All Things in Moderation

Vital Statistics:

Stocks are higher this morning as Chinese markets rallied in the wake of the government’s decision to support markets. Bonds and MBS are down again.

The Fed’s decision will come out at 2:00 pm, and the press conference will start at 2:30. This decision will carry more weight than the usual Fed decision, as market participants will be looking closely at the dot plot and the updated economic forecasts.

Import and export prices rose in February, with import prices rising 10.9% YOY and export prices rising 16.6%. Keep in mind that these numbers predate the Ukraine situation.

February retail sales disappointed, rising only 0.3% MOM. Ex-vehicles and gasoline, they fell 0.4%. On a year-over-year basis, retail sales rose 17%, however it is clear that rising gasoline prices are beginning to depress other categories of spending.

Does it seem like mortgage rates are rising faster than the 10-year bond yield? Your gut is correct. MBS spreads (which are basically the difference between the yield on mortgage backed securities and Treasuries are indeed increasing. The Fed’s re-introduction of QE in response to COVID pushed them down, but now that QE is over, they are returning to normal, albeit we are wider than normal. The green bars below represent the MBS spread, which sits at 114 basis points. Note the spike up to 175 in the early days of COVID, when the mortgage market froze and everyone in mortgage-land was getting margin calls.

Chart: MBS Spreads

Some of this widening is due to volatility in the bond market. The CBOE has a volatility index for Treasuries, and that index has been pushing up since the pandemic began. The Fed’s purchases of MBS kind of papered over the effect of increasing volatility, but now the impact is being felt in widening spreads.

Chart: Treasury volatility

The punch line for non-bond geeks: Mortgage rates are rising easily when the 10-year yield increases. They are moving down grudgingly (if at all) when the 10 year yield falls. Note that this doesn’t take into account competitive activity between mortgage bankers. This only represents what MBS investors are willing to pay for generic mortgage backed securities. Mortgage rates have a “Wall Street” component and a “mortgage banker” component. MBS spreads represent the Wall Street component.

Mortgage applications fell by 1.2% last week as purchases increased 1% and refis fell 3%. “Mortgage rates continue to be volatile due to the significant uncertainty regarding Federal Reserve policy and the situation in Ukraine,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Investors are weighing the impacts of rapidly increasing inflation in the U.S. and many other parts of the world against the potential for a slowdown in economic growth due to a renewed bout of supply-chain constraints.”

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Vital Statistics:

Stocks are higher this morning as we begin the FOMC meeting. Bonds and MBS are down.

Inflation at the wholesale rose at a 10% clip in February, according to the Producer Price Index. Ex-food and energy it rose 8.4%. Rising energy costs were the big driver of the increase and we are seeing increased diesel prices push up transportation costs, which is now flowing into intermediate goods. The Fed will almost assuredly raise rates this week, however all eyes will be on the dot plot and the new economic forecasts.

The Nasdaq officially closed in bear market territory as many high flyers are getting some air taken out of their multiples. Leaders like Netflix and Tesla have been smacked down hard so far this year. The mortgage bankers have been wrecked as well.

Sarah Bloom Raskin, Biden’s nominee just had a blow dealt to her nomination after West Virginia Senator Joe Manchin expressed opposition to her nomination. Without Manchin’s support, she will need a Republican to vote for her, and that chance is remote.

What is the issue here? Well, she wanted the Fed to take into account climate in banking regulation. In practice this would mean restricting credit to the energy industry. For example, the Fed could decide that excessive energy exposure would cause a bank to flunk its stress test, which would limit dividends and buybacks.

Note that ethical, social governance (ESG) investors are pushing energy companies to shut down production, along with a group of banks and money managers which control $60 trillion in assets via Climate Action 100+ which have refused to lend to natural resource companies. The Arizona AG is investigating this group for antitrust violations under the theory that colluding to raise prices is illegal regardless of whether it is done for profits or ideology.

The bottom line is that increasing production to counter higher prices is going to be more difficult than it was in the early 00s, the last time energy prices spiked. In normal times, the cure for high prices is high prices. That might not be the case this time around. Which means the Fed has its work cut out for it.

Mortgage delinquencies fell to 3.4% from 5.8% a year ago. “Nonfarm employment grew by 6.7 million workers during 2021, the largest one-year increase, supporting income growth and keeping more families current on their loans. Nonetheless, places hit hard by natural disasters have experienced a spike in missed payments. Serious delinquency rates for December in the Houma-Thibodaux metro area were nearly two percentage points higher than immediately before Hurricane Ida. ”

Back to the issue with energy companies. ESG investors and the big passive investors are driving corporate decision making in a way that didn’t exist even 5 years ago. To grasp the implications of this, it is important to understand the way index fund managers are paid: They are paid to mimic the index, not to pick good stocks. In other words, if XYZ corp is a dog with fleas, but the index they are matching has 2.4542% of XYZ corp, the manager will have to hold 2.452% of his or her fund in XYZ corp.

This creates something similar to what business school professors would call an agency cost. The incentives of the manager and the shareholder are not aligned. The manager of your index fund doesn’t have to care how the stock performs. Since they have no skin in the game with corporate performance they can costlessly push for things that might not be investor’s best interest. Ain’t their money. And that, folks is the “cost” of that rock bottom management fee. . At a minimum, it certainly raises fiduciary responsibility questions. If you support the ESG ideology, great, but if you don’t chances are your retirement fund does.

I have a feeling that the era of outperformance by passive fund managers is about to come to an end as the big index names get tied down with ideological institutional investors. It will become what people used to call “a stock picker’s market.”

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Vital Statistics:

Stocks are higher this morning as Russia and Ukraine begin talks. Bonds and MBS are down.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The markets expect the Fed to hike the Fed Funds rate by 25 basis points, and to announce that they have ended their Treasury and MBS purchase program, but will still reinvest the proceeds from maturing bonds back into the market.

A lot of the attention will focus on the dot plot and revisions to the economic forecast, particularly the core PCE which is the Fed’s preferred measure of inflation. In December, the Fed was forecasting 2.6% headline PCE inflation and 2.7% core (i.e ex-food and energy) inflation. While the Consumer Price Index (CPI) and PCE are not constructed exactly alike, they are similar enough. And last week, we saw a 7.9% increase in the headline CPI and 6.4% increase on the index less food and energy. And before someone says “Putin” these are February numbers, which precede the invasion. So, the inflation estimates are going up.

The dot plot from December shows the Fed expects about 3 rate hikes this year:

The Fed funds futures see another 4 hikes.

How those two things reconcile will be a big indicator in how the bond market behaves. Note the Fed was predicting a 4% increase in GDP this year in December. Stock market investors will be watching that forecast.

Aside from the Fed, we will get the Producer Price Index on Tuesday, retail sales on Wednesday, housing starts on Thursday and LEI on Friday. So we are in for a heavy week of data.

Housing inventory remains exceptionally low, according to Zillow. It estimates that US inventory fell to 729,000 homes in February. The big drivers of this have been the lack of homebuilding we have seen since the real estate bubble burst, and rising mortgage rates. With rates increasing, many homeowners who considered buying a move-up property are staying put, and many older Americans are aging in place.

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Vital Statistics:

Stocks are higher this morning as investors adjust to a new normal with a war in Ukraine. Bonds and MBS are down small.

Goldman cut its estimate for US growth this year from 2% to 1.75%, and it estimates we have a 1 in 3 chance of a recession next year. They are basing this view on the shape of the yield curve. With the Fed reducing its purchases of Treasuries and MBS the shape of the yield curve (in other words the difference between longer-term rates and shorter term rates) is beginning to return to transmitting useful information. Long-term rates in the context of QE have a very low signal-to-noise ratio.

Despite the bearishness on the US economy, the Fed Funds futures have moved to the hawkish side again, with traders seeing a Fed funds rate of 1.75% as the most likely outcome at the end of the year. We will get a fresh dot plot and projections next week at the FOMC meeting, where the market has penciled in a 25 basis point rate hike. Given the war in Ukraine and inflationary pressures, the press conference will be closely watched by investors and journalists.

Robust asset price appreciation lifted household net worth by over $5 trillion in the fourth quarter of 2021. This is from Federal Reserve data. Separately, CoreLogic said that homeowner’s equity rose 29% in Q4. Negative equity fell to about 1.1 million homes. This home equity will probably bring back the “house as ATM” trade as investors tap home equity to refinance credit card debt or remodel.

One of the biggest surprises for me so far has been that some major hedge fund hasn’t blown up as a result of Russian debt bets. When Russia defaulted on its sovereign debt in the late 90s, we saw numerous blowups, including Long Term Capital Management.

So far, junk bond spreads (which is the difference between the yield on CCC and lower rated bonds and Treasuries) are behaving. The market seems relatively sanguine. If things start going sideways in the financial markets, this is going to be your canary in the coal mine. Note the spike at the beginning of COVID. This is when the market for non-QM disappeared almost overnight.

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Vital Statistics:

Stocks are lower this morning as commodities continue to rise. Bonds and MBS are down.

Inflation at the consumer level rose 0.6% MOM and 7.9% YOY. Ex-food and energy, it rose 0.5% MOM and 6.4% YOY. Food, shelter and energy were the biggest contributors to the increases. Food prices rose 8.6% YOY which was the biggest jump since 1981. Fertilizer prices have doubled, which is filtering its way into commodity prices like wheat, corn and soybeans.

Last year’s torrid increase in home prices has yet to show up in the CPI, but it will. The shelter index rose only 4.7% YOY, while rents and home prices are appreciating close to 20%. Rising real estate prices impact the indices with a 12-18 month lag, so its impact has yet to be felt.

The labor market is still tight, according to the JOLTs index. There were 11.3 million job openings at the end of January. This is a slight decline from December, but still quite strong. The quits rate slipped to 2.8% from its record high in December. The quits rate is a leading indicator for wage growth, so wage-push inflation is on the table as well.

Nickel is still suspended in London, as far as I know. But it isn’t just nickel that is rising. Take a look at the year-over-year numbers for these metals (and coal). Pretty astounding.

These input prices will filter into final prices with a lag, so consider this to be sort of a preview of what is to come. For example, nickel is an input into stainless steel, so expect things like appliances to increase in price.

Mortgage credit availability increased in February, although we are still well below pre-pandemic levels. “Credit availability increased to its highest level since May 2021, driven by growth in jumbo loan programs, as well as those that include allowances for ARMs and expanded credit score and LTV requirements,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “In a period of rising mortgage rates, affordability challenges, and declining volume, lenders have made efforts to slightly broaden their product offerings.”  

Mortgage applications rose 10% last week as purchases rose 9% and refis increased 11%. On a YOY basis, the refi index is down 50%, while the purchase index is down about 7%. “Mortgage rates dropped for the first time in 12 weeks, as the war in Ukraine spurred an investor flight to quality, which pushed U.S. Treasury yields lower. A 6-basis-point decline in the 30-year fixed-rate mortgage led to a slight rebound in total refinance activity, with a larger gain in government refinances. Looking ahead, the potential for higher inflation amidst disruptions in oil and other commodity flows will likely lead to a period of volatility in rates as these effects work against each other,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity also increased, as prospective buyers acted on lower rates and the early start of the spring buying season. The average loan size remained close to record highs, with higher-balance loan applications continuing to dominate growth.”  

Mortgage lenders are glum about future prospects, according to the Fannie Mae Lender Sentiment Survey. “For the sixth consecutive quarter, mortgage lenders expressed bearishness about near-term profit margin expectations amid headwinds from declining refinance activity, slower purchase mortgage demand growth, and narrowing spreads,” said Doug Duncan, Senior Vice President and Chief Economist at Fannie Mae. “For consumers, rising interest rates, lack of supply, and strong home price appreciation have reduced refinance activity and further constrained home purchase affordability, which, of course, is dampening lenders’ expectations of future business activity. Numerous uncertainties, including heightened inflation and the Fed’s monetary policy reaction, which must now also account for the inflationary impact of Russia’s war on Ukraine, suggest increased market volatility, but the general underlying, upward rate trend aligns with lenders’ expectations.”

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Vital Statistics:

Stocks are higher this morning after yesterday’s bloodbath. Bond and MBS are down.

Bonds are subject to a push-pull situation, where investors on one hand are buying in the flight-to-safety trade, while others are selling because of inflation.

Home prices rose 19.1% YOY in January, according to CoreLogic. Home price appreciation is expected to slow to 3.8% this year, as a result of rising rates. Given the supply chain shortages and rising input costs, new homes are taking longer to build, which does little to mitigate the massive supply / demand imbalance. Inventory is at a generational low.

Nearly 6,000 homes have sold at prices $100,000 over asking price this year. January was a highly competitive month, where 70% of home sales had bidding wars.

“The housing market was in a frenzy in the beginning of 2022, with buyers competing for a limited supply of homes and sellers reaping the rewards of bid-up prices,” said Redfin Deputy Chief Economist Taylor Marr. “Buyers are likely to face strong competition at least through the next few months as demand is buoyed by the temporary drop in mortgage rates fueled by the Russian invasion of Ukraine. But bidding wars may ease a bit by summer as more new listings come on the market and mortgage rates resume their rise.  Homes are still likely to sell above list price, but the premiums will probably be lower.”

Tappable equity in US homes hit a 16 year high, according to Black Knight Financial Services. Home prices have been on a tear, and borrowers have been using cash-outs to refinance credit card debt and other liabilities. Last year, approximately $1.2 trillion of loans were cash-out refinances. About $275 billion in home equity was extracted in 2021, and that should continue.

Does this massive amount of equity extraction set us up for another 2006 debacle? Probably not. Post-cash out LTVs are about 10 points lower than they were in the bad old days.

Plus, real estate bubbles don’t come around that often. Prior to 2006 the previous bubble was during the 1920s. Bubbles are largely psychological phenomenons which require buy-in from everyone involved: lenders, buyers, regulators, etc. The memories of 2006 are too fresh for that to re-occur and the market fundamentals of supply and demand are not in place.

Small business optimism fell again in January, according to the NFIB. Price-raising activity is back to levels not seen since the early days of the Reagan Administration. This is the second month where small business optimism fell below the half-century average. A net 45% of small businesses reported raising compensation, which was a touch below December’s record 48%.

Note that price controls, a vestige of central planning and occasionally used in the US are making a comeback. This has always been a disastrous policy, since price controls create shortages and create black markets. The Biden Administration is already jawboning energy companies about price gouging, and as prices continue to rise, expect to see more of this.

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Vital Statistics:

Stocks are lower this morning as the war in Ukraine continues. Bonds and MBS are up. US Treasuries are rallying, and the German Bund went negative in the overnight session

Western economies are considering an embargo on Russian oil. Since Russia is the third largest producer of oil behind the US and Saudi Arabia, this will push up prices and compound the inflation issue.

Most of the United States relies on West Texas Intermediate oil, which in theory should be unaffected by events in Russia. The East Coast refineries do get oil from international markets, however that could come from any number of sources. I think Hawaii uses Russian oil, which makes sense geographically. Ramping up production in the US will take some time, and at the moment you cannot raise capital for E&P projects.

It isn’t just oil that is rallying: Base metals like copper, aluminum and zinc are climbing, and wheat is limit up yet again. Take a look at the chart of wheat below. See those flat lines for the past two trading days? That means the contract was limit up. The commodity exchanges put daily limits on how far a price can move. This means that prices would be higher absent these limits.

Rising food prices are being driven by something most of us never think about: fertilizer. Fertilizer prices have tripled over the past year.

Rising markets attract fast money, and you have to imagine institutions investors are raising money for commodity funds hand over fist right now. Which will lead to higher commodity prices going forward.

So, rising commodity prices. What about labor?

The labor economy remains strong, according to Friday’s Employment Situation Report. Nonfarm employment rose 678,000, while the unemployment rate fell to 3.8%. Leisure and hospitality reported the biggest increase in payrolls. Average hourly earnings rose 5.1%.

The Atlanta Fed’s GDP Now estimate sees Q1 growth at 0%.

So what does this all mean with interest rates? My guess is that the Fed is going to increase rates to quell inflation, but with growth hitting the wall, the yield curve will flatten. So we could see a higher Fed Funds rate, but long term rates, such as mortgages could move up much slower. In other words, if the Fed raises the Fed Funds rate 100 basis points this year, I don’t think we will see a 100 basis point increase in mortgage rates.

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Vital Statistics:



Stocks are flattish this morning as commodities rise and the war in Ukraine enters its second week. Bonds and MBS are down.



Jerome Powell’s testimony yesterday caused market participants to pare back their bets on the markets now centered on only a 25 basis point hike in March. At one point yesterday, markets were factoring in a chance of the Fed doing nothing this month. He will have another day of questioning on the Hill today.



Commodity prices continue to climb with oil hitting the highest levels since 2008. It isn’t just oil however – metals like aluminum and zinc are rising as well. The Bloomberg commodity index had the biggest weekly gain since the 1960s.



Initial jobless claims fell to 215k last week, while nonfarm productivity rose 6.6%. This is good news, as productivity is the key to higher living standards. Unit labor costs rose only 0.3%.

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Vital Statistics:

Stocks are higher this morning as commodities rise and Western firms continue to impose “self-sanctions” against Russia. Bonds and MBS are down small.

Jerome Powell heads to the Hill today for his semiannual Humphrey-Hawkins testimony. Here are his prepared remarks. On inflation:

Inflation increased sharply last year and is now running well above our longer-run objective of 2 percent. Demand is strong, and bottlenecks and supply constraints are limiting how quickly production can respond. These supply disruptions have been larger and longer lasting than anticipated, exacerbated by waves of the virus, and price increases are now spreading to a broader range of goods and services.

On tapering and reducing the size of the balance sheet:

The process of removing policy accommodation in current circumstances will involve both increases in the target range of the federal funds rate and reduction in the size of the Federal Reserve’s balance sheet. As the FOMC noted in January, the federal funds rate is our primary means of adjusting the stance of monetary policy. Reducing our balance sheet will commence after the process of raising interest rates has begun, and will proceed in a predictable manner primarily through adjustments to reinvestments.

Finally, on Ukraine:

The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain. Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.

Conclusion, inflation is not transitory, we are raising rates in March, and the effects of the Ukraine invasion are impossible to model.

United Wholesale reported fourth quarter and full year numbers. Volumes were up on a YOY basis compared to the fourth quarter of 2020, which is surprising. Margins collapsed from 305 bp to 80, which is par for the course for what we are seeing with the mortgage banks. Like crosstown rival Rocket, they expect margins to hold steady here going into the first quarter.

The economy added 475,000 jobs in February, according to ADP. The January number was revised upward big time, from -300k to +500k. About a third of the job gains were in leisure / hospitality. “Hiring remains robust but capped by reduced labor supply post-pandemic. Last month large companies showed they are well-poised to compete with higher wages and benefit offerings, and posted the strongest reading since the early days of the pandemic recovery,” said Nela Richardson, chief economist, ADP. “Small companies lost ground as they continue to struggle to keep pace with the wages and benefits needed to attract a limited pool of qualified workers.”

Mortgage applications fell marginally last week as purchases fell 2% and refis rose 1%. We are back to 2019 levels in apps. “Mortgage rates last week reached multi-year highs, putting a damper on applications activity,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Although there was an increase in government refinance applications, higher rates continue to push potential refinance borrowers out of the market. Purchase activity remained weak, but the average loan size increased again, which indicates that home-price growth remains strong, and a greater share of the activity is occurring at the higher end of the market.”

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Vital Statistics:

Stocks are lower this morning as the risk-off trade continues. Bonds and MBS are up.

The markets continue to buy sovereign debt in a flight to safety. The German Bund yield went below 0% overnight and is now sitting right above 0. The 10-year flirted with 1.7% as well.

We are seeing big moves in commodity prices again, with wheat trading at 982, up 23% since before the invasion. WTI Oil is above $100 a barrel.

I suspect that mortgage originators will get a break yet again as yields work lower and mortgage grudgingly follow. I suspect this will take a while to work out. Maybe 2022 won’t be as bad as people are fearing. Unless things take a turn south in the overall bond market, margin calls shouldn’t be an issue for lenders.

The thing I am going to watch closely is credit spreads and whether we see an impact on the banks. Some of the usual suspects in Europe (SocGen, Deutsche Bank) are taking a beating on this Russian situation, and Raiffeissen getting smoked, down almost 50% since January 31. The Russian market is more or less uninvestable at this point, and might even get downgraded from an “emerging market” to a “frontier market.” Note Russian stocks are halted again today, and Euro exchanges are beginning to suspend Russian GDRs from trading.

If credit spreads begin to widen, it will have reverberations in the mortgage market. First and foremost, it will cause a flight to safety, which means that Treasury yields will fall. It will also be beneficial to Fannie and Freddie mortgage backed securities since those are more or less guaranteed by the US Government. Non-QM might take a hit. That said, rising home prices provide a benign backdrop for housing credit.

Jerome Powell heads to the Hill tomorrow and Thursday for Humphrey-Hawkins testimony. I am not sure what he can realistically comment on Ukraine except to say that the Fed will be monitoring the economic data closely and react accordingly. Investors are paring back bullish bets on rate hikes. The March Fed Funds Futures are now pricing in only a marginal chance of a 50 basis point hike.

The December futures are centering around an end-of-year Fed Funds rate of 1.25%. They were looking at 1.75% pre-invasion.

Home Prices rose 19.6% in February, according to the Clear Capital Home Data Index. This is the most timely real estate index out there. The West and South saw prices rise 23%, while the Northeast and Midwest rose about 15.5%. Separately, home prices rose 19.1% in January, according to CoreLogic. They are expected to rise 3.8% next year.

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