Morning Report: Sanctions start to bite

Vital Statistics:

S&P futures4,327-54.2
Oil (WTI)95.243.63
10 year government bond yield 1.89%
30 year fixed rate mortgage 4.19%

Stocks are lower as markets take stock of the Ukraine situation. Bonds and MBS are up.

The reality of sanctions is begging to be evident in some of the financial markets. The Russian Ruble is in free-fall, trading as low as 110 to the dollar this morning. It entered the year at 75 to the dollar. The US Treasury has banned transactions with the Russian Central Bank, which means that Russia has no tools to manage currency rates, and this will trigger an inflationary wave in the country. Russian sovereign credit default swaps are pricing in a 50% chance of default

Russia introduced capital controls to prevent capital from fleeing the country and hiked its interbank interest rate to 20%. . Russia’s economy is about to collapse and will probably be too small to be included in the G-20 much longer.

Supposedly 3 Russian banks will be banned from SWIFT, which allows banks to transact. This will allow companies who are re-thinking their business dealings in Russia some time to get their capital out. Supposedly the sanctions include a pretty hefty fine, so pretty much every company with exposure there has their lawyers poring over the language and I guess they will choose to err on the side of caution and reduce their exposure.

What does all this mean in the short term? First of all, bonds and stocks will be driven by headlines and not by economic data. Friday’s jobs report will matter, as will Jerome Powell’s Humphrey-Hawkins testimony this week. Things like the ISM, productivity etc becomes less relevant.

Second, oil is going up. The US is going to release some reserves from the Strategic Petroleum Reserve in order to reduce prices. That said, most of the US oil comes from North America, so Russia’s output doesn’t really matter all that much.

Third, whenever you have this sort of financial contagion, you should expect credit to tighten. Hedge funds with big positions are going to get slammed with margin calls. I heard on Bloomberg that a big institution was trying to move a big block of Rosneft stock and there was no bid. The stock has gotten cut in half over the past few days.

Here is a good place for finance geeks to get the latest and greatest of what is going on. Adam Tooze’s substack is on it.

If we start to see credit tighten in the US, then the Fed is put into a bind: It needs to tighten to control inflation, but if credit markets seize up, the playbook is to do the exact opposite. The Fed Funds futures are beginning to reflect this reality. Two weeks ago, the March Fed Funds futures saw a 50% chance of a 50 basis point hike. Today, it is 10%. The December futures are now looking at 125 – 175 basis points in hikes this year. Not too long ago, we were looking at 150 – 200.

Mortgage rates will probably move down only grudgingly as the 10 year falls. MBS investors are going to be more worried about the Fed unloading its book so they are reluctant to stick their necks out too much. I see MBS spreads stable to wider as the market sorts everything out.

Rocket reported fourth quarter earnings last week. Volumes fell 29% and gain on sale fell from 4.41% to 2.8%. Earnings per share fell 71%. Rocket sees margins staying stable or increasing in the second quarter.

Morning Report: Markets sanguine about Ukraine

Vital Statistics:

S&P futures4,29814.2
Oil (WTI)92.07-0.93
10 year government bond yield 1.97%
30 year fixed rate mortgage 4.18%

Stocks are higher this morning as war continues in Ukraine. Bonds and MBS are down. Even though the 10-year Treasury yield dropped about 10 bps yesterday, mortgage rates fell about a basis point. I think mortgage rates will go only grudgingly lower if the 10 year rallies. The Fed is about to wrap up its purchases of MBS in March, so that tailwind is just about gone.

The markets are surprisingly sanguine about the whole Russia / Ukraine situation. I guess the markets are viewing the economic fallout from this as contained. Here is one thing to keep an eye on: If one of the sanctions is to boot Russia from SWIFT, the International Banking infrastructure, then pretty much any Russian debt is going to be unpaid, and therefore worthless.

Old times might remember a hedge fund called Long Term Capital Management, which blew up after Russia defaulted on its sovereign debt in the late 90s. Most of the exposure seems to be in European banks, although Citi supposedly has some too.

Personal Incomes were flat in January, according to the Bureau of Economic Analysis. Personal spending rose 2.1%. The Personal Consumption Expenditures Price Index, which is the Fed’s preferred measure of inflation, rose 0.6% MOM and 6.1% YOY. The core index, which excludes food and energy rose 0.5% MOM and 5.2% YOY.

Rocket reported fourth quarter numbers. Volume fell 29% compared to the fourth quarter of 2020, and gain on sale contracted from 4.41% to 2.8%. The combination of lower volumes and lower margins contributed to a 71% reduction in earnings per share. For the first quarter Rocket is forecasting volumes to fall to 52-57 billion however gain on sale is expected to increase slightly to a range of 2.8% to 3.1%.

Consumer sentiment improved marginally in the second half of February, however it remains at the lowest level in a decade, according to the University of Michigan Consumer Sentiment Survey. To put that into perspective, 2012 was when the US residential real estate market finally bottomed out. This means consumers are in a pretty foul mood. Note this is before the Russian invasion of Ukraine which probably isn’t going to help things.

From the release: “The February descent resulted from inflationary declines in personal finances, a near universal awareness of rising interest rates, falling confidence in the government’s economic policies, and the most negative long term prospects for the economy in the past decade”

Below is the chart for economic expectations:

Pending home sales fell 5.7% in January, according to NAR. “With inventory at an all-time low, buyers are still having a difficult time finding a home,” said Lawrence Yun, NAR’s chief economist. Given the situation in the market – mortgages, home costs and inventory – it would not be surprising to see a retreat in housing demand.”

Morning Report: Russia invades Ukraine

Vital Statistics:

S&P futures4,123-92.2
Oil (WTI)99.917.23
10 year government bond yield 1.87%
30 year fixed rate mortgage 4.2%

Stocks are lower this morning after Russia invades Ukraine. Bonds and MBS are up.

The action in the markets is pretty dramatic this morning, with the 10 year yield falling 10 basis points. Actual bond prices are up over a point, but MBS are up about half a point. Stocks are getting clobbered, and anything oil-sensitive like airlines are getting whacked. The NASDAQ 100 has entered bear market territory, falling 20.5% since late December.

We have a lot of Fed-Speak this morning. I doubt anyone will be revising their remarks on what is happening overseas, but this situation for the Fed has become quite fluid.

Oil is up big this morning, with West Texas Intermediate up 8% and North Sea Brent trading up 7.6%. Brent is trading over $100 a barrel. Natural gas futures are up big as well. None of this bodes well for gasoline prices going forward as refineries are about to switch over from producing heating oil to gasoline for the summer driving season.

The action in commodities puts the Fed in a bind since it becomes harder for them (and central banks worldwide) to engineer a soft landing. Rising commodity prices will increase inflation, however it will also depress the economy. The stagflation case is bolstered by what is going on. The Atlanta Fed GDP Now estimate has 1.3% growth in Q1, however rising gas prices translate into lower consumer spending and lower GDP growth.

The Fed Funds futures have dramatically shifted in March, with the futures now predicting a 87% chance of a 25 basis point increase and a 13% chance of 50 basis points. Given the uncertainty, I think the prediction of 150 basis points in hikes this year is probably going to get trimmed back.

The main takeaway is that the bond market will be driven by global risk on / risk off sentiment than economic numbers as long as this crisis lasts. MBS will probably lag any improvement in rates as the Fed’s tapering will be the dominant factor. Fortunately for mortgage bankers, this means we probably won’t have a repeat of the margin calls of 2020, even if rates move lower since the Fed won’t be buying. I suspect mortgage spreads will just widen as the 10 year yield falls and mortgage rates go nowhere.

Fourth quarter GDP was revised upward from 6.9% to 7% however personal consumption expenditures were revised downward. I suspect much of this growth is inventory build as supply chains catch up with demand.

New Home Sales continue to disappoint, as Jan sales came in at a seasonally adjusted annual rate of 801,000. This is 4% lower than December’s rate and 19% lower than a year ago. The median new home price came in at 397k, which is up 18% from a year ago.

Morning Report: Consumer Confidence falls

Vital Statistics:

S&P futures4,33232.2
Oil (WTI)91.91-0.43
10 year government bond yield 1.97%
30 year fixed rate mortgage 4.15%

Stocks are lower this morning despite continued Ukraine / Russia fears. Bonds and MBS are down.

Initial sanctions on Russia seem to be less severe than initially feared. The main piece is a halt on the Nord 2 pipeline. That said, this is apparently a “first tranche” of sanctions, so more might be coming if things don’t change.

Consumer confidence fell in February, according to the Conference Board.

“Concerns about inflation rose again in February, after posting back-to-back declines. Despite this reversal, consumers remain relatively confident about short-term growth prospects. While they do not expect the economy to pick up steam in the near future, they also do not foresee conditions worsening. Nevertheless, confidence and consumer spending will continue to face headwinds from rising prices in the coming months.”

Consumer confidence is still much better than the aftermath of the financial crisis, however it remains below pre-COVID levels. Interestingly, the University of Michigan Consumer Sentiment Index is much worse, having fallen back to 2012 levels. I suspect the Conference Board is more accurate. The labor market is much stronger today than 2012 and that is a big driver of consumer confidence. Well, that and gas prices.

Mortgage Applications fell to December 2019 lows, according to the MBA. Purchases fell by 10% while refis fell by 16%. Refinances now account for about half of all mortgages.

“Higher mortgage rates have quickly shut off refinances, with activity down in six of the first seven weeks of 2022,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Conventional refinances in particular saw a 17 percent decrease last week. Purchase applications, already constrained by elevated sales prices and tight inventory, have also been impacted by these higher rates and declined for the third straight week. While the average loan size did not increase this week, it remained close to the survey’s record high.”

ARMs increased to 5.1% of total applications. I suspect we will be seeing more activity in this space, however the spread between an ARM and a fixed is still pretty tight, which means there isn’t much incentive to go with the ARM versus the 30 year. That said, if you plan on moving in 5 years, why not take out a 5/1 and save some money?

The non-QM space has been having issues lately, and I have been hearing about some lender out West not honoring locks. The rapid move in interest rates is exposing one of the big issues of NQM, and that is the difficulty in hedging the product. NQM loans are not deliverable into TBAs, and the rates seem to move much less frequently than TBAs. But, when they move, they move. We saw a lot of reprices last week as buyers of NQM rates re-adjusted upwards.

The big question is how does one hedge the interest rate risk? TBAs might be the least worst choice, but there hasn’t been a long enough track record of this product that you can use to come up with a correlation between conforming loans and NQM. I think a lot of people are flying blind here, and maybe some risk managers said “Wait a minute. We have no idea what our interest rate risk here is. Let’s hold off buying more paper until figure out what our exposure is.” This is all speculation of course, but I suspect that conversation is happening a lot right now.

Morning Report: Ukraine Situation Escalates

Vital Statistics:

S&P futures4,338-5.2
Oil (WTI)93.752.63
10 year government bond yield 1.94%
30 year fixed rate mortgage 4.12%

Stocks are flattish this morning despite the escalation of hostilities in Ukraine. Bonds and MBS are up.

Russia has inserted troops into the breakaway Ukraine regions, and Germany has suspended approval for the Nord 2 gas pipeline. Overnight Asian stocks were down a couple of percent, but the European markets are more sanguine about the situation. Bonds remain well bid, with the 10 year trading at 1.94%.

Commodity markets have been well-bid on this situation, with North Sea Brent oil contracts pushing close to $100 a barrel. Natural gas prices in Europe are soaring as well.

Home prices rose 17.5% YOY, according to the FHFA House Price Index. The Mountain region remains the top performer with prices rising 23% YOY.

Existing Home Sales rose 6.7% in January, according to the National Association of Realtors. The median home price rose 15.4% YOY to reach $350,300. This increase was driven at least partially by low inventory, which fell to 860,000 units, or about 1.6 month’s worth of inventory. These stats are both record lows.

“Buyers were likely anticipating further rate increases and locking-in at the low rates, and investors added to overall demand with all-cash offers,” said Lawrence Yun, NAR’s chief economist. “Consequently, housing prices continue to move solidly higher.”

The inventory of starter homes (or homes below $500k) is “disappearing” while higher priced homes are seeing increased supply. This is depressing the first time homebuyer percent, which fell to 27%. Pre-2008, that number was typically closer to 40%. Investor purchases rose to 27% as well. We are starting to see some kvetching from liberal politicians about big money managers (i.e. Blackrock, American Homes 4 Rent) crowding out the first time homebuyer.

Morning Report: Housing starts disappoint

Vital Statistics:

S&P futures4,440-29.2
Oil (WTI)91.35-2.23
10 year government bond yield 1.97%
30 year fixed rate mortgage 4.17%

Stocks are lower this morning on continued Ukraine fears. Bonds and MBS are flat.

The Fed released the minutes from the January FOMC meeting yesterday. The Fed will be taking it meeting by meeting, and did allow for the possibility that they might have to be more aggressive than the December dot plot indicated, which is a nod to the fact that the Fed Funds futures and the December dot plot have a pretty big difference between forecasts.

In their discussion of the outlook for monetary policy, many participants noted the influence on financial conditions of the Committee’s recent communications and viewed these communications as helpful in shifting private-sector expectations regarding the policy outlook into better alignment with the Committee’s assessment of appropriate policy. Participants continued to stress that maintaining flexibility to implement appropriate policy adjustments on the basis of risk-management considerations should be a guiding principle in conducting policy in the current highly uncertain environment. Most participants noted that, if inflation does not move down as they expect, it would be appropriate for the Committee to remove policy accommodation at a faster pace than they currently anticipate. Some participants commented on the risk that financial conditions might tighten unduly in response to a rapid removal of policy accommodation. A few participants remarked that this risk could be mitigated through clear and effective communication of the Committee’s assessments of the economic outlook, the risks around the outlook, and the appropriate path for monetary policy.

The Fed Funds futures moved ever-so-slightly less hawkish on the news, with the March futures now predicting a roughly 2/3 chance of a 25% hike and a 1/3 chance of a 50 basis point hike compared to roughly a toss-up the day before.

Bottom line, the Fed is looking at the Fed Funds futures and it realizes the market is much more hawkish than they were in December. They are still of the opinion the inflation will moderate as supply chain issues work themselves out, however they are ready to act as necessary if that turns out to not be the case. They are concerned that credit will tighten as they raise rates, but they hope that they can avoid this through clear communication.

Housing starts disappointed yet again, coming in at 1.64 million versus the 1.71 that was expected. Building Permits came in at 1.9 million, which was above expectations, so perhaps this will change in the future. Materials aka “sticks and bricks” remain expensive and that is undoubtedly affecting things. Lumber continues its upward trend:

One of the most precious commodities these days is apparently garage doors. “It used to take us 20 weeks to build a house,” said Adrian Foley, the president and C.E.O. of the Brookfield Properties development group, which develops thousands of single-family homes annually in North America. “And now it takes us 20 weeks to get a set of garage doors.”

Shortages of skilled labor are an issue as well. The US has a glut of humorless BAs, and not enough welders or electricians.

In other economic news, unemployment claim ticked up to 248k last week. This well above pre-pandemic levels, which were averaging around 220k. One data point doesn’t make a trend, but we might be seeing signs the labor market is cooling.

Morning Report: Rising utility prices increase industrial production

Vital Statistics:

S&P futures4,445-19.2
Oil (WTI)93.721.63
10 year government bond yield 2.00%
30 year fixed rate mortgage 4.16%

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

Mortgage applications fell 5.4% last week as purchases fell 1% while refis fell 9%. “Mortgage rates increased across the board last week following the recent rise in Treasury yields, which have moved higher due to unrelenting inflationary pressures and increased market expectations of more aggressive policy moves by the Federal Reserve,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting.  Consistent with this period of higher mortgage rates, refinance applications fell 9 percent last week and stood at around half of last year’s pace. The refinance share of applications was also at its lowest level since July 2019.”

Retail Sales rose 3.8% in January, according to Census. This was well above the 2% consensus. Ex-vehicles they rose 3%. On a YOY basis, retail sales rose 13%. December sales were revised downward however. These numbers are not adjusted for inflation.

Single-family rents increased 12% YOY in December, according to CoreLogic.

Industrial production rose 1.4% in January, according to the Fed. Much of this was driven by utilities, which had the highest increase in the history of the index, which goes back to 1972. Not sure what is driving that, as natural gas rose in January, but nothing record-breaking.

Manufacturing production, which strips out utilities, rose 0.2%. Capacity Utilization increased to 77.3%. This is 1.8% higher than pre-pandemic, but below longer-term averages.

Homebuilder sentiment edged down in January, according to the NAHB Housing Market Index.

Morning Report: Rising home prices are affecting affordability

Vital Statistics:

S&P futures4,43349.2
Oil (WTI)92.02-2.63
10 year government bond yield 2.04%
30 year fixed rate mortgage 4.15%

Stocks are higher this morning after Russia sent some troops home, in an apparent de-escalation of the situation in Ukraine. Bonds and MBS are down.

The Producer Price Index (a measure of inflation on the wholesale side) rose 1% MOM and almost 10% on a YOY basis. Ex-food and energy, prices rose 8.3% YOY.

Roughly 69% of American households cannot afford a median-priced home, according to research from the National Association of Homebuilders. The study considers a home affordable if the PITI payment is under 28% of gross monthly income. The income required to purchase the median home is $99,250.

Home prices rose 14.6% in the fourth quarter, according to the National Association of Realtors. The study also looked at qualifying income based on different down payment scenarios. The West Coast continues to be the most expensive single family market.

Morning Report: Q1 GDP estimates below 1%

Vital Statistics:

S&P futures4,4080.2
Oil (WTI)92.42-0.63
10 year government bond yield 1.99%
30 year fixed rate mortgage 4.10%

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

The upcoming week will have some housing data including housing starts and the NAHB Housing Market Index. We will also get the Producer Price Index tomorrow. We will also have some Fed-Speak in the latter part of the week.

Mortgage delinquencies decreased in the fourth quarter, according to the MBA. “Mortgage delinquencies descended in the final three months of 2021, reaching levels at or below MBA’s survey averages dating back to 1979,” said Marina Walsh, CMB, MBA’s Vice President of Industry Analysis. “The fourth-quarter delinquency rate of 4.65 percent was 67 basis points lower than MBA’s survey average of 5.32 percent. Furthermore, the seriously delinquent rate, the percentage of loans that are 90 days or more past due or in the process of foreclosure, was 2.83 percent in the fourth quarter, close to the long-term average of 2.80 percent.”  

St. Louis Fed Head James Bullard thinks the Fed needs to “front-load” the rate hikes. “I do think we need to front-load more of our planned removal of accommodation than we would have previously. We’ve been surprised to the upside on inflation. This is a lot of inflation,” Bullard told CNBC’s Steve Liesman during a live “Squawk Box” interview. Our credibility is on the line here and we do have to react to the data,” he added. “However, I do think we can do it in a way that’s organized and not disruptive to markets.”

The current estimate for Q1 GDP from the Atlanta Fed is below 1%. The Atlanta Fed’s GDP Now has Q1 GDP coming in at 0.7%. This means the economy is weak and probably won’t react well to rate hikes. The Fed has a fine line to walk here as it doesn’t want to push the economy into a recession. The Fed has to be hoping beyond hope that the current spate of inflation is supply-chain driven and works itself out.

Morning Report: The Fed and the markets are out of sync

Vital Statistics:

S&P futures4,5057.2
Oil (WTI)91.140.43
10 year government bond yield 2.00%
30 year fixed rate mortgage 4.07%

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

Yesterday’s inflation numbers caused the Fed Funds futures to recalculate their assessments for what the Fed will do this year. The March futures were predicting a 90%+ chance of a 50 basis point hike at the March meeting. The December futures are now predicting the Fed Funds rate will be at 1.75% by the end of the year. That is a lot of tightening, along with the tapering.

I would note that the current Fed funds futures prediction is WAY out of step with the dot plot from the December FOMC meeting. Here is the dot plot:

The Fed voters see the end of year Fed Funds rate at 75 basis points, while the market sees them at 175 basis points. That is a big delta between the market and the Fed. There has been the perception that the Fed is behind the curve, and I think that reflects this. Regardless, if the increase in inflation is mainly due to supply chain issues that work their way out over the summer, then I have to imagine the markets are too aggressive.

Ordinarily, an aggressive pace of tightening risks a recession in the following year. Watch the 10 year bond yield: if the Fed Funds rate begins to equal the 10 year bond yield, or even increase above it, that is a recessionary sign.

That said, this isn’t just a US phenomenon. Global sovereign yields have also increased over the past month or so. The Japanese Government Bond is yielding 23 basis points, the highest since 2016. The German Bund yields 25 basis points, the highest since 2019. Big picture, the world has been supporting weak economies by issuing lots and lots of debt, and we are probably now going to go into a deleveraging. And deleveragings are never fun.

Consumer sentiment crashed in February, according to the University of Michigan’s Consumer Sentiment Survey.

Sentiment continued its downward descent, reaching its worst level in a decade, falling a stunning 8.2% from last month and 19.7% from last February. The recent declines have been driven by weakening personal financial prospects, largely due to rising inflation, less confidence in the government’s economic policies, and the least favorable long term economic outlook in a decade. Importantly, the entire February decline was among households with incomes of $100,000 or more; their Sentiment Index fell by 16.1% from last month, and 27.5% from last year. The impact of higher inflation on personal finances was spontaneously cited by one-third of all consumers, with nearly half of all consumers expecting declines in their inflation adjusted incomes during the year ahead. In addition, fewer households cited rising net household wealth since the pandemic low in May 2020, largely due to the falling likelihood of stock price increases in 2022.

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