All Things in Moderation

Vital Statistics:

Stocks are flat after GDP came in negative for the second consecutive quarter. Bonds and MBS are up.

The Fed hiked the Fed Funds rate 75 basis points yesterday as expected. The vote was unanimous. Jerome Powell made hawkish remarks during his press conference. The prepared remarks are here. The money quote:

My colleagues and I are strongly committed to bringing inflation back down, and we are moving expeditiously to do so. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses…. From the standpoint of our Congressional mandate to promote maximum employment and price stability, the current picture is plain to see: The labor market is extremely tight, and inflation is much too high.

The September Fed Funds futures contracts are pricing in a 80% chance of a 50 basis point hike and a 20% chance of a 75 basis point hike. For the end of the year, the December futures are seeing the Fed Funds rate up either 75 or 100 basis points from here. The June 2023 futures see lower rates than December. In other words, we are probably about 75% of the way through this tightening cycle. Of course the economic effect of tightening starts to be felt in six to 9 months, so late 2022 / early 2023 will be when the impact really begins to be felt.

The advance estimate for second quarter GDP came in at -0.9%, which is the second consecutive quarter of declining GDP. GDP was negatively affected by inventory investment, government spending, and housing. Personal Consumption Expenditures were positive. The PCE Price Index rose 7.4%, the same as the first quarter. Note this is probably not going to influence the Fed much given it is older data.

As I am sure you will hear in the media and from the Administration, two consecutive quarters of negative GDP growth is not an official recession. The National Bureau of Economic Research makes the final determination, and given the strength of the labor market they have the leeway to say we aren’t in one.

Of course as the economy weakens due to the recent rate increases, the NBER might have to bow to reality and declare one. But they will probably hold off as long as they can. Note that initial jobless claims are ticking up again, hitting 256k last week. The prior week’s 251k reading was revised upward to 261k.

The GDP print and the Fed’s hawkishness is pushing the bond market up (rates down), which is creating an interesting dynamic. The yield curve inversion remains, with the 2s / 10s spread at negative 21 basis points. If the Fed raises rates another 50 basis points in September and the 10 year stays here, we will have a fully inverted yield curve. You can see below the 2s / 10s spread going back to the 1980s. It has been a decent recessionary indicator, although you could argue we are in one now.

Mr. Cooper’s earnings came in better than expectations, and the stock traded up about 5 bucks on the news. Net income came in at $151 million, which was driven primarily by servicing, although origination income was positive as well. Volume fell 33% QOQ to $7.8 billion. Mr. Cooper is valuing its servicing book at 155 basis points.

Mr. Cooper has held up better than most originators during this environment due to the relative size of its servicing book. If rates stabilize or start heading downward, that tailwind will probably weaken.

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Vital Statistics:

Stocks are higher this morning as we await the Fed de Bonds and MBS are up.

The Fed decision is slated to come out at 2:00 pm today. The Fed Funds futures implied probability graph shows about a 3/4 chance of a 75 basis point hike and a 25% chance of a 100 basis point increase.

Retail inventories rose 2%, (higher than expected) in June, which probably bodes well for the advance estimate of second quarter GDP which comes out tomorrow. Wholesale inventories rose 1.9% as well. These numbers suggest that the supply chain issues of the past two years are working themselves out. Note that WalMart is cutting prices to deal with excess inventory.

“The increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars. We’re now anticipating more pressure on general merchandise in the back half; however, we’re encouraged by the start we’re seeing on school supplies in Walmart U.S.” said Doug McMillon, Walmart Inc. president and chief executive officer.

Food and fuel price inflation seems to be turning the corner however. The GSCI commodity index is heading back downward, although we are still well above levels seen last year:

As the old saying goes, the cure for high prices is high prices. Eventually demand falls and supply increases. Case in point: corn, which is down 26% from its April highs.

Mortgage Applications fell 1.8% last week as purchases fell 0.4% and refis fell 2%. “Mortgage applications declined for the fourth consecutive week to the lowest level of activity since February 2000,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Increased economic uncertainty and prevalent affordability challenges are dissuading households from entering the market, leading to declining purchase activity that is close to lows last seen at the onset of the pandemic.”

Homebuilder Pulte reported second quarter earnings yesterday. Demand remains strong for housing, however increasing mortgage rates are having an impact. One thing that stood out to me was the increase in gross margins, which rose to 30.9%, an increase of 430 basis points compared to last year and 190 basis points from the first quarter. Whatever cost increases that Pulte is dealing with (labor and material costs) are more than covered by rising prices.

The other thing I notices was a decent uptick in the cancellation rate, from 7% to 15%, as well as the 8% drop in orders. Backlog decreased slightly on a unit basis, but rose 18% on a dollar basis. It is strange to think that housing starts remain low when building homes seems to be pretty profitable and the demand is there. Perhaps it is nothing more than a skilled labor shortage, although the company didn’t mention it.

The fallout from Sprout continues. California lender New Wave is suing the company for defaulting on a purchase agreement for $32.8 million worth of loans. New Wave ended up selling the loans to a different buyer and Sprout is refusing to return the holdback amount.

Pending Home Sales fell 8% last month, according to NAR. Year-over-year, transactions are down 20%. This (along with the end of rate / term refis) explains why mortgage originators are struggling compared to the past two years.

“Contract signings to buy a home will keep tumbling down as long as mortgage rates keep climbing, as has happened this year to date,” said NAR Chief Economist Lawrence Yun. “There are indications that mortgage rates may be topping or very close to a cyclical high in July. If so, pending contracts should also begin to stabilize.”

Mortgage rates may indeed be stabilizing, as the yield curve continues to invert. The spread between the two-year and the 10-year is now negative 29 basis points. Mortgage rates are affected by bond market volatility, and if we get some stability in the 10 year, we should see mortgage rates work lower compared to Treasuries.

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Vital Statistics:

Stocks are lower this morning as we get a slew of important earnings and the Fed meeting begins. Bonds and MBS are up.

Home price appreciation appears to be decelerating, according to the FHFA House Price Index. Home prices rose 1.4% MOM in May, which was a decrease from the downward-revised 1.6% in April. On a YOY basis, home prices are still up some 18.3%.

Separately, the Case-Shiller Home Price Index rose almost 20% in May. Prices remained the strongest in the South and Southwest. Rising mortgage rates will make gains like this unsustainable soon enough.

Agency mortgage REIT AGNC Investment reported that the mortgage backed securities market (where lenders sell their loans) was difficult in the second quarter. Tangible book value per share fell about 13%.

“Financial markets remained under significant pressure in the second quarter as the Federal Reserve indicated a more aggressive path of monetary policy tightening,” said Peter Federico, the Company’s President and Chief Executive Officer. “The expectation of materially higher short-term rates drove significant interest rate volatility and increased the probability of a recession. This challenging monetary policy and macro-economic environment led to broad-based financial market weakness during the second quarter. Agency MBS were no exception, as the spread between Agency MBS and swap and Treasury rates widened meaningfully in April and again in June.

“Looking ahead, while the near-term outlook continues to be uncertain, the longer-term outlook for Agency MBS has improved substantially. At current valuation levels, Agency MBS are extremely attractive relative to historical levels. The Federal Reserve has begun to reduce its portfolio organically, but that runoff will occur at a slower pace than previously anticipated as a result of reduced prepayments. Finally, and perhaps most importantly, the net supply of Agency MBS is now expected to be meaningfully lower than prior expectations.

“These positive developments provide reason for optimism that this period of weakness in the Agency MBS market is nearing its end. The favorable returns associated with Agency MBS in this wider spread regime and an improving technical outlook for mortgage supply and demand should provide a supportive backdrop for Agency MBS investors. Moreover, in this compelling investment environment, we believe AGNC is well-positioned to generate strong risk-adjusted returns for our stockholders.”

What all this means is that AGNC was hit hard by weakness in the mortgage backed securities market. When the company says that “spreads widened” it means that the interest rate on mortgages rose faster than the yield on the 10-year. However, the relative valuation of mortgage backed securities is the best it has been in a while, which means that spreads should tighten as volatility wanes. This means that mortgage rates will probably move lower if the 10 year stays here. This is good for origination, though we probably won’t see a return of the rate / term refi business unless rates move materially lower.

New home sales fell 8% MOM and 17% YOY to a seasonally-adjusted annual rate of 590,000. This came in well below consensus. Homebuilding (and the real estate sector in general) continues to punch below its weight.

Consumers confidence continues to fall, according to the Conference Board. “Consumer confidence fell for a third consecutive month in July,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The decrease was driven primarily by a decline in the Present Situation Index—a sign growth has slowed at the start of Q3. The Expectations Index held relatively steady, but remained well below a reading of 80, suggesting recession risks persist. Concerns about inflation—rising gas and food prices, in particular—continued to weigh on consumers.”

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Stocks are higher this morning as we head into a big week of tech earnings. Bonds and MBS are down as we enter Fed week.

This week is packed with economic data, and the Fed will announce its decision on Wednesday. Aside from the Fed decision, we will get some important data including the first estimate of second quarter GDP, the employment cost index, personal incomes / outlays and house price data. We also get earnings from market heavyweights such as Apple and Amazon.

The Chicago Fed National Activity Index (sort of a meta-index of various economic indicators) was flat in June compared to a downward-revised May. Production and incomes were growing below trend, while the labor force and orders are above trend. Overall, the economy is growing below trend, which means the actions taken by the Fed are beginning to have an effect. One of the The CFNAI was flashing inflationary signs a few months ago, however we are back to normal.

There seems to be a growing consensus that inflation and interest rates have peaked for the year. While the Fed Funds rate is the most visible indicator of Fed tightening, two other levers are acting as well – quantitative tightening (or the reduction of asset purchases) and the stronger dollar. Quantitative tightening has more or less taken the wind out of the sails for the housing market and the dollar is helping on the commodity front. Supply chain issues remain a problem.

The Fed Funds futures are becoming more dovish, with the market now firmly handicapping a 75 basis point increase this month, and then another 100 basis points over the rest of the year. If you look at the far-out futures (basically summer of 2023), the Fed funds forecast is looking lower. In other words, the market thinks the Fed will be cutting rates in 2023.

You can hear the change in sentiment from Wall Street strategists as well. The emerging consensus is that the peak for rates and inflation happened in June, and inflation is beginning to subside as gas prices fall. Note the Philly Fed manufacturing index from last week showed inflation beginning to subside as well, as both the “prices paid” and “prices received” sub-indices fell substantially.

Housing Wire has a good piece on the pain in the non-QM market. Non-QM loans are mortgages which can’t be guaranteed by the government or Fannie / Freddie. These loans have been beaten up in the market due to the rapid rise in interest rates and the inability for dealers to hedge interest rate risk.

When FGMC shut its doors, it had about $418 million in loans on its warehouse lines, with Customers Bank, Flagstar, JVB and Texas Capital having the exposure. Many of these non-QM loans have low coupons and are now trading at “scratch and dent” prices.

John Toohig, a trader with Raymond James said: [There’s] a lot of underwater coupons due to rapidly rising rates,” Toohig said. “The problem with non-QM is that most banks won’t be the liquidity source for those loans in whole-loan form [purchasing] vs. the aggregators putting them into RMBS [private label securitization deals] — which doesn’t work right now [either]. “So, I wouldn’t be surprised that there is some pain coming at the warehouse-line level [revolving lines of credit used to fund mortgage originations] as loans start to age. The good news for prime jumbo [is] banks want to own those loans and balance-sheet them. The same cannot necessarily be said for non-QM.” 

Note that the National Financial Conditions Index seems to be reversing, which is good for riskier assets. Some junk spreads are tightening as well. This is part of what is driving the improving sentiment.

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

The index of leading economic indicators fell 0.8% in June, after falling 0.6% in May. For the first half of the year, it is down 1.8%.

“The US LEI declined for a fourth consecutive month suggesting economic growth is likely to slow further in the near-term as recession risks grow,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Consumer pessimism about future business conditions, moderating labor market conditions, falling stock prices, and weaker manufacturing new orders drove the LEI’s decline in June. The coincident economic index which rose in June suggests the economy grew through the second quarter. However, the forward-looking LEI points to a US economic downturn ahead. Amid high inflation and rapidly tightening monetary policy, The Conference Board expects economic growth will continue to cool throughout 2022. A US recession around the end of this year and early next is now likely. Accordingly, we’ve downgraded our forecast of 2022 annual Real GDP growth to 1.7 percent year-over-year (from 2.3 percent), while 2023 growth was downgraded to 0.5 percent YOY (from 1.8 percent).”

Note that Ford just announced planned layoffs, and initial jobless claims rose to 250k so it looks like the labor market has probably peaked. The recent Atlanta Fed GDP Now index predicts the economy fell 1.6% in the second quarter. According to the classis model of recession (two consecutive quarters of negative GDP growth) we are already in one. That said, the NBER makes the final call, and they can choose to ignore this if they want.

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Vital Statistics:

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

Mortgage applications fell 6.3% last week as purchases fell 7% and refis fell 4%. “Mortgage applications declined for the third week in a row, reaching the lowest level since 2000. Similarly, with most mortgage rates more than two percentage points higher than a year ago, demand for refinances continues to plummet, with MBA’s refinance index also falling to a 22-year low,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity declined for both conventional and government loans, as the weakening economic outlook, high inflation, and persistent affordability challenges are impacting buyer demand. The decline in recent purchase applications aligns with slower homebuilding activity due to reduced buyer traffic and ongoing building material shortages and higher costs.”

You can see the chart below of the MBA refinance index hitting lows last seen around 2000.

Existing Home Sales fell 5.4% in June, according to the National Association of Realtors. This is the fifth decline in a row. Sales fell 14.2% YOY to a seasonally adjusted annual rate of 5.1 million. “Falling housing affordability continues to take a toll on potential home buyers,” said NAR Chief Economist Lawrence Yun. “Both mortgage rates and home prices have risen too sharply in a short span of time.”

The median home price rose 13.4% to $416,000. Days on market hit a record low of 14 days. “Finally, there are more homes on the market,” Yun added. “Interestingly though, the record-low pace of days on market implies a fuzzier picture on home prices. Homes priced right are selling very quickly, but homes priced too high are deterring prospective buyers.”

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Vital Statistics:

Stocks are higher this morning as earnings continue to come in. Bonds and MBS are flat.

Homebuilder sentiment collapsed in July according to the NAHB / Wells Fargo Housing Market Index. “Production bottlenecks, rising home building costs, and high inflation are causing many builders to halt construction because the cost of land, construction, and financing exceeds the market value of the home,” says NAHB chairman Jerry Konter. “In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”

The issues surrounding inflation and supply chain bottlenecks are well-known, however it looks like demand is softening, which is new. Fears of a recession, along with high prices and rates are causing potential buyers to put plans on hold for the moment. It will be interesting to see the cancellation rates when the builders start reporting.

Housing starts disappointed again, falling 6.3% YOY to a seasonally adjusted annual rate of 1.55 million. Building Permits were flat at 1.66 million. It looks like activity is primarily slowing in the West, where prices have been soaring. Single family starts are still holding up.

The stock market has noticed the issues surrounding homebuilding, with the S&P SPDR Homebuilder ETF (XHB) down 31% YTD.

The Mortgage Bankers Association reported that applications for new home purchases fell 12% YOY in June. “Higher mortgage rates and heightened economic uncertainty cooled borrower demand in June, leading to new-home purchase applications declining to the lowest level since April 2020,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Additionally, new residential construction and permitting activity weakened from March through May, reducing the number of homes available for home buyers. MBA’s estimate of new home sales for June fell to a pace of 620,000 homes, a 15 percent drop of over 100,000 units compared to May.”

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Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

Filed under: Economy | 24 Comments »

Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

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