 basis points.

This is a signal that the yield curve is going to flatten this year pretty dramatically. The steepness of the yield curve generally provides a signal about what the market is thinking regarding growth. When the economy is accelerating, investors generally rotate out of long-term government bonds and invest into riskier assets.

What we are seeing is a flattening yield curve, which is generally a signal for weaker economic growth. At the end of the year, the consensus for the Fed funds rate was 75 basis points and the 10 year was 1.63%. Now the consensus is for a 125 basis point Fed Funds rate and a 1.8% 10-year.

A flattening yield curve is a big signal that the market believes the current level of inflation is temporary and will return to its historical 2% level. It is also a signal that economic growth is going to decelerate as well.

I would caution that global central banks are managing interest rates pretty tightly, and much of the demand for Treasuries is artificial. The signal-to-noise ratio of the yield curve is not what it used to be, but it is something to watch.

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Vital Statistics:

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

Personal incomes rose 0.3% in December, according to the BEA. Consumption fell by 0.6%. The PCE inflation index rose 5.8% on the headline number, and 4.9% if you exclude food and energy. On the spending side, goods increased while services fell. This is consistent with the increase in COVID cases.

The Fed has a difficult line to walk here, with weak spending going into a tightening cycle. FWIW, as the US population generally ages, spending is going to decline as boomers have bought their last TVs, their last sofas, etc.

The employment cost index rose 1% in the fourth quarter as salaries rose 1.1% and benefits rose 0.9%. For the year, employment costs increased 4.4%. Rising employment costs will be a big driver of any wage-price spiral we might get. It isn’t a given that we see one, but if the labor shortages continue, and cost of living adjustments get baked into people’s expectations we might.

Origination activity declined in December, according to Black Knight. That said, cash-out refis are up for the year, as borrowers tap home equity to refinance expensive credit card debt. The purchase / refi mix was almost 50-50 in December.

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Vital Statistics:

Stocks are higher this morning after a stronger-than-expected GDP report. Bonds and MBS are down.

The Fed maintained the Fed Funds rate at current levels, but cleared the decks for a rate hike at the March meeting. It will continue to lower its purchases of Treasuries and MBS. Bonds and MBS sold off in the aftermath of the statement, and the implementation note indicated that the Fed plans to begin balance sheet reduction. In addition, it plans to eventually hold primarily Treasuries, not MBS: “In the longer run, the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.” IMO that statement about minimizing effect on credit allocation is an indirect statement that the Fed is uncomfortable with 20% home price appreciation. MBS got clobbered on the announcement yesterday, dropping about a point, while the sell-off continues today. MBS investors are understandably gun-shy about catching a falling knife, so it might take a day or two for things to settle down.

Economic growth rebounded in the fourth quarter, as GDP increased at a 6.9% annual rate. Inventory build was the primary driver of growth, especially motor vehicles. Consumption also rose, which was dominated by services. The PCE Price Index rose 6.5%, which is a red flag for the Fed. Ex-food and energy it rose 4.9%, well above its 2% target rate.

So if the economy is growing at such a high rate, why doesn’t it feel like it? The answer is in real disposable income, which decreased 5.8%. Real disposable income reflects the inflation rate and wage increases. If wages don’t keep up with inflation, it creates a surly consumer.

In other economic news, durable goods orders fell 0.9%, while core capital goods (a proxy for business capital expenditures) was flat. Initial Jobless Claims came in at 260k.

Pending Home Sales fell 3.8% in December, according to NAR. “Pending home sales faded toward the end of 2021, as a diminished housing supply offered consumers very few options,” said Lawrence Yun, NAR’s chief economist. “Mortgage rates have climbed steadily the last several weeks, which unfortunately will ultimately push aside marginal buyers.” Sales are down 6.9% YOY. While it is hard to believe if you live in the Northeast, we are close to the beginning of the Spring Selling Season.

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Vital Statistics:

Stocks are rebounding as we await the Fed’s decision. Bonds and MBS are flat. Oil is rallying on Ukraine tensions.

The Fed’s decision is set for 2:00 PM EST. While no changes in the Fed Funds rate are expected, the focus will be on the balance sheet and the reduction of the central bank’s holdings of mortgage backed securities and Treasuries. This could have an effect on MBS prices which would affect rates. Be careful locking around that time. Jerome Powell will hold a press conference at 2:30.

Mortgage applications fell 7.1% last week, according to the MBA. The purchase index fell 2% while refis fell 13%. “All mortgage rates in MBA’s survey continued to climb, with the 30-year fixed rate rising for the fifth consecutive week to its highest level since March 2020,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. He noted the 30-year fixed rate is now 77 basis points higher than a year ago. “Unsurprisingly, borrower demand for refinances subsided, with applications falling for the fourth straight week. After almost two years of lower rates, there are not many borrowers left who have an incentive to refinance. Of those who are still in the market for a refinance, these higher rates are proving much less attractive to them.”

The IMF has downgraded its outlook for global growth from 4.9% to 4.4%. Supply chain issues are expected to last through mid-year and then abate.

Flagstar reported earnings that came in slightly below expectations. Mortgage originations fell to $10.7 billion, which is down 15% from the third quarter and 19% from a year ago. Gain on sale margins fell to 1.02%, which was a big decline from 1.5% in the third quarter and 1.93% a year ago. The MSR portfolio multiple increased from 1.08% to 1.12%.

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Vital Statistics:

Stocks are lower this morning as the January FOMC meeting starts. Bonds and MBS are up small.

Yesterday looked like it would be a big down day on the markets, however it reversed around midday and ended up on the day. We have a similar situation this morning. Earnings season begins in earnest this week, and it seems like expectations are sky-high.

Home prices rose 1.1% in November, and are up 17.5% YOY, according to the FHFA House Price Index. It looks like the torrid pace of home price appreciation is beginning to cool off.

“House price levels remained elevated in November, but the data indicate a pivot,” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “The last four months reflect average gains of 1.0 percentage point, down from the larger prior changes during the spring and summer months. This new trend is a welcome shift but still twice the monthly average we have seen in the last 20 years, which echoes concerns about access and affordability in housing markets.”

Separately, the Case-Shiller home price index showed an 18.8% gain for the year in November. They also see a deceleration in home price appreciation, and expect to see further deceleration as mortgage rates rise:

“We have previously suggested that the strength in the U.S. housing market is being driven in part by a change in locational preferences as households react to the COVID pandemic. More data will be required to understand whether this demand surge represents an acceleration of purchases that would have occurred over the next several years or reflects a more permanent secular change. In the short term, meanwhile, we should soon begin to see the impact of increasing mortgage rates on home prices

Freddie Mac also anticipates that home price appreciation will slow this year, falling to 6.5% from 15.9% in 2021. Interestingly, it raised its forecast for originations to 3.27 trillion from the 3.1 trillion it was forecasting in September. This is a 30% drop however from their estimate of 4.65 trillion in 2021.

“As mortgage rates rise, we do expect some moderation in housing demand, causing house price growth to temper,” Sam Khater, Freddie Mac’s chief economist, said in a press release. “However, the combination of a large number of entry-level homebuyers facing a shortage of entry-level inventory of homes for sale should keep the housing market competitive.” Below is a top-level summary of the Freddie’s forecast:

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Vital Statistics:

Stocks are lower this morning as we head into Fed Week. Bonds and MBS are up.

The movement in asset prices has been interesting. Stocks are getting clobbered, although the stock market was up big last year and earnings expectations are sky-high. Commodities in general are up, especially oil and lumber. Bitcoin has been cut in half, while gold is holding up. There are two things going on, IMO: the first is Ukraine and the threat of military action. The second is the Fed taking away the punchbowl.

Global bond yields have been falling over the past few days, with the German Bund now negative 10 basis points after briefly trading with a positive yield. If the markets were really worried about war, the dollar would be rising, and it is more or less in the same place it has been. It is possible the US gets involved in Ukraine, but I doubt it – American voters are pretty war-weary at this point.

Ultimately, this market behavior is being driven by the Fed. Rates are going to rise, stock market multiples are going to shrink, and short-term money market funds will be able to compete with other asset classes for capital. The big question is what happens to real estate prices. Nearly everyone thinks home price appreciation is going to slow. That said, the supply and demand situation is so unbalanced that I can’t see a decline in home prices unless long-term interest rates really rise, and we get a massive homebuilding boom.

The big question is whether the economic strength we have been seeing is sustainable. If it was driven entirely by stimulus, then we should see a weakening in the numbers in the next few months. This would take some pressure off the Fed, although the inflation numbers are going to be elevated over the next year, which is a function of last year’s growth in home prices. If this is the case, we have might be looking at that 70s show, where we go back and forth between inflation and recessions.

The Fed meets on Tuesday and Wednesday. No changes are expected in rates, however the markets will be looking closely for clues about how the Fed will go about reducing the size of its balance sheet. The last time they tried, it created problems in the repo market. We’ll see if they can prevent unintended consequences this time around.

The upcoming week has a lot of important data, with home prices, the initial estimate for 4th quarter GDP (the range is huge here: 3.7% to 7.1%), new home sales, personal incomes and outlays, and consumer sentiment.

Speaking of GDP estimates, the Chicago Fed National Activity Index declined in December, which indicates the economy grew below trend. This index is a meta-index of a bunch of different indicators, so it is not really market-moving, however it is useful for getting a general sense of how the economy is performing.

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Vital Statistics:

Stocks are lower this morning after lead sled-dog Netflix stunk up the joint with earnings after the close yesterday. Bonds and MBS are finally having an up day.

Fannie Mae anticipates that 2022 will be establish a new “normal” for the housing market. The top-level view is that inflation will remain elevated for the year, and home price appreciation will slow to the high single digits. Economic growth will also return to longer term trends. GDP is expected to fall to 3.1%, home price appreciation will grow 7.6%, and inflation will start at 7% before slowing to 4%.

“We expect economic growth to continue slowing as the impacts of fiscal stimulus fade and the country’s attention increasingly turns to rising inflation,” said Doug Duncan, Fannie Mae Senior Vice President and Chief Economist. “The Fed has accelerated the pace at which it intends to reduce monetary accommodation, as inflation appears more resilient than initially expected. Currently, we expect inflation to run above the Fed’s two-percent target through 2023, and for the Fed to respond by tightening over that period. The resultant rise in interest rates will likely put additional stress on housing affordability measures vis-à-vis higher mortgage rates for consumers and the continued, though decelerating, rise in home prices. While consumers still have a significantly elevated level of savings, the rate of saving has fallen such that, over time, we believe ‘excess’ saving will likely be eroded and affordability increasingly constrained. We observe an early indication of this in recent increases in debt-to-income measures associated with incoming mortgage originations.”

One of the bigger inputs to the inflation indices is home prices, although it tends to impact the index with a 12-18 month lag. Rental prices, along with owner’s equivalent rent are the vehicle. Rents are increasing at a rapid clip, according to Redfin.

The Index of Leading Economic Indicators rose in December, according to the Conference Board. “The U.S. LEI ended 2021 on a rising trajectory, suggesting the economy will continue to expand well into the spring,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “For the first quarter, headwinds from the Omicron variant, labor shortages, and inflationary pressures—as well as the Federal Reserve’s expected interest rate hikes—may moderate economic growth. The Conference Board forecasts GDP growth for Q1 2022 to slow to a relatively healthy 2.2 percent (annualized). Still, for all of 2022, we forecast the US economy will expand by a robust 3.5 percent—well above the pre-pandemic trend growth.”

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Vital Statistics:

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

The NASDAQ is officially in correction territory (down 10% from its peak). It is the old adage: Don’t fight the Fed. BTW, the March Fed Funds futures see a 90%+ probability of a rate hike. A month ago, it was only a 43% chance.

Initial Jobless Claims rose to 286,000 last week. I would assume the increase in Omicron cases drove the increase, but if the labor market is softening, the Fed has a big problem on its hands. The labor force participation rate is still well below pre-pandemic levels, which can act like a brake on the economy.

Applications for new home purchases slowed in December, according to the MBA. “Applications to buy a new home slowed in December, while the activity remained tilted to higher-priced homes,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Supply chain challenges, labor shortages and higher materials costs also contributed to last month’s decline, as projects were delayed or cost more to complete. The average loan size set another survey record at $423,102, as these higher costs are pushing sales prices higher.” 

Existing Home Sales fell 4.6% in December, however 2021 was the best year since 2006. The driver of the decrease was inventory again, with only 910,000 homes for sale. This is down 18% from November and 14% from a year ago. This is an all-time low for the series, and represents a 1.9 month supply.

The median home price rose 16% YOY to $358,000. NAR is predicting that home price appreciation will slow to 3% to 5% this year as rising mortgage rates crimp consumer demand. It also sees homebuilding picking up in 2022 and 2023.

IMO, the supply and demand imbalance will be the driver of home price appreciation, not mortgage rates. Rising incomes will offset the increase in rates (in other words, DTIs aren’t going to change all that much), and professional investors will still find these assets attractive, certainly compared to what else is out there.

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Vital Statistics:

Stocks are higher this morning after yesterday’s major sell-off. Bonds and MBS are flat.

UK inflation came in hotter than expected, which is causing a sell-off in sovereign debt across the world. The German Bund actually ticked a positive 1/10 of a basis point this morning. Inflation must be serious if you can make money lending to the German Government, though the annual interest on a million euro bund probably won’t cover a beer at Hofbrauhaus.

Housing starts rose to 1.7 million units on an annualized basis. Building Permits came in at 1.87 million. Meanwhile, builder confidence slipped due to rising expenses. “Higher material costs and lack of availability are adding weeks to typical single-family construction times,” said NAHB Chairman Chuck Fowke, a homebuilder from Tampa, Florida. “NAHB analysis indicates the aggregate cost of residential construction materials has increased almost 19% since December 2020.” Lumber is up 85% over the past 3 months.

Housing starts are still too low to make up for the supply shortage, however rising mortgage rates, labor costs, and commodity prices are making it difficult. The S&P SPDR Homebuilder ETF XHB is down 9% so far this year.

Mortgage applications rose by 2.3% as purchases rose 8% and refis fell 3%. “Mortgage rates hit their highest levels since March 2020, leading to the slowest pace of refinance activity in over two years,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The 30-year fixed rate reached 3.64 percent and has increased more than 30 basis points over the past two weeks. FHA and VA refinance declines drove most of the refinance slowdown.”

Energy traders are beginning to predict $100 oil this year. The relaxation of COVID restrictions, supply chain issues, and security are all compounding to push up WTI, which is up 14% YTD.

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Vital Statistics:

Stocks are lower this morning on fears of inflation and aggressive Fed countermeasures. Bonds and MBS are down.

We won’t have much market-moving data this week, however we will get bunch of housing data with the NAHB Housing Market Index, housing starts, and existing home sales. Earnings season is underway, with a slew of bank earnings this week.

Rising rates have cut the number of high quality refinance candidates to just 7.1 million, the lowest since November 2019. “The latest numbers from Freddie have cut the number of high-quality refinance candidates to just 7.1 million – down from about 11 million at the end of December, and from as high as nearly 20 million earlier in 2020,” Black Knight said. “The last time the population was this small was back at the start of November in 2019, when rates were around 3.75%.”

Black Knight is counting high quality candidates as those with <80 LTV, >720 FICO, and current rates 0.75% above current interest rates. If you relax the LTV and FICO constraints, the number increases to 12 million. Despite these numbers, anyone who has a lot of credit card debt should take a look at a cash-out debt consolidation refi.

Bidding wars are cooling off, however they are still elevated compared to a year ago, according to Redfin. 60% of homes received multiple offers, which was down from 75% in April but up from 54% a year ago. “Buyers should anticipate that they may not win a house until their sixth or seventh bid. If you’re the type of person who falls in love with a house, this is not your market,” said Candace Evans, a Redfin team manager in New York. “If you show a house to 10 buyers, you’ll probably get eight offers. An agent on my team just put a home in the Bronx on the market and started receiving offers even though there hadn’t been a single open house or tour yet. The house ultimately received over 10 offers and went for well above the asking price.”

Given the abject lack of new construction, expect this to continue. Note that lumber is back up near the tops of last summer.

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