All Things in Moderation

Vital Statistics:

Stocks are lower this morning as we start Fed week. Bonds and MBS are down.

The upcoming week will have a lot of market-moving events. The biggest event will be the FOMC meeting on Tuesday and Wednesday, with the Fed Funds futures handicapping a 86% chance of a 75 basis point hike and a 14% chance of 50. We will get the jobs report on Friday, along with the ISM data and productivity.

The government is beginning to worry about liquidity in the Treasury market. One of the problems with borrowing a lot of money is that you need to continue to attract a lot of money in order to roll over the maturing debt. The fear is that we could get some failed auctions. Part of this is being driven by the events in the UK, where yields on UK Gilts (The UK’s version of a Treasury) spiked some 120 basis points in the course of a few days.

The root of the buyers strike is due to a lot of things, but the ultimate reason is nothing more than price and value. With inflation running at anywhere between 5% to 6%, a 10-year Treasury paying 4% isn’t an attractive investment. Global central banks have engineered a bubble in sovereign debt, which is something I don’t think we have seen before. Central banks in general have only been around for about a century so this is all new territory.

Note that the Fed is now paying more in interest than it receives in income from its Treasury and MBS portfolio. The Fed pays all of its profit to Treasury, and now that it is running losses, it is accumulating an IOU. When the Fed starts earning profits again, those profits will pay off the IOU. The Fed also does not mark its portfolio to market, which is good news because it is probably a few hundred billion dollars underwater on its MBS portfolio.

Public interest lawyers are warning that the 5th Circuit’s ruling on the CFPB’s funding structure could upend the mortgage market. “The Fifth Circuit’s decision threatens to paralyze mortgage lending in Mississippi, Louisiana, and Texas because lenders will lose certainty about what law applies to future mortgages that they make,” McCoy said, referring to the states within the Fifth Circuit. She was part of the original leadership team at the CFPB during the Obama administration.

“We do like to settle rules that give us some safe harbors for the way that we make mortgages and we don’t want that to all go away,” Mortgage Bankers Association president and CEO Robert Broeksmit said Monday at the trade association’s annual convention. Still, he vowed to keep fighting what he called the bureau’s regulatory overreach. “Now is no time to make you hire more lawyers to try to understand what the bureau is doing.”

FWIW, the MBA believes this ruling would only affect payday lenders, however the CFPB’s days of being exempt from the appropriations process are probably over.

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Stocks are lower this morning after Amazon.com earnings missed expectations. Bonds and MBS are down.



Personal incomes rose 0.4% MOM in September, according to the BEA. Spending rose 0.6% MOM. The PCE Price Index rose 0.3% MOM, while it rose 0.5% if you exclude food and energy (i.e. the core rate). On an annual basis, prices rose 6.2% and the core rate rose 5.1%.

The highlighted numbers show the monthly changes in both indices. July certainly looks like an outlier, but I see no discernable downward trend in the core rate, which is what the Fed is targeting.



The employment cost index (in other words the cost of employees from an employer’s point of view) rose 5.2% YOY in September, according to BLS.



I sat down with Clear Capital’s Kenon Chen at the Nashville MBA and discussed interest rates, the housing market, and what to look for going into year end. Here is the podcast.



Consumer sentiment improved in October, according to the University of Michigan’s Consumer Sentiment Index. Inflation expectations continue to remain elevated, which is bad news for the Fed. “The median expected year-ahead inflation rate rose to 5.0%, with increases reported across age, income, and education. Last month, long run inflation expectations fell below the narrow 2.9-3.1% range for the first time since July 2021, but since then expectations have reverted to 2.9%. Uncertainty over inflation expectations remains elevated, indicating that inflation expectations are likely to remain unstable in the months ahead.”



Pending home sales fell 10.2% in September, according to the National Association of Realtors. “Persistent inflation has proven quite harmful to the housing market,” said NAR Chief Economist Lawrence Yun. “The Federal Reserve has had to drastically raise interest rates to quell inflation, which has resulted in far fewer buyers and even fewer sellers. The new normal for mortgage rates could be around 7% for a while,” Yun added. “On a $300,000 loan, that translates to a typical monthly mortgage payment of nearly $2,000, compared to $1,265 just one year ago – a difference of more than $700 per month. Only when inflation is tamed will mortgage rates retreat and boost home purchasing power for buyers.”



Let me geek out for a second about Yun’s comments. This is real inside-baseball stuff.

FWIW, I don’t see mortgage rates sitting at 7% for long. If the Fed hikes another 75 basis points in December, and that appears to be the end of the hiking process, then I could see the 10-year going nowhere as the yield curve inverts in anticipation of a recession.

With MBS spreads at 15 year highs, if spreads revert to normal, then we should see a 110 basis point decrease in mortgage rates, even if the 10 year goes nowhere. This chart is from AGNC Investment, a mortgage REIT. Note that MBS spreads are wider than the depths of the financial crisis.

MBS spreads are simply the incremental yield that investors demand to hold mortgage backed securities versus Treasuries. If the spread is 180 basis points, (or 1.8%) and the 10 year yields 4%, that means MBS investors expect to receive a yield of 5.8%. Historically, they would have required 4.8%.

Mortgage rates are based on what MBS investors are willing to pay for these securities. If spreads are large (as they are now), you could say that MBS are cheap relative to Treasuries. If spreads are narrow (as they were in early 2021), you could say that MBS are rich. Right now, MBS are extremely cheap relative to Treasuries. Bond fund managers are always swapping in and out of different fixed income asset classes to find the best returns, and we should see them swap into MBS at some point, which should put some downward pressure on mortgage rates.

Bond funds have seen outflows, and when fund managers need to raise capital to fund redemptions, they generally sell the most liquid part of the portfolio. They do this because they can raise the most money with minimal impact on the price of the security. If they tried to raise funds by selling, say non-QM loans or junk bonds, they would crash that market, which would lower the net asset value of their portfolio. So, they raise capital first, then make the adjustments for the best returns later. So when we see a sell-off in fixed income as an asset class, MBS are the first to get whacked. And I think that is where we are now.

If the Fed’s dot plot in December indicates that the tightening cycle is largely done, I expect bond investors to flood into MBS since you can get a government-guaranteed rate of return far in excess of Treasuries. That will cause a furious rally in MBS, with a corresponding drop in mortgage rates. I suspect we will see a mortgage rate in the low 6s by mid 2023.

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Stocks are higher this morning after the GDP report. Bonds and MBS are up as well.

The advance estimate for third quarter GDP came in at 2.6%, an uptick from the 0.6% decline in the second quarter. The increase was driven by an uptick in consumption as well as government spending. Housing was a drag. Trade was also a positive contributor as exports increased and imports decreased. Personal consumption expenditures rose 1.4%. Both numbers were better than expected, which put a bid under stocks.

The report contained some good news on inflation. The PCE price index rose 4.2% compared to an increase of 7.3% in the second quarter. Ex-food and energy, the PCE index rose 4.5% compared to 4.7% in the second quarter. The inflation news pushed the 10 year bond yield back below 4%.

In other economic data, durable goods orders rose 0.4%, which was below expectations. Ex-transportation they fell 0.5%. Core capital goods (a proxy for business capital investment) also declined. Initial jobless claims ticked up marginally to 217k, which is historically a very low number.

Homebuyer affordability declined in September, according to the MBA. “Homebuyer affordability took an enormous hit in September, with the 75-basis-point jump in mortgage rates leading to the typical homebuyer’s monthly payment rising $102 from August,” said Edward Seiler, MBA Associate Vice President of Housing Economics, and Executive Director with Research Institute for Housing America. “With mortgage rates continuing to rise, the purchasing power of borrowers is shrinking. The median loan amount in September was $305,550 – much lower than the February peak of $340,000.”

New home sales continue to decline. In September, new home sales came in at 603,000, which was a decline of 10.9% compared to August and 17.6% from a year ago.

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Stocks are lower this morning after disappointing numbers out of Google and Mr. Softee. Bonds and MBS are up.

Mortgage applications fell 1.7% last week, as purchases fell 2% and refis actually ticked up. “The ongoing trend of rising mortgage rates continues to depress mortgage application activity, which remained at its slowest pace since 1997,” said Joel Kan, MBA Vice President and Deputy Chief Economist. “Refinance applications were essentially unchanged, but purchase applications declined 2 percent to the slowest pace since 2015 – over 40 percent behind last year’s pace. Despite higher rates and lower overall application activity, there was a slight increase in FHA purchase applications, as FHA rates remained lower than conventional loan rates.” Mortgage rates increased 20 basis points, from 6.94% to 7.16%.

Mortgage REIT AGNC Investment reported earnings yesterday, and discussed the current market. Mortgage originators should think of mortgage REITs as the buyers of their production. Inside the investor presentation, they showed just how wide MBS spreads have become. Take a look at the chart below.

The MBS spread is the difference in yield between a 10 year Treasury and corresponding mortgage backed security. The yield that investors like AGNC demand for these securities are the basic input to determine mortgage rates in general. AGNC investment holds primarily agency securities (in other words, bonds backed by Fannie and Freddie loans).

On the conference call, the CEO described what is going on the MBS market. The first thing he said is that in the early stages of market downturns agency mortgage backed securities are the first ones sold. This is because agency mortgage backed securities are the most liquid fixed income market in the US after Treasuries. So there tends to be a “sell what you can” aspect to this. And certainly bond funds have seen outflows.

The hiccup in the UK bond market was a big catalyst for the widening of MBS spreads. Since agency mortgage backed securities have no credit risk (they are government-guaranteed) the widening is due to liquidity and volatility overall in the bond market.

MBS spreads right now are wider than they were in December 2008, when the financial crisis was peaking. They are wider than they were in early-mid 2020 when the MBS market froze and the mortgage REITs were beset by margin calls. Can they go wider? Sure. But we are seeing a historically unprecedented market and these spikes don’t last very long.

Over the past 10 years, MBS spreads have averaged about 78 basis points, and are at 190 bps now. Here is what that means. If the 10 year yield stays the same, there is a built-in improvement in mortgage rates of 112 basis points. In other words, we could see rates fall to the low 6% range over the next few months, even if the Fed continues raising rates and the 10 year stays where it is.

From the standpoint of MBS investors, a government-guaranteed 6% rate of return is pretty attractive, certainly compared to investment-grade corporate bonds or junk. And if the economy does enter a recession, investors will sell credit risk and hide out in Treasuries and MBS. I expect this to happen at the end of the year, when lots of asset managers revise their risk allocations.

During the call, one of the analysts asked about the dividend. AGNC currently pays a monthly dividend of $0.12, which works out to a 18.6% dividend yield. Mortgage REIT investors have been waiting for the other shoe to drop, which means a dividend cut.

The analyst asked point-blank if the portfolio can cover the dividend yield. ANGC’s CEO said, after the caveats about always re-evaluating the correct dividend yield “But what’s really, I think, critical to understanding, I think is the heart of your question is you have to understand what drove the decline in our book value. And if you look at the performance of mortgages and you look at that graph that we show, I think it’s clear to everybody when you look on Page 7, that mortgage spreads have gone in one direction only for the better part of the last 18 months, 65 basis points wider, if you will, from August to now. So the decline in our book value is driven primarily by wider spreads. So while it hurts your book value currently because the decline in book value came from wider spreads, it also enhances the go-forward return on our portfolio…So, going forward, I still believe that those two things are reasonably well aligned, and obviously, conditions change and markets are volatile and we’re going to continue to be diligent about monitoring that. But to go forward, the return on our portfolio still is consistent with our dividend.”

If AGNC was planning on cutting the dividend, this would have been the time to do it. Mortgage stocks in general are about as popular as mask mandates, but we are probably at peak pessimism about the sector in general.

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

The FHFA House Price Index declined 0.7% in August. Prices were up 11.9% from a year ago. “U.S. house prices declined in August at a similar pace to the previous month. This is the first time since March 2011 that the index has seen two consecutive months of decline.” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “The recent monthly decline solidifies the deceleration of 12-month house price growth that began earlier this year. Higher mortgage rates continued to put pressure on demand, notably weakening house price growth.”

The index value for August was 392.03. The 10/1/21 index value was 357.59. This works out to be a 9.63% increase over the past 11 months. This would put the 2023 conforming loan limit around $709,500, with one last data point needed.

Separately, the S&P CoreLogic Case-Shiller Index reported a 0.3% monthly decline in July (it is a month behind FHFA). Prices rose at a 15.8% annual clip, with the Southeast showing the biggest growth. The leading cities were Miami and Tampa.

Consumer confidence declined in October, according to the Conference Board.

“Consumer confidence retreated in October, after advancing in August and September,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index fell sharply, suggesting economic growth slowed to start Q4. Consumers’ expectations regarding the short-term outlook remained dismal. The Expectations Index is still lingering below a reading of 80—a level associated with recession—suggesting recession risks appear to be rising.”

“Notably, concerns about inflation—which had been receding since July—picked up again, with both gas and food prices serving as main drivers. Vacation intentions cooled; however, intentions to purchase homes, automobiles, and big-ticket appliances all rose. Looking ahead, inflationary pressures will continue to pose strong headwinds to consumer confidence and spending, which could result in a challenging holiday season for retailers. And, given inventories are already in place, if demand falls short, it may result in steep discounting which would reduce retailers’ profit margins.” 

Note that we will be getting the first estimate of Q3 GDP on Thursday. The Atlanta Fed’s GDP Now index sees a gain of 2.9%. This seems out of step with the majority of the economic reports, but perhaps the comment about retailer inventories, specifically inventories in place, explains it.

If retailers built up inventory for the holiday shopping season, that would bump up Q3 GDP, but if the sales don’t materialize it would mean Q4 is looking rough. And if retailers are forced to discount in order to move the merchandise, then that will dampen inflation.

I suspect that this will push the Fed to begin to slow the rate hikes, and we could see the Fed signal that with its December projections. Don’t forget that all of these summer and fall rate hikes haven’t had time to impact the economy yet.

The MBA issued a statement supporting Fannie and Freddie’s steps to widen credit scoring and appraisals to open credit to underserved borrowers.

“Given the ongoing affordability challenges facing homebuyers, FHFA’s targeted adjustments to the GSEs’ pricing framework announced by Director Thompson at MBA’s 2022 Annual Convention are well-timed and will improve access to credit for low- and moderate-income households, first-time buyers, and minority buyers.

“The announced updates on credit scoring models should help broaden the scope of eligible borrowers and expand access to homeownership for underserved communities. MBA supports competition in the credit scoring space, and we will work with FHFA to ensure costs and the implementation process are monitored to mitigate unintended consequences to lenders and borrowers.

“FHFA’s increased focus on appraisal transparency – a years-long recommendation by MBA – will help the industry work together on data collection, with a shared goal of providing more accurate and equitable appraisals for borrowers.”

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Stocks are higher as earnings continue to come in. Bonds and MBS are up.

The upcoming week has a lot of important economic data. Tomorrow, we will get the FHFA House Price Index for August. Lots of mortgage bankers are looking at this number and trying to game what the new conforming loan limits will become after the September index level gets reported.

We will get new home sales, consumer confidence, GDP, personal incomes and outlays, and consumer sentiment. The personal incomes and outlays contains the Personal Consumption Expenditures Index which is the Fed’s preferred measure of inflation.

The MBA sees 2023 origination volume declining 9% to $2.05 trillion. “Next year will be particularly challenging for the U.S. and global economies. The sharp increase in interest rates this year – a consequence of the Federal Reserve’s efforts to slow inflation, will lead to an equally sharp slowdown in the economy, matching the downturn that is happening right now in the housing market,” said Fratantoni. “MBA’s forecast calls for a recession in the first half of next year, driven by tighter financial conditions, reduced business investment, and slower global growth. As a result, the unemployment rate will increase from its current rate of 3.5 percent to 5.5 percent by the end of the year. Inflation will gradually decline towards the Fed’s 2 percent target by the middle of 2024.”

The MBA sees home price appreciation declining to about zero next year. That said, the supply issue (or lack thereof) will remain an issue. The MBA forecasts that the number of jobs in the industry will contract some 25%-30% from peak levels.

We will get GDP on Wednesday, and the consensus seems to be that growth will be in the mid-to-high 2% range. The negative growth of Q1 and Q2 probably overstated the economic weakness, and this report will probably overstate growth. Retail sales bounced back in Q3, and that drove the increase in the Atlanta Fed’s GDP Now index.

Finance of America is getting out of the forward mortgage business but will continue to do reverse mortgages. The specialty finance and services products such as fix and flip will continue as well.

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

The resignation of Liz Truss doesn’t seem to have had an impact on UK assets, as the pound and gilts continue to drop. The pain in gilts is spilling over into other sovereign debt with Treasury yields briefly hit 4.34% this morning.

The CFPB’s funding arrangement has been ruled unconstitutional, according to a Federal Appeals Court. Elizabeth Warren’s idea for the CFPB was to have it funded by the Federal Reserve, which is outside the purview of Congress. This would make it impossible for Congress to cut its funding. This potentially could vacate some rulings the Bureau has made in the past. I don’t think there is anything that would affect the mortgage business, however. I believe the actual litigation in question concerns payday lenders.

The Fed Funds futures have been inching upwards. A 75 basis point hike in two weeks is more or less a lock, and the December futures have a 60% chance for another 75 basis points and 40% for only 50. They are then looking at another 25 bps in February, which will put the Fed Funds rate at a range of 4.75% – 5%, where they pretty much remain for the rest of 2023.

Note that a month ago, a target rate of 4.5% – 4.75% wasn’t even considered.

Since monetary policy acts with a lag, the string of 75 basis point hikes starting in June, the economic impact of this has barely begun to hit. The Atlanta Fed’s GDP Now index sees 2.9% in Q3, which seems optimistic, given that one strong retail sales print caused them to revise upward that number from about 0.5% to 2.5%.

I find it hard to believe that we see a massive growth acceleration in the midst of a tightening cycle, but that is what their models are saying.

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

St. Louis Fed President James Bullard said yesterday that he expects the Fed to end its “front-loading” of aggressive rate hikes by early next year. “In 2023 I think we’ll be closer to the point where we can run what I would call ordinary monetary policy,” he said. “Now you’re at the right level of the policy rate, you’re putting downward pressure on inflation, but you can adjust as the data come in in 2023. Not that there wouldn’t be further adjustments, but they would be more based on the data coming in as opposed to us trying to get off zero and up to some level that’s reasonable.”

Meanwhile, the Beige Book indicated that the economy is experiencing “slight to modest” growth, while prices (inflation) is showing “some degree of moderation.” The labor market appears to be loosening up, with wage increasing beginning to decline.

Speaking of the labor market, initial jobless claims remain quite low, falling to 214,000 last week.

Ally reported earnings yesterday. They are mainly an auto lender (they used to be known as GMAC), however they do have a mortgage origination arm. Their direct-to-consumer mortgage origination volume was $500 million, which was down 85% compared to a year ago. Refinance activity was down 98%.

The Conference Board Index of Leading Economic Indicators fell 0.4% in September, which was below the street expectation of 0.3%. “The US LEI fell again in September and its persistent downward trajectory in recent months suggests a recession is increasingly likely before yearend,” said Ataman Ozyildirim, Senior Director, Economics, at The Conference Board. “The six-month growth rate of the LEI fell deeper into negative territory in September, and weaknesses among the leading indicators were widespread. Amid high inflation, slowing labor markets, rising interest rates, and tighter credit conditions, The Conference Board forecasts real GDP growth will be 1.5 percent year-over-year in 2022, before slowing further in the first half of next year.”

Existing Home Sales fell 1.5% in September to a seasonally-adjusted average rate of 4.71 million. Year-over-year, sales are down a whopping 24%. The inventory of homes for sale declined as well, to 1.25 million units. “The housing sector continues to undergo an adjustment due to the continuous rise in interest rates, which eclipsed 6% for 30-year fixed mortgages in September and are now approaching 7%,” said NAR Chief Economist Lawrence Yun. “Expensive regions of the country are especially feeling the pinch and seeing larger declines in sales.”

The median home prices rose 8.5% YOY to $384,800. Days on market rose to 19, and 70% of properties sold within a month. The first time homebuyer accounted for 29% of sales, which is historically a low amount. Affordability constraints are almost certainly an issue, but low first time homebuyer percentages have been low for the past 15 years.

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Stocks are lower this morning after negative comments from Minneapolis Fed President Neel Kashkari. Bonds and MBS are down.

Minneapolis Fed President Neel Kashkari said the Fed may need to push the Fed Funds rate above 4.75% if core inflation keep accelerating. “Core services inflation — which is the stickiest of all — keeps climbing, and we keep getting surprised on the upside.” This, along with accelerating UK inflation put the kibosh on a two day rally in bonds.

Rising rates and home prices continue to depress housing starts. Starts were down 8.1% MOM and 7.7% YOY to a seasonally adjusted annual rate of 1.44 million. Building permits were up 1.4% MOM to 1.56 million.

Mortgage applications fell 4.5% as purchases fell 4% and refis fell 7%. This is the lowest level in 25 years. “The speed and level to which rates have climbed this year have greatly reduced refinance activity and exacerbated existing affordability challenges in the purchase market,” said Joel Kan, MBA Vice President and Deputy Chief Economist. “Residential housing activity ranging from new housing starts to home sales have been on downward trends coinciding with the rise in rates. The current 30-year fixed rate is now well over three percentage points higher than a year ago, and both purchase and refinance applications were down 38 percent and 86 percent over the year, respectively.”

Fears of a recession and an increase in defaults have pushed up the yields on credit risk transfer securities, which are the insurance for mortgage backed securities issued by Fannie and Freddie. The junk-rated tranches of these securities are now double digits. So far, defaults and delinquencies are under control, but the markets are beginning to show some concern.

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Stocks are higher this morning as earnings continue to surprise on the upside. Bonds and MBS are down.

Industrial Production rose 0.4% in September, according to the Federal Reserve. July and August were revised downward. Capacity Utilization rose to 80.3%. Interestingly, construction was a big contributor to growth, increasing 1.1%. Given the anecdotal evidence we are seeing regarding a housing recession I think there is a decent chance that this might be a spurious data point, although seasonality could be at play here as well.

Builder mortgage applications fell 13% YOY in September, according to the MBA. “New home purchase activity declined in September as prospective homebuyers pulled back in response to higher mortgage rates, increased concern about an impeding recession, and a broader slowdown in home-price growth,” said Joel Kan, MBA Vice President and Deputy Chief Economist. “The average 30-year fixed mortgage rate increased almost a full percentage point in the last month, greatly reducing the purchasing power of many home shoppers. MBA’s estimate of new home sales declined 9 percent in September, partially reversing the 18 percent increase in August during that brief period when mortgage rates decreased.”

Builder confidence continues to fall, as the NAHB / Wells Fargo Housing Market Index declined to 38, half the level it was six months ago. “This will be the first year since 2011 to see a decline for single-family starts,” said NAHB Chief Economist Robert Dietz. “And given expectations for ongoing elevated interest rates due to actions by the Federal Reserve, 2023 is forecasted to see additional single-family building declines as the housing contraction continues. While some analysts have suggested that the housing market is now more ‘balanced,’ the truth is that the homeownership rate will decline in the quarters ahead as higher interest rates and ongoing elevated construction costs continue to price out a large number of prospective buyers.”

Regionally, the Northeast did the best, while the West did the worst.

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