All Things in Moderation

Vital Statistics:

Stocks are lower as we end a hideous quarter for the markets. Bonds and MBS are up.

FGMC has filed for bankruptcy. It won’t affect closed loans and the company obtained DIP financing. “While we have made considerable efforts to address our ongoing financial challenges related to the state of the mortgage market, we ultimately must do what is best for our borrowers and consumers,” said Aaron Samples, chief executive officer of FGMC. “After careful review and consideration, the Company determined that pursuing the protections of chapter 11 is the right and responsible path at this time. As part of this process, the Company retained a portion of its workforce to manage the day-to-day business. We are requesting that the court approve a variety of motions that will promote a smooth transition for all pertinent parties while also preserving value for the benefit of the Company’s stakeholders.”

Personal incomes rose 0.5% MOM, according to the Bureau of Economic Analysis. This number was in line with expectations. Personal consumption expenditures came in light, rising only 0.2%, when the Street was looking for a 0.5% increase. If you adjust for inflation, spending fell 0.4%.

The inflation indices were at least somewhat encouraging. PCE Inflation rose 0.6% MOM, which was an increase however the YOY change was flat at 6.3%. Ex-food and energy PCE inflation rose 0.3% MOM and fell to 4.7% YOY.

Overall, the spending number is discouraging, and indicates that second quarter GDP might be weaker than people are thinking.

Jerome Powell said yesterday that he was more concerned about the risk of inflation than the risk of recession. Is there a risk we would go too far? Certainly there’s a risk,” Mr. Powell said Wednesday. “The bigger mistake to make—let’s put it that way—would be to fail to restore price stability.” He was speaking at the European Central Bank’s annual economic conference.

The risk is that the economy transitions into a higher-inflationary regime where higher inflationary expectations get baked into the economy. This happened in the 1970s, and the Fed found itself with a economy where growth stagnated and inflation kept ratcheting higher. The state of affairs was eventually described via the misery index, which was the sum of inflation, unemployment and interest rates.

Inflationary expectations tend to have reinforcing effects. People tend to accelerate purchases in order to buy before prices rise. This exacerbates shortages. Workers expect annual cost-of-living increases which further increases the prices of finished goods. This psychological phenomenon is what the Fed is trying to ward off.

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Vital Statistics:

Stocks are flattish this morning after yesterday’s tech rout. Bonds and MBS are flat.

The final revision of first quarter GDP came in at -1.6%, a downward revision from the previous -1.5%. The PCE Price Index (basically inflation) was revised upward to 7.1%. Ex-food and energy it rose 5.2%. Consumption was revised downward to 1.8% from 3.1%.

The latest GDP Now estimate from the Atlanta Fed has growth increasing at 0.3% in the second quarter. If that is how it plays out, we will have managed to avoid a technical recession, however growth is anemic and the recent increases in the Fed Funds rate won’t begin to impact the economy until later this year.

Mortgage applications rose 0.7% last week as purchases rose 0.1% and refis increased 2%. The numbers were affected by the Juneteenth holiday.

“Mortgage rates continue to experience large swings,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. He noted the 30-year fixed rate declined 14 basis points last week to 5.84 percent after increasing 65 basis points during the past three weeks. Rates are still significantly higher than they were a year ago, when the 30-year fixed rate was at 3.2 percent.

“The decline in mortgage rates led to a slight increase in refinancing, driven by an uptick in conventional loans,” Kan said. “However, refinances are still 80 percent lower than a year ago and more than 60 percent below the historical average. Overall purchase activity has weakened in recent months due to the quick jump in mortgage rates, high home prices, and growing economic uncertainty.”

The abrupt shutdown of First Guaranty has left a lot of lenders with uncertain pipelines. The company laid off almost 80% of its staff on Friday, and basically left a skeleton crew to wind things down. “FGMC has experienced significant operating losses and cash flow challenges due to unforeseen historical adverse market conditions for the mortgage lending industry, including unanticipated market volatility,” Cassie Vacante, senior vice-president of Human Resources, wrote in a WARN notice.

I have heard rumors that liquidity is beginning to dry up in the non-QM space. I have to imagine the fallout from FGMC is related to it. Last week there were rumors that FGMC was hit by margin calls, which might be indicative of weakening buy-side demand for private label securities. While these are rumors only, it seems to fit.

Home Prices rose 21% in May, according to the Clear Capital Home Data Index. In the Southern region, prices rose 23%, led by a slew of Florida locations. The Northeast is beginning to experience home price appreciation at long last. Note this index is a month ahead of the FHFA and Case Shiller indices so it reflects more recent data. The rise in mortgage rates has yet to affect home price appreciation.

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Stocks are higher this morning as China eases lockdown restrictions. Bonds and MBS are down.

House prices rose 1.6% MOM and 18.8% YOY according to the FHFA House Price Index. “House price appreciation continues to remain elevated in April,” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “The inventory of homes on the market remains low, which has continued to keep upward pressure on sales prices. Increasing mortgage rates have yet to offset demand enough to deter the strong price gains happening across the country.”

Separately the Case-Shiller Home Price Index rose 1.8% MOM and 21.2% YOY. These appreciation numbers go back to April, so this is before the Fed really started pushing up rates. That said, I think the supply and demand situation is not really conducive to any sort of meaningful / widespread home price depreciation.

Consumer confidence fell again in June, according to the Conference Board. “Consumer confidence fell for a second consecutive month in June,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “While the Present Situation Index was relatively unchanged, the Expectations Index continued its recent downward trajectory—falling to its lowest point in nearly a decade. Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by yearend.”

The one bright spot is that the present situation (which is how things actually are) is holding up. The other bright spot is that consumers are more pessimistic about the overall economy than they are about their personal financial situations.

Times are still good for landlords as the CoreLogic Single Family Rent Index rose 14% YOY in April. Some numbers are absolutely staggering: Miami was up 41% on a YOY basis. Orlando was up 26%. The downside is that these numbers will almost certainly add to inflationary pressures going forward.

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Vital Statistics:

Stocks are higher as markets continue to rebound. Bonds and MBS are down.

We are heading into a pretty big week for data, although the jobs report will slip into next week. We will get home prices and consumer confidence tomorrow, the final revision to Q1 GDP on Wednesday, personal incomes and outlays on Thursday, and ISM data on Friday. Markets will have an early close on Friday ahead of the 4th of July weekend.

First Guaranty mortgage laid off almost all of their staff on Friday. It sounds like they were short on cash and unable to strike a deal to raise more. Instead of ponying up more cash, main backer PIMCO decided to pull the plug instead.

Durable Goods orders increased in May, according to the Census Bureau. Orders were up 0.7% while shipments increased 1.3%. The report shows that demand remains strong, and some of the supply side numbers show that supply chain issues may be easing a touch, which is good news for the inflation numbers and the economy overall.

Pending Home Sales rose 0.7% in May, according to NAR. The Northeast saw the biggest gain, with home sales rising 15.4%. “Despite the small gain in pending sales from the prior month, the housing market is clearly undergoing a transition,” said NAR Chief Economist Lawrence Yun. “Contract signings are down sizably from a year ago because of much higher mortgage rates. Trying to balance the housing market by choking off demand via higher mortgage rates is damaging to consumers and the economy,” Yun added. “The better way to balance the market is through increased supply, which also helps the broader economy.”

His point about housing construction being the answer to soaring home prices is spot-on. Historically housing has led the economy out of a recession. It wasn’t unusual to see housing starts spike above a 2 million annualized pace coming out of recessions in the past. This was almost par for the course in the 1970s and 1980s.

The 2008 financial crisis never witnessed a rebound in home construction as we did have an overhang of foreclosures and excess new construction. That overhang was probably balanced out by the mid teens, and now we have an abject shortage of housing. The government would love to see new home construction, however the constraints are on the supply side – materials and especially labor.

I suspect the recovery from the current / imminent recession will finally be the one that ushers in a wave of new home construction. The big question will be whether we have the workers to do it.

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Vital Statistics:

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

The S&P Flash Composite Purchasing Managers Index showed the economy slowed pretty dramatically in June. PMI Indices are based on questionnaires given to business executives, so they are a little more timely than some of the government statistics.

Service industries fared a little better than manufacturers, which is starting to see evidence of demand destruction. New orders contracted for the first time since July of 2020. Pricing pressures show no sign of abating however. Business confidence numbers fell to the lowest in over a decade.

It is possible that we are on the cusp of “bad news is good news” as far as market sentiment – where economic weakness is interpreted as good news for stocks and bonds because it means the Fed may ease up on the brakes. We aren’t there quite yet, but it feels like we are close.

Regardless of the PMI data, the Fed Funds futures are still a lock for 75 basis points in hikes at the next meeting.

New Home Sales rose 10.7% MOM to a seasonally adjusted annual pace of 696,000 units. This is still down over 5% on a YOY basis. The Street was looking for 587k, so this is an upside surprise. Note that April’s number was exceptionally low, so perhaps some sales got pushed to May. Regardless, housing still remains a bit of a drag on the economy.

The University of Michigan Consumer Sentiment index slipped in June to 50. This is a big decline from May, and it confirms the lousy initial reading. This is the lowest reading on record for the index. It is down an astounding 41% on a YOY basis.

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Stocks are higher this morning as Jerome Powell heads to the Hill to testify in front of the House. Bonds and MBS are up.

Jerome Powell reiterated his commitment to reducing inflation and said a recession is a possibility. “At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so,” the Fed chief said in remarks for the Senate Banking Committee. “We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2%,” Powell said. “We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy.”

Despite the increase in interest rates, the employment market remains resilient. Initial Jobless Claims ticked down slightly to 229,000 last week, which is still historically very low.

The CFPB is reviewing the Non-QM rule. The CFPB’s Qualified Mortgage Rules to explore ways to spur streamlined modification and refinancing in the mortgage market, as well as assessing aspects of the “seasoning” provisions. The other thing probably worth exploring is the APOR / HPML issue and how it is applied in a period of rapidly rising interest rates.

The number of mortgages in forbearance fell last week to 0.85% from 0.94%. So far we are seeing scant evidence that the increase in interest rates and the weakening economy is having an effect on loan performance. “Servicers are whittling away at the remaining loans in forbearance, even as the pace of monthly forbearance exits slowed in May to a new survey low,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “Most borrowers exiting forbearance are moving into either a loan modification, payment deferral or a combination of the two workout options.”

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Vital Statistics:

Stocks are lower this morning as investors get more bearish about the economy. Bonds and MBS are up.

Jerome Powell heads to the Hill for his Humphrey Hawkins testimony. The meat of the message is this quote from the prepared remarks:

Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy. We will make our decisions meeting by meeting, and we will continue to communicate our thinking as clearly as possible. Our overarching focus is using our tools to bring inflation back down to our 2 percent goal and to keep longer-term inflation expectations well anchored.

The Fed Funds futures still anticipate a 89% chance of a 75 basis point hike in July and a 11% chance of a 50 basis point hike. The central tendency for December is a Fed Funds futures rate of 3.5%, which means another 200 basis points are anticipated.

Citigroup sees a 50% chance of a global recession this year. Chief Global Economist Nathan Sheets said: “The global economy continues to be afflicted by severe supply shocks, which are pushing up inflation and driving down growth. But more recently, two further factors have burst onto the scene: Central banks are hiking policy rates with increasing vigor in their fight against inflation, and the global consumer’s demand for goods looks to be softening. We conclude that central banks face a daunting challenge as they seek to wrestle inflation down,” Sheets added. “The experience of history indicates that disinflation often carries meaningful costs for growth, and we see the aggregate probability of recession as now approaching 50%. Central banks may yet engineer the soft—or ‘softish’—landings embedded in their forecasts (and in ours), but this will require supply shocks to ebb and demand to remain resilient.”

Mortgage applications rose 4.2% last week as purchases rose 8% and refis fell 3%. “Mortgage rates continued to surge last week, with the 30-year fixed mortgage rate jumping 33 basis points to 5.98 percent – the highest since November 2008 and the largest single-week increase since 2009,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “All other loan types also increased by at least 20 basis points, influenced by the Federal Reserve’s 75-basis-point rate hike and commentary that more are coming to slow inflation. Mortgage rates are now almost double what they were a year ago, leading to a 77 percent drop in refinance volume over the past 12 months.”

Existing Home Sales fell 3.4% MOM and 8.6% YOY in May, while the median home price reached $400,000. “Home sales have essentially returned to the levels seen in 2019 – prior to the pandemic – after two years of gangbuster performance,” said NAR Chief Economist Lawrence Yun. “Also, the market movements of single-family and condominium sales are nearly equal, possibly implying that the preference towards suburban living over city life that had been present over the past two years is fading with a return to pre-pandemic conditions.”

Inventory remains an issue, although it is improving. Unsold homes sat at a 2.6 month supply at the end of May. A balanced market is more like 6%. Lawrence Yun is bearish on sales going forward: “Further sales declines should be expected in the upcoming months given housing affordability challenges from the sharp rise in mortgage rates this year,” Yun added. “Nonetheless, homes priced appropriately are selling quickly and inventory levels still need to rise substantially – almost doubling – to cool home price appreciation and provide more options for home buyers.”

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Vital Statistics:

Stocks are higher to begin this shortened week after a horrendous two weeks. Bonds and MBS are down.

There isn’t a lot of market-moving data this week, however Jerome Powell will head to the Hill for his semiannual Humphrey-Hawkins testimony. Aside from a lot of Fed-Speak, new home sales on Friday will be important.

The Fed Funds futures are predicting another 75 basis point hike at the July Fed meeting. This would imply about 150 basis points of tightening in the context of six weeks. This amounts to one of the biggest moves ever from the Fed, and the last time the Fed moved like this the overall interest rate environment was much higher. Going from 9.25% to 10.75% in the 80s probably has less of an impact than going from 0.5% to 2.25%.

With the Atlanta Fed’s GDP Now index predicting flat growth in Q2, the new home sales number will probably take on more significance than normal. Given the lousy housing starts number last week, I expect new home sales to come in weak as well, which will probably seal the deal for a negative Q2. That will make us officially in a recession.

So far, it doesn’t appear that there are any systemic issues in the financial markets. No blow-ups that spew counterparty risk all over the place. Corporate balance sheets are generally unleveraged, and most of the debt issuance during the pandemic was about refinancing existing debt and locking in low rates.

Growth decelerated in May, according to the Chicago Fed National Activity Index. This index is comprised of various economic indicators and is intended to be sort of a meta-index for the economy. The index fell to 0.1%, which is barely above trend. Sales and employment trends added to the index, while production, consumption and housing were weak spots.

New Residential is changing its name to Rithm Capital. It will now be an internally-managed REIT versus an externally managed one. “We are taking this opportunity to rebrand to Rithm Capital and demonstrate the growth of our Company,” said Mr. Nierenberg. “We have changed dramatically since our inception, from an owner of MSR assets to a company with complementary operating companies and a unique portfolio of investments. The new name and brand help distinguish us from our operating companies, including Newrez, and reflect our culture, team and ambitions for growth beyond residential mortgages.”

I have absolutely no idea what Rithm is supposed to mean. Is it an acronym? But this is definitely one of the stranger name changes since Nationstar rebranded as Mr. Cooper.

The company also declared its normal $0.25 dividend. This gives the stock a double-digit dividend yield. So far the anticipated dividend cuts in the mortgage space have yet to materialize.

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Stocks are rebounding this morning after yesterday’s blood bath. Bonds and MBS are down.

Biden said that a recession isn’t inevitable in an interview with AP. On the subject of what voters should take away from the fact that economists suggesting a recession is possible next year, he said:

“They shouldn’t believe a warning. They should just say: “Let’s see. Let’s see, which is correct.” And from my perspective, you talked about a recession. First of all, it’s not inevitable. Secondly, we’re in a stronger position than any nation in the world to overcome this inflation. It’s bad. Isn’t it kind of interesting? If it’s my fault, why is it the case in every other major industrial country in the world that inflation is higher? You ask yourself that? I’m not being a wise guy. Someone should ask themself that question. Why? Why is it? If it’s a consequence of our spending, we’ve reduced the deficit. We’ve increased employment, increased pay. There was a survey done uh, uh, by the, uh, I forget which one it was, which one it was now, about three months ago. You had more people had lower debt (inaudible) credit cards, more savings in their savings account, higher pay in the job they had, more satisfaction in the job they had and they were in good shape financially.”

The Conference Board’s Index of Leading Economic Indicators fell 0.4% in May. “The US LEI fell again in May, fueled by tumbling stock prices, a slowdown in housing construction, and gloomier consumer expectations,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The index is still near a historic high, but the US LEI suggests weaker economic activity is likely in the near term—and tighter monetary policy is poised to dampen economic growth even further.”

Given the abrupt rise in interest rates, I suspect the LEI hasn’t caught up to the new reality yet. Even the MBA forecast from earlier this month has a Q2 and end of year forecast for the 30 year fixed rate mortgage around 5%. It is currently 6%. Last week’s CPI report was a game changer.

Industrial production rose 0.2% in May, which was a touch below consensus. Manufacturing production fell 0.1%. Capacity Utilization inched up to 79%. Capacity Utilization is much lower than it was in the 1970s, and is at least one positive statistic on the inflation front. Of course the economy is much different today – we are no longer a manufacturing-focused economy but this is at least one positive development.

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Vital Statistics:

Stocks are lower this morning as markets digest the Fed’s move yesterday. Bonds and MBS are down.

The Fed raised the Fed Funds rate 75 basis points yesterday. This was the biggest increase since 1994. We got a new set of projections as well, with the Fed raising its inflation and unemployment forecasts and cutting GDP growth forecasts. The dot plot moved upward pretty dramatically. You can see the June versus March plots below:

The central tendency in March was for a Fed Funds rate between 1.75% and 2% by the end of the year. That forecast is now 3.25% – 3.5%. The forecast for 2022 GDP was lowered from 2.8% to 1.7%, while the forecast for unemployment was moved up from 3.5% to 3.7% and the forecast for inflation was increased to 5.2% from 4.3%. The core inflation forecast (ex-food and energy) was bumped up slightly from 4,1% to 4.3%.

Jerome Powell said the central bank focused a lot on the University of Michigan sentiment index, especially the part about inflationary expectations. The median expectation for inflation was 5.4%, but the mean was 7.4%. That is a big concern for the Fed. The fear is that we get a wage-price spiral, where prices rise, workers demand higher compensation, which increases prices and drives further inflation. The big question concerns whether the Fed is chasing oil prices. Since the Fed has no control over commodity prices, it really should focus on core inflation. That said, its mandate is to manage headline inflation, so it may be forced to overreact to rising food and energy prices.

With the Atlanta Fed predicting 0% GDP growth this quarter, and the lousy retail sales print yesterday, we might already be in a recession. And if we are, we might be getting to the point where bad economic news is considered good news since investors will assume economic weakness will take the top off inflation and allow the Fed to take a breather on rate hikes. The minutes to the June meeting will be interesting to read.

So far, the yield curve has steepened in response to the meeting, with 2s / 10s trading at 14 basis points. Corporate credit spreads are behaving as well, so we aren’t seeing indications that economic weakness is spilling over into the financial sector, at least not yet.

Housing starts disappointed again, as rising home prices, mortgage rates, and materials prices make new houses expensive. Starts fell 14% MOM and 4% YOY to a seasonally-adjusted annualized pace of 1.55 million. Building Permits came in flat YOY at 1.7 million.

The NAHB / Wells Fargo Housing Market Index (which measures builder sentiment) fell to the lowest level since June of 2020. This is the sixth consecutive monthly decline. Building materials costs are up 19% YOY, except for lumber.

Housing remains a weak part of the economy, however it usually leads the economy out of a recession. If we get some relief on inflation and rising interest rates, perhaps the housing sector will get some legs later this year or next.

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