All Things in Moderation

Vital Statistics:

Stocks are lower this morning after disappointing earnings from tech leaders Amazon and Apple. Bonds and MBS are down.

Personal income rose 0.5% in March, according to the Bureau of Economic Analysis. February was revised upward from 0.5% to 0.7% as well. The Personal Consumption Expenditures Index (the Fed’s preferred measure of inflation) rose 0.9% in March, which was a big acceleration from February which rose 0.5%. This was driven primarily by increases in food and energy which increased due to the situation in Ukraine.

The core PCE price index rose 0.3% which was flat with February’s numbers. On an annual basis, the PCE price index rose 6.6%. Ex-food and energy it rose 5.2%. Personal Consumption Expenditures rose 1.1% and the savings rate fell.

Overall this report shows that incomes are expanding, which is good for the economy, however the increase in inflation will keep the Fed in a defensive role. This report also seems to contradict the first quarter’s initial read on GDP, which seems out of step with most of the other data out there. I suspect GDP will be revised upward in future releases.

Employment costs rose 1.4% in the first quarter as wages rose 1.2% and benefits increased 1.8%. On a year-over-year basis 4.5% as wages rose 4.7% and benefits increased 4.1%.

Annaly Capital (one of the biggest mortgage REITs out there) reported first quarter earnings. Book value per share fell a whopping 15% as MBS spreads widened, which was offset by increases in the value of the servicing book.

“The market environment during the first quarter of 2022 was one of the most challenging for fixed-income in decades, characterized by exceptional volatility with substantial spread widening and a notable increase in benchmark rates,” remarked David Finkelstein, Annaly’s Chief Executive Officer and President. “While our portfolio continued to generate strong earnings, our book value was not immune to the effects of Agency MBS underperformance resulting from market turbulence.”

Investors like Annaly are the ultimate buyers of the mortgage banking production. They are wary about the Fed’s impending balance sheet reduction and are therefore unlikely to aggressively bid mortgage backed securities. This flows through to TBA prices and finally through to the rates mortgage bankers can offer borrowers.

Mortgage backed securities are driven primarily by two factors: the level of overall interest rates in the market, and the volatility of interest rates in the market. Volatility is a key driver, since mortgage backed securities exhibit what bond geeks call negative convexity. This is because of prepayment risk. The takeaway should be that if Treasuries settle down and find a level, then we should see an improvement in MBS spreads, which will help push down borrowing rates.

Consumer sentiment improved in April, according to the University of Michigan Consumer Sentiment Survey. While sentiment is better than it was in March, we are still well below levels from a year ago. Even if you look at a longer-term chart, you can see that the mood of consumers is quite dour.

The downward slide in confidence represents the impact of uncertainty, which began with the pandemic and was reinforced by cross-currents, including the negative impact of inflation and higher interest rates, and the positive impact of a persistently strong labor market and rising wages. The global economy has added even more uncertainties about prospects for the U.S. economy, including the growing involvement in the military support for Ukraine, and renewed supply line disruptions from the covid crisis in China. Who would not be apprehensive about future conditions, even if on balance they anticipated a continued expansion? 

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Vital Statistics:

Stocks are higher this morning despite an awful GDP print. Bonds and MBS are flat.

GDP fell 1.4% in the first quarter, according to the Bureau of Economic Analysis. This was well below the Street consensus, which predicted a gain of 1.1%. Personal Consumption Expenditures rose 2.5%, which again was below the Street consensus of a 3.4% increase.

Decreased private inventory investment and declining government spending (i.e. the expiration of COVID-related stimulus and assistance programs) subtracted from growth, while increases in consumption and construction helped increase GDP. Imports rose, which again is a negative factor.

The decline in inventory investment was driven primarily by autos, which can be volatile although a chip shortage is impacting low inventory levels. The increase in personal spending was driven by healthcare and was offset by decreased spending on goods.

Overall, this report seems out of step with what the Atlanta Fed’s GDP Now index was predicting. I suspect the muted reaction in the markets (interest rates didn’t move) is driven by expectations that the number will be revised upward in coming reports.

That said, even if GDP gets revised positively, the combination of stagnating growth and high inflation puts the Fed in a pickle. If unemployment starts ticking upward, it might be time to dust off the misery index.

Separately, initial jobless claims fell to 180,000 last week. These are still incredibly low numbers, which indicates the weakness we are seeing in the GDP numbers aren’t filtering through to the labor market.

Profits on the median-priced single family home declined in the first quarter of 2022 from 51.6% to 47.2%, according to data from ATTOM. This is still much higher than historical averages, however it might indicate that the housing market is beginning to cool off.

“Home prices simply can’t continue to go up as rapidly as they have for the past few years,” said Rick Sharga, executive vice president of market intelligence for ATTOM. “The combination of higher prices, rising mortgage rates and the highest rates of inflation in 40 years may be pricing some prospective buyers out of the market, which means we may begin to see lower sales numbers. Ultimately, as affordability worsens, price appreciation should slow down, and we may even see modest price corrections in some markets.”

The report said that the typical home seller had owned the property for only 5.7 years which was down from 6.8 years a year ago.

The first time homebuyer is being sidelined by rising mortgage rates. The 200 basis point increase in mortgage rates makes a big impact on affordability. At the end of 2021, the median home price was $346,900 and the average mortgage rate was about 3%. For a typical mortgage with 20% down, the principal and interest payment works out to be about $1,170. At 5%, that payment jumps to $1,490. Big increase.

“Prospective homebuyers have pulled back this spring, as they continue to face limited options of homes for sale along with higher costs from increasing mortgage rates and prices. The recent decrease in purchase applications is an indication of potential weakness in home sales in the coming months,” said MBA associate vice president Joel Kan in a Wednesday statement. 

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Vital Statistics:

Stocks are higher this morning as some big tech companies report earnings. Bonds and MBS are flat.

Mortgage Applications fell 8.3% last week as purchases fell 8% and refinances fell 9%. “With mortgage rates increasing last week to the highest level since 2009, applications continued to decline,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Overall application activity fell to the lowest level since 2018, with both purchase and refinance applications posting declines. Refinance applications were 70 percent below the same week a year ago, when the 30-year fixed rate was in the 3-percent range.”

The average mortgage rate rose from 5.2% to 5.37%. The refinance share of mortgage activity fell to 35%. The MBA refinance index is back to early 2018 levels.

Chart: MBA refinance index:

Pending Home Sales fell again in March, according to NAR. This is the fifth monthly decline in a row. “The falling contract signings are implying that multiple offers will soon dissipate and be replaced by much calmer and normalized market conditions,” said Lawrence Yun, NAR’s chief economist. “As it stands, the sudden large gains in mortgage rates have reduced the pool of eligible homebuyers, and that has consequently lowered buying activity. The aspiration to purchase a home remains, but the financial capacity has become a major limiting factor.”

The Senate has confirmed Lael Brainard as the vice-chair of the Fed.

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Vital Statistics:

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

Durable Goods Orders rebounded 0.8% in March. Ex-transportation they rose 1.1%. Core Capital Goods (a proxy for business capital investment) rose 1%.

Home prices rose 2.1% MOM and 19.4% YOY, according to the FHFA House Price Index. “House prices rose to set a new historical record in February,” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “Acceleration approached twice the monthly rate as seen a year ago. Housing prices continue to rise owing in part to supply constraints.” Home price appreciation is definitely accelerating.

Separately, the Case-Shiller Index rose 20.2% YOY. Note that Case-Shiller is a more broad-based index than FHFA, which only looks at homes which are backed by a GSE / government loan. This excludes jumbos, all-cash sales and non-QM.

Notable MSAs include Phoenix (up 33%), Tampa (up 33%) and Miami (up 30%). “The macroeconomic environment is evolving rapidly and may not support extraordinary home price growth for much longer,” wrote Craig Lazzara, managing director at S&P DJI, in a release. “The post-Covid resumption of general economic activity has stoked inflation, and the Federal Reserve has begun to increase interest rates in response. We may soon begin to see the impact of increasing mortgage rates on home prices.” The median mortgage payment on the median house with a 30 year fixed rate loan is 46% higher (or $550), according to research from Realtor.com. This is cooling demand as we hit the main part of the spring selling season.

New home sales fell 12.6% YOY to a seasonally-adjusted annual pace of 763,000 units, according to the Census Bureau. The median home price rose 21% to $436,700. Shortages of materials and labor make it difficult for builders to focus on starter homes, so they are spending more effort on the luxury sector. After spiking in the early days of the pandemic, new home sales have been on the weak side. Aside from the aftermath of the bubble and the COVID spike, we are at 1997 levels in building.

Consumer confidence decreased in April, according to the Conference Board. “Consumer confidence fell slightly in April, after a modest increase in March,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index declined, but remains quite high, suggesting the economy continued to expand in early Q2. Expectations, while still weak, did not deteriorate further amid high prices, especially at the gas pump, and the war in Ukraine. Vacation intentions cooled but intentions to buy big-ticket items like automobiles and many appliances rose somewhat.”

It is important to note that expectations have been on the decline since early 2021 while the present situation index has been improving. The big question involves consumers’ expectations of their financial situation. If they think inflation will be worse in 6 months, they may accelerate purchases in order to beat the price increases. This would worsen inflation. Conversely if they think the economy is going to weaken, they will defer purchases, which will lower inflation and take some pressure off the Fed. The survey doesn’t ask why consumers feel how they feel, so we’ll have to see how it plays out.

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Vital Statistics:

Stocks are lower this morning after Chinese stocks were down 5% in the overnight session. Bonds and MBS are up.

The upcoming week is full of data, with home price indices on Tuesday, GDP on Thursday, and personal incomes / spending on Friday. There is no Fed-speak as we are in the quiet period ahead of the May FOMC meeting next week.

The Fed Funds futures are locked in on a 50 basis point hike next week:

Mortgage delinquencies hit a record low in March, according to Black Knight Financial. The national delinquency rate fell to 2.84%, which beat the previous record of 3.22% in early 2020. A strong employment market, combined with continued student loan deferrals, along with super-low interest rates have helped borrowers keep their heads above water.

The Chicago Fed National Activity Index dropped in March as employment-related indicators made less of a positive impact. Overall, the economy is still growing well above the historical trend, and is territory usually reserved for economic booms.

Despite the rise in home prices, Realtor.com noted that median listing prices are falling in a few MSAs, particularly in the Rust Belt. “Many of the metro areas seeing median list price declines have seen an [influx] of smaller homes come to market, which carry lower price tags,” says George Ratiu, manager of economic research for Realtor.com. “At the same time, several of the cities have unemployment rates, which, while still historically low, are above the national level. [This indicates] that buyers may face steeper affordability challenges from rising mortgage rates.”

It is important to note that Realtor.com is using a median listing price, which is different than the repeat-sales price that home price indices like Case-Shiller or Clear Capital use. So this isn’t really indicative that home prices, which have been rising at a double digit pace have suddenly hit the wall and are beginning to decline. Realtor.com’s observations reflect a change in product mix. That said, affordability has taken a big hit over the past year as higher mortgage rates and more expensive housing are conspiring to make life difficult for the first time homebuyer.

Janet Yellen says that inflation may have peaked, and she doesn’t see a recession. Investors are beginning to buy Treasuries, as they bet the sell-off has gone too far, too fast and the economy is poised to slow. “We have been incrementally adding longer-duration bonds into our portfolios in anticipation of market participants pricing in slower growth moving forward,” said Gavin Stephens, director of portfolio management at Goelzer Investment Management.

It looks like Twitter and Musk are about to agree to a friendly deal at his original bid of $54.20 per share. It doesn’t contain a no-shop provision, so a process has yet to be run.

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Vital Statistics:

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

St. Louis Fed President James Bullard made some hawkish comments yesterday, saying he would like to see the Fed Funds rate at 3.5% by the end of the year. He also said that unemployment should fall below 3% (!). “What we need to do right now is get expeditiously to neutral and then go from there.” Given that inflation rates are much higher than interest rates, monetary policy is still incredibly loose. Real (i.e. inflation-adjusted) interest rates are highly negative.

The last time the unemployment rate was below 3% was in the early 1950s.

Where were interest rates during the early 1950s? The 3 month T-bill was between 1.5% and 2% for the most part, and high quality corporate debt was yielding about 3%. The inflation rate in 1952 was 1.92%. So real interest rates were about 0%, give or take.

Housing starts came in at a seasonally-adjusted annual rate of 1.79 million in March, which was higher than expected. This is up 4% on a YOY basis. Building Permits rose to a 1.87 million pace.

Despite the increase in housing starts, homebuilder confidence continues to sag. The NAHB / Wells Fargo Housing Market Index, which measures homebuilder sentiment fell for the fourth month in a row. “The housing market faces an inflection point as an unexpectedly quick rise in interest rates, rising home prices and escalating material costs have significantly decreased housing affordability conditions, particularly in the crucial entry-level market,” said NAHB Chief Economist Robert Dietz. Interestingly, the Northeast (which has been the laggard in the US housing market over the past 15 years) rose while everywhere else fell.

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Vital Statistics:

Stocks are flattish this morning as financials report earnings. Bonds and MBS are up small.

The upcoming week has a lot of housing data, with the NAHB Housing market index, housing starts, and existing home sales. We will also get leading economic indicators. The focus will be earnings.

Mortgage applications for new home purchases fell 5% YOY, according to the MBA Builder Application Survey. “Mortgage applications for new home purchases increased in March, which is consistent with typical seasonal trends and a sign of strong underlying demand for housing,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Potential buyers have increasingly looked to new homes as an option, given the lack of existing homes for sale. The average loan size continued to set record highs and reached $436,151. Growth in applications for larger loans continued to dominate application activity.”

Shortages of materials and labor continue to bedevil home builders. The lead times to get things like garage doors are measured in months. This is slowing the pipeline for new homes, and also helps explain the skew towards more expensive homes. The starter homes are rising in price due to general inflation, and rising mortgage rates are making the payment unaffordable for most first-time homebuyers. Builders will probably compensate by developing more attached townhome style properties instead of single family detached homes.

With a shortage of homes overall, remodeling is an alternative for someone who might be in the market for a move-up property. The NAHB remodeling index was flat YOY and way higher than it was pre-pandemic.

Mortgage origination fell at Wells Fargo during Q1. Volumes were down 27% YOY and revenues fell 33% as lower gain on sale margins were partially offset by rising servicing income.

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Given that markets are closed today, I thought it would be fun to dust off my old merger arbitrageur hat and game out the Twitter situation.

Elon Musk bought 9.2% of Twitter and was offered a seat on the Board of Directors. He rejected this offer as it would tie his hands. His view of the stock is that Twitter’s political bias has caused it to underperform as it only caters to a tiny slice of the potential market. There is a secondary free speech aspect to this as well – he is a self-described free speech absolutist. He views Twitter as a “town square” and believes that all voices should be allowed to speak.

Clay Travis said that the typical Twitter user skews D+15, in other words, Twitter is about as liberal as Hawaii or Vermont. If you take into account BlueCheckMark Twitter, which generates about 90% of the traffic, it is D+40, which is about as blue as Park Slope. Musk is betting that the company will perform better if it widens its appeal.

At this point, Musk has put out a non-binding offer. This is what is known in the the industry as a “bear hug letter.” Twitter has now retained Goldman Sachs to advise the company. I am sure the Board will reject Musk’s offer outright – it wouldn’t be doing its job otherwise. The Board’s job is to get the best price for the company, in accordance with its fiduciary responsibilities. There is a dance to this whole thing, and notwithstanding Musk’s “best and final” language, I am sure his bankers have told him that he will have to up his bid. This is boilerplate M&A.

Goldman will probably run a sale process for the company. It will open up a data room, bring in potential buyers, and eventually auction off the company. Twitter may say it is not for sale, and perhaps its ESG shareholders would prefer to keep Twitter as it is, but as time goes on, the shareholder base will turn over from mutual funds to merger arbitrage hedge funds. And the arbs are in the business of getting the best price and moving onto the next deal. So, as time goes on, the shareholder base is getting more and more amenable to a sale, and the Board is going to be getting pressure to cut a deal from the hedge funds.

Eventually Musk will have to put up or shut up. He will have to table a binding offer for control of the company. The regulatory process should be relatively straightforward since there is no antitrust overlap and no shareholder vote required. This takes DOJ / FTC and the SEC out of play. I don’t know if FCC has to weigh in – if they do, there is a chance that Biden’s FCC will try and block it on public interest grounds. Clinton’s FCC tried to do that with the Time Warner – AOL deal back in the late 90s.

Will the arb funds care if a bunch of twentysomething employees threaten to quit? Not in the least. They will take the money and run. As time goes on, the ululating “stakeholders” will matter less and less. The journalists as a class are of course hopping mad about this, and a lot of ink will be spilled over “dangers” to “democracy” but ultimately this will come down to the arbs, not hacks like Robert Reich or Max Boot.

Does Musk really want the company? Who knows? Corporate raiders and activist investors have been known to write a bear hug letter in hopes of getting a process run and then flip their stock to the winner. That said, Elon Musk probably isn’t Carl Icahn and there is ego involved. Once an investor puts their reputation on the line, it isn’t easy to back down, and Musk has an ego.

My guess is that Goldman will run a process, and Twitter will go with a white knight like Disney which will promise to maintain the status quo. If the white knight bids a stupid price, Musk will probably sell. If not, he’ll go hostile and buy the company.

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Vital Statistics:

Stocks are flattish as bank earnings come in. Bonds and MBS are down small.

Retail sales rose 0.5% MOM in March, according to the Census Bureau. Ex-vehicles, they rose 1% and ex vehicles and gas they increased 0.2%. On a year-over-year basis, retail sales rose 6.9%. It is important to note that these numbers are not adjusted for inflation. In other words, the increase in retail sales looks primarily due to price increases and not increased demand. One print does not make a trend, but it looks like consumers might be getting more cautious. If so, this bodes ill for growth going forward.

Consumer sentiment rebounded this month according to the University of Michigan Consumer Sentiment Survey. The increase was driven by more upbeat expectations for the future. That said, consumers were downright dour in March, so it isn’t like sentiment is good – it is down 26% on a year-over-year basis. Consumer sentiment surveys are particularly sensitive to gasoline prices, although expectations for wage gains were another big component in the improved sentiment.

The labor market remains strong, as initial jobless claims came in at 185,000. Any reading below 200k is an exceptional reading.

The supply chain remains stretched, according to the latest reading on business inventories. Total inventories increased 1.5% MOM and 12% YOY. Like the retail sales number, business inventories are not adjusted by inflation, so on an apples-to-apples basis they were up single digits. A way to measure supply chain pain is to look at the inventory-to-sales ratio. Inventory build is often a big driver of economic growth, and when it is low like it is now, it is an indicator that manufacturers have to catch up, and that process will increase growth. It could also be considered an inflation indicator, however it really means that there is pent-up demand and that is a bullish signal for growth.

The TBA market (which is the basic input into rate sheets) remains incredibly illiquid. For the past week or so, bid-ask spreads have increased from about 1 tick (or 1/32) to 10 ticks (or 31 basis points). I suspect fears of the Fed unwinding its balance sheet are driving this, but it will result in mortgage rates being less sensitive to the movements of the 10 year. Also as rates rise, the price difference between the months is increasing, which will translate into higher lock costs.

This is real capital markets inside baseball stuff, but if you are unimpressed with the latest scenario you run, this is part of the reason why.

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Vital Statistics:

Stocks are flattish as we kick off earnings season. Bonds and MBS are up.

Inflation at the wholesale level rose 11.2% in March, according to the Producer Price Index. Ex-food energy and trade services prices rose 7%. Over half of the increase was driven by rising energy costs. These numbers were hotter than what the Street was looking for, but bonds seem to be behaving this morning. You can see below we are at extremely elevated levels historically:

Note that inflation is not just a US phenomenon. UK inflation surged to a 30 year high as well.

Mortgage applications fell by 1.3% last week as purchases rose 1% and refis fell by 5%. Refis are down 62% on a YOY basis. “Mortgage rates across all loan types continued to move higher, with the 30-year fixed rate exceeding the 5-percent mark to 5.13 percent–the highest since November 2018,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Refinance activity as a result declined to the slowest weekly pace since 2019.”

Separately, the MBA is forecasting that 2022 originations will come in at $2.58 trillion compared to roughly $4 trillion in 2021.

MBS spreads continue to widen, along with bid-ask spreads in the TBA market. I assume this is being driven by fears of the Fed’s exit from the MBS market. While we are not at the wide levels of early 2020, MBS spreads are wider than they have been historically. This would indicate that mortgage rates might move lower if the 10 year stabilizes here.

JP Morgan reported earnings this morning. Earnings fell on a YOY and QOQ basis as provisions for loan losses increased. Mortgage banking volume fell 37% YOY to $25 billion. The home lending segment reported profits of $1.2 billion, up 8% compared to Q421 and down 20% on a YOY basis. Rising servicing income offset declining gain on sale and volumes. The stock is down about 3% on the open.

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