All Things in Moderation

Vital Statistics:

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

Inflation at the consumer level rose 8.5% in March as energy prices soared in the wake of Russia’s invasion of Ukraine. Gasoline prices accounted for about half of the increase in the index. Food prices rose 10%, which was the largest increase in over 40 years. You can see from the graph below that we are back at levels not seen since the early 80s.

If you strip out food and energy, prices rose 6.5%. Note that the recent uptick in housing prices will begin to filter in as well, although it generally takes about 12-18 months for the numbers to reflect the increases.

Home prices rose 20% YOY in February, according to CoreLogic. “New listings have not kept up with the large number of families looking to buy, leading to homes selling quickly and often above list price. This imbalance between an insufficient number of owners looking to sell relative to buyers searching for a home has led to the record appreciation of the past 12 months. Higher prices and mortgage rates erode buyer affordability and should dampen demand in coming months, leading to the moderation in price growth in our forecast.”

Small business optimism fell again in March, and it looks like small business is generally in a dour mood. Inflation has overtaken labor quality as the number 1 problem. A net 31% of business owners cited inflation as their biggest problem, which was the highest reading since 1981. Expectations about the future (in other words business conditions in the next six months) hit a net negative 49%, which is a low for this index which goes back almost 50 years. The expectations index is being drive by fears that the Fed, which is behind the curve, will cause a recession.

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Vital Statistics:

Stocks are lower this morning as COVID cases ramp up on China. Bonds and MBS are down.

The upcoming week has some inflation data with CPI and PPI on Tuesday and Wednesday. These readings will reflect the impact of the Russian invasion on food and energy prices, and the Street is looking for 8.4% inflation on the headline number and 6.6% ex-food and energy. The Producer Price Index, which measures wholesale inflation is expected to come in at 10% on the headline number and 8.4% ex-food and energy.

My guess is that the Fed is going to hike by 50 basis points at the May meeting regardless of how the numbers come in, so it shouldn’t be market-moving. That said, bond investors are in a “shoot first and ask questions later” mood, so we could see a sell-off regardless.

Mortgage backed security spreads (which are basically the yield on a mortgage backed security minus the yield on the corresponding treasury) are at 1.15%, which is well over long-term averages. Historically, it has been around 0.9%, so perhaps mortgage rates will stabilize around these levels. One can only hope.

The big fear in the markets right now is that the Fed is going to cause a recession in 2023 as increasing interest rates sap economic growth. Investors are watching the spread between the 10 year bond and the 2 year bond as an indicator. If the economy is heading into a recession, you would expect to see corporate bond yields creeping up, and that is most certainly not the case.

Amazon.com just issued a 40 year bond at Treasuries + 1.55%. This means you can tie up your money at 40 years an earn a whopping 4.3% per year. In retailing, 40 years is eons. Who were the top retailers in the early 1980s? Federated Department stores, Sears, K Mart, F.W. Woolworth, and Dayton-Hudson (Wal Mart was still in the early growth stage). Federated became known as Macy’s, and Dayton-Hudson is know known as Target.

What do the top 4 have in common? They all have declared bankruptcy at some point, and their debt traded down to distressed levels.

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Vital Statistics:

Stocks are flattish as we round out a data-light week. Bonds and MBS are down again.

The assets held by the Federal Reserve hit $8.9 trillion, which should be a high-water mark since the Fed is expected to start reducing its balance sheet relatively soon. Here is a chart of the assets held by the Fed since before the financial crisis of 2008.

It is important to note that there is no historical analog to draw on here. Central banks are a relative newcomer, historically. Woodrow Wilson brought the Federal Reserve into existence in 1913, so these entities haven’t been around all that often. For most of their existence they were the lender of last resort and helped manage the currency. Buying up assets to support the economy is new and it will be interesting to see whether global central banks can stick the landing.

With all of the Fed’s tightening, will the central bank cause a recession? It depends on the timeline. This year? Probably not. The employment market is still red-hot – WalMart is paying new truck drivers $110k to start – and that provides a strong buffer against a slowdown. Second, most of Corporate America took advantage of the ultra-low interest rate environment to refinance their corporate debt and lock in ultra-low rates for the foreseeable future.

That said, watch the slope of the yield curve; particularly the spread between the 10 year bond and the 2 year. Ordinarily it costs more to borrow for 10 years than 2 years, which is a positively-sloping yield curve. When it costs more to borrow for 2 years instead of 10 years, we get an “inverted” yield curve, and that has historically been a pretty strong indicator of a recession in the next 12 – 18 months. The yield curve inverted briefly about a week ago and has bounced back. This will be something to watch going forward.

What are rising rates doing to home prices? Theoretically, if the cost of borrowing rises, then this should be a negative for home prices. We are starting to see some evidence of competitive behavior amongst sellers, according to data from Redfin. “Price drops are still rare, but the fact that they are becoming more frequent is one clear sign that the housing market is cooling,” said Redfin Chief Economist Daryl Fairweather. “It goes to show that there’s a limit to sellers’ power. There is still way more demand than supply, and buyers are still sweating, but sellers can no longer overprice their home and still expect buyers to clamor at their door. That’s because higher mortgage rates are eating into homebuyers’ budgets. As the cooldown continues to set in, it is important that sellers price their home carefully. Homes that sit on the market for several days have a scarlet letter that makes them more difficult to sell. Buyers should be wary of bidding significantly over asking on newly listed homes, and to take a closer look at the homes that have been on the market for more than a week.”

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Vital Statistics:

Stocks are lower this morning after yesterday’s release of the FOMC minutes. Bonds and MBS are down small.

The FOMC minutes contained details on how the Fed intends to start reducing the size of its balance sheet.

In their discussion, all participants agreed that elevated inflation and tight labor market conditions warranted commencement of balance sheet runoff at a coming meeting, with a faster pace of decline in securities holdings than over the 2017–19 period. Participants reaffirmed that the Federal Reserve’s securities holdings should be reduced over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the SOMA. Principal payments received from securities held in the SOMA would be reinvested to the extent they exceeded monthly caps. Several participants remarked that they would be comfortable with relatively high monthly caps or no caps. Some other participants noted that monthly caps for Treasury securities should take into consideration potential risks to market functioning. Participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate. Participants also generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warrant.

In the discussion about rate policy, it sounded like absent the invasion of Ukraine, the Fed would have hiked by 50 basis points. The uncertainty over how the war would affect the economy drove the cautious decision to only increase by 25. By May, any lingering uncertainty will be gone, and it sounds like a 50 basis point hike is a foregone conclusion.

St. Louis Fed Head James Bullard said the central bank is “well behind the curve” in getting inflation under control. He is a hawk and was one of the voters to recommend a 50 basis point hike at the last meeting. He also said that the economy is generally strong, with low unemployment and decent growth. He also added that there are technical factors affecting the shape of the yield curve which reduce its efficacy as a potential recession indicator.

Black Knight Financial Services is in play, according to a report in Housing Wire. Private Equity firms were supposedly the interested suitors. I cannot imagine Intercontinental Exchange, which owns Ellie Mae, would be permitted to buy the company given antitrust concerns.

Mortgage credit availability decreased in March, according to the MBA’s Mortgage Credit Availability Index. “Overall credit availability was down slightly in March, driven by a reduction in higher LTV and lower credit score programs,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Credit availability has gradually trended higher since mid-2021 but remains around 30 percent tighter than it was in early 2020.”

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Vital Statistics:

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

Bonds sold off hard yesterday after Lael Brainard gave a speech and said that balance sheet reduction will be much faster than before: “It is of paramount importance to get inflation down. Accordingly, the Committee will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting. Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–19. 

The Fed Funds futures continue to get even more hawkish.

Mortgage applications fell by 6.3 last week as purchases fell 3% and refis fell 10%. “Mortgage application volume continues to decline due to rapidly rising mortgage rates, as financial markets expect significantly tighter monetary policy in the coming months,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “As higher rates reduce the incentive to refinance, application volume dropped to its lowest level since the spring of 2019.”

The services economy improved in March, according to the ISM. “The Prices Index registered 83.8 percent, up 0.7 percentage point from the February figure of 83.1 percent and its second-highest reading ever, behind December 2021 (83.9 percent). Services businesses are continuing to replenish inventories, as the Inventories Index expanded for a second straight month; the reading of 51.7 percent is up 0.9-percentage point from February’s figure of 50.8 percent. The Inventory Sentiment Index (40.2 percent, down 15.1 percentage points from February’s reading of 55.3 percent) returned to contraction in March, indicating that inventories are in ‘too low’ territory and not meeting current business requirements.”

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Vital Statistics:

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

Home prices rose 20% YOY in February, according to data from CoreLogic. “New listings have not kept up with the large number of families looking to buy, leading to homes selling quickly and often above list price. This imbalance between an insufficient number of owners looking to sell relative to buyers searching for a home has led to the record appreciation of the past 12 months. Higher prices and mortgage rates erode buyer affordability and should dampen demand in coming months, leading to the moderation in price growth in our forecast.” In terms of geography, the West and the Southeast saw the biggest growth, while prices lagged in the Midwest and the Northeast.

Affordability is the lowest in 15 years, according to Black Knight. “This combination of accelerating growth and sharply rising interest rates has resulted in the tightest affordability in 15 years. In fact, outside of the skewed 2004-2007 market, the 29.1% of median income now required to make the P&I payment on the average-priced home bought with 20% down is the highest share in 25 years. Entering the year, a prospective homebuyer who could budget a $1,700 monthly P&I payment – roughly the amount required to buy the average home today, excluding taxes and insurance – could afford a $497,000 house. With Freddie Mac reporting the average 30-year rate at 4.42% on March 24, that same borrower can now afford less than $425,000. The average P&I payment has increased 24%, or approximately $329 per month, while at the same time, the average homebuyer’s buying power has dropped by 15%. In the recent past, a payment-to-income ratio above 21% has worked to cool the housing market and regulate prices, but today’s record-low inventory continues to fuel significant growth even in the face of the tightest affordability in 15 years.”

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Vital Statistics:

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

The upcoming week is relatively-data light, with the ISM Services Index about the only meaningful report. We do have a smattering of Fed-speak though and the minutes from the March FOMC meeting on Wednesday. Investors will be looking at the minutes for insight into how the Fed plans to reduce the size of its MBS holdings. This has been the dark cloud over the MBS market as MBS spreads have widened considerably over the past month.

FHFA Director Sandra Thompson said “We’re preparing the enterprises to adjust to supervision in a way that they would be regulated outside of conservatorship,” Thompson said. “The safety and soundness of the enterprises, making sure their operations are really in tip-top condition — which they are — making sure their financial condition is as expected and that they never have to rely on the federal government again, [are] really important.”

Construction spending rose 0.5% MOM and 11.2% YOY, according to Census. Residential construction rose 1.1% MOM and 16.5% YOY. Labor and materials shortages continue to bedevil the residential construction industry.

With Q1 in the books, the Atlanta Fed’s GDP Now estimate came in 1.5% as of April 1.

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Vital Statistics:

Stocks are lower this morning as we start off the second quarter. Bonds and MBS are down.

The economy added 431,000 jobs in March, according to the Employment Situation Report. The unemployment rate slipped 0.2% to 3.6%, which the labor force participation rate was flat at 62.4%, which is still below pre-pandemic levels. Jobs grew the most in leisure / hospitality and professional / business services. Average hourly earnings rose 5.6%, which is below headline inflation, and implies that real (inflation-adjusted) wages are falling.

Personal incomes rose 0.5% MOM in February, according to the Bureau of Economic Analysis. The personal consumption expenditures (PCE) inflation index rose 0.6%. On a year-over-year basis, the headline PCE index rose 6.4%, and ex-food and energy it rose 5.6%. This index is the Fed’s preferred measure of inflation, and this is the fastest pace since 1983.

The ISM Manufacturing Index fell 1.5 points in March. “The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. In March, progress was made to solve the labor shortage problems at all tiers of the supply chain, which will result in improved factory throughput and supplier deliveries. Panelists reported lower rates of quits and early retirements compared to previous months, as well as improving internal and supplier labor positions. March brought back increasing rates of price expansion, due primarily to instability in global energy markets. Suppliers are not waiting to experience the full impacts of price increases before negotiating with their customers. Panel sentiment remained strongly optimistic regarding demand, with six positive growth comments for every cautious comment, down from February’s ratio of 12-to-1. Demand expanded, with the (1) New Orders Index remaining in growth territory, supported by weaker growth of new export orders, (2) Customers’ Inventories Index remaining at a very low level and (3) Backlog of Orders Index continuing in strong growth territory.

Consumption (measured by the Production and Employment indexes) grew during the period, though at a slower rate, with a combined minus-0.6-percentage point change to the Manufacturing PMI^® calculation. The Employment Index expanded for a seventh straight month; panelists indicate their ability to hire continues to improve, to a greater degree than in February. Challenges with turnover (quits and retirements) and resulting backfilling continue to plague panelists’ efforts to adequately staff their organizations, but to a lesser extent compared to February. Amid signs of staffing and supplier delivery improvements, production expanded at disappointing levels, likely due to timing issues. Inputs — expressed as supplier deliveries, inventories, and imports — continued to constrain production expansion.”

House prices rose over 20% YOY, according to the Clear Capital Home Data Index. The West and the South are experiencing the fastest home price appreciation, while the Midwest and Northeast lag. The fastest growing MSAs include places like Nashville and Phoenix. I have to imagine that as remote working takes off, more companies will relocate to where it is cheaper. IMO, it kind of explains why the Motor City became the Mortgage City.

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