Morning Report: More discussion on MBS spreads

Vital Statistics:

S&P futures3,818-1.25
Oil (WTI)88.08-1.02
10 year government bond yield 4.01%
30 year fixed rate mortgage 6.95%

Stocks are lower this morning after 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.

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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.

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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.

33 Responses

  1. This thread is hysterical.


    • I cannot figure out if he is just trying to open the overton window or he honestly believes this.


      • I’d bet he really believes it. From his Progressive perspective, failure to control some part of media is failure to control all media. I also think he makes the mistake I and many others often make and that is overstating the actual influence of media. If the media were as powerful as the author believes, how did Trump win in 2016? How did he increase is votes by 10 million, something no other incumbent has done in the modern era?


    • It is. I think this is the best part:

      “Liberals are accustomed to solid, stable institutions run by people who are vulnerable to public pressure. But institutions run by the far right aren’t like that. We can’t pressure Fox News to take Tucker Carlson off the air, no matter how racist he gets. They just don’t care.”


      • “Also, they’ve failed to acknowledge me as the arbiter of what is racist.” – Probably.


      • Liberals are accustomed to solid, stable institutions run by liberals who are vulnerable to public pressure from left-wing activists.


      • I was wrong. This is the best part. When people tell you who they are, believe them:


        • This is just bizarrely detached.

          “the right has focused on securing total control of institutions (judicial, political, media)”

          In what mirror-universe is he living?


    • In one breath he says: “To take an example, think about something that’s been happening on here a lot lately: transphobes coordinating harassment campaigns.” Then in the next he says: “Liberals are accustomed to solid, stable institutions run by people who are vulnerable to public pressure.”

      Public pressure? Like coordinating targeted harassment campaigns?

      They can’t articulate their positions on why free speech is bad for more than a few sentences without saying that what makes a tactic or behavior bad is having the wrong politics while doing it.


  2. Good read:


  3. I remember the “shellacking” Obama got in 2010 as the party in power so I’m expecting the same this election! Dems don’t really stand a chance except around the edges. Not happy about the election deniers getting control in some of the states but it’s up to the electorate. We get what we vote for!


    • The voters get was they deserve, and they get it good and hard.,

      Although the way things are it’s hard not to elect an election-denier—the number of Democrats pre-denying 2022 and 2024 election results keeps on growing and Republicans ain’t no better there, ultimately. We’re at a point where for both parties the only measure for election legitimacy is that they win.

      Ultimately I’m not worried about the “election deniers” as I don’t foresee their election denial having much impact, and most don’t presently seem interested in relitigating 2020 so that suggests they are all smarter than Trump.

      We will see. But I will be fascinated to see how Republicans—if there is indeed a red wave—will consider this election the most secure election ever, while the Democrats will be on about how elections were stolen, mostly with no sense of irony. 😉


      • KW:

        Although the way things are it’s hard not to elect an election-denier

        I hate the term “election deniers”. It is such a nonsense term. No one is “denying” any election. They are questioning the legitimacy of certain election processes and outcomes.

        But that said, you are correct. There are as many “election denying” D’s as there are R’s, and there has been for years. Which is why I see this newfound concern-trolling over “election deniers” as just another manifestation of TDS. Anything Trump or Trump supporters say or do is deemed to be an extreme threat to the fabric of the nation, even if what they are saying/doing is no different to what others, particularly Dems, have been doing over and over again for years.


      • KW:

        But I will be fascinated to see how Republicans—if there is indeed a red wave—will consider this election the most secure election ever, while the Democrats will be on about how elections were stolen, mostly with no sense of irony.

        I suspect that, even if there is a red wave, the R narrative will not be “most secure election ever”, but rather “the wave was so big even D cheating couldn’t stop it.” R opposition to the loosening up of election processes is not going to go away just because they win. They will still understand that they won despite, not because, of those policies.


        • I suspect that, even if there is a red wave, the R narrative will not be “most secure election ever”, but rather “the wave was so big even D cheating couldn’t stop it.

          Agree 110%


        • As well as the R’s being barely a check on Biden. McConnell will be Majority leader and any Trump Senators will be utterly sidelined as will Rick Scott. McCarthy will rely on Democratic votes to get more spending passed and we”ll hear about how we have to control the Presidency for anything to happen. If and when that happens again nothing but more spending will occur.

          You have nothing to worry about LMS, if R’s win it will slow the growth of spending by 10% max and zero regulatory effects will occur other than to accelerate under Biden.


        • Fair enough, and I’m sure this is true. Although I don’t know if it’s better.


      • Kevin, I understand the origins of your comment but it bothers me to this day. Elections have consequences and I will accept the results whether I’m happy about it or not.


    • It’s unfortunate that the response to election concerns is to simply deny that any such thing could ever happen vs investigate them and provide more transparency to the process & outcome.

      The January 6th committee was a missed opportunity to thoroughly review how elections are conducted and certified.


      • Jnc…………I have to say I’m disappointed in this comment. Every election there are folks who try to beat the system………..from both sides and the reason I know about them is because they are prosecuted. Elections are sacred in this country. Anyone who tries to vote twice, vote for a dead person, trash votes into a dumpster or whatever shenanigan they think will work, is prosecuted. Unless you’re Mark Meadows I guess…………..LOL

        Our elections are safe, regardless of all the conspiracy theories out there. Like I said, I’ll accept the results and except for CA, I’m probably on the losing end this election. I guess we’ll see how R’s are going to fix the economy……………LOL


        • Denying results and trying to force the country to keep you in power are two different things. I know most of you guys here think there’s an equivalence, but I’m just not seeing it. Which Dem who was disappointed or thought the results were skewed in some way…………….incited an insurrection. Who?


        • They are, and not giving Trump a pass on that. But there is constant “anyone who questions the election results when my party won is trying to destroy Democracy and must be silenced and/or shamed” followed up with a “but if the other side wins they stole it and the polls indicate they are going to steal the next one!!”

          Ironically, both sides bitch about both-sides-ism but there’s a reason people talk about it.


        • I’d argue (despite her concession) HRC came very close. But let’s say that doesn’t count and it’s only Trump.

          Does it make election denial, constantly calling the winner illegitimate, and trying to unseat the winner via more legitimate but still ultimately fraudulent means (impeachment over fraudulent or trumped-up offenses, or urging them 25th amendment solution because how much you dislike the current winner means they are incompetent to serve) … does that make those good things? Let’s just grant that Trump was the worst election denier ever, and subtract his post-2020 election insurrection from the calculus. The rest of it is a good idea? Just don’t have a riot at the Capitol (unless they are protesting the appointment of a conservative SCOTUS jurist or something).


        • Our elections are safe—but like cybersecurity, you’re only as safe as the latest security update and there are always people trying to see what they can get away with. Which is why pushing for security, pushing back on things you believe present an increased risk for security, makes sense. And both parties do that, in their way.


      • I dunno, the possibility Russia interfered with the 2016 was thoroughly investigated. Election concerns are investigated, sometimes.


  4. It’s really interesting to me that y’all assume Dems will act the way R’s acted after 2020. I guess we’ll see though! Complaining about an election and questioning the veracity of an election is sooooooo different than what Trump and his supporters did. I’ll come back after the election and if I’m wrong and Dems are calling it a rigged election I’ll eat my words…………there are legitimate concerns about suppressing the vote of communities that don’t have the same opportunities as other communities but I’ve never seen a Dem try to stay in power even though they lost. Anywhoooo, I’m grateful I live in CA and the weirdos are the minority here………… far!


    • With the small exception of the Capitol riot, I expect the Democrats will react as bad or worse in 2024–if Republicans win. If it’s Trump winning I expect it will be much much worse (though not covered that way by the mainstream press, of course).

      They reacted poorly when Trump won and did plenty of damage—just not at the Capitol so it mostly impacted the middle-class types and not our nobles so not nearly as big a story. And not done to prevent the legal certification process directly.

      Again, not defending Trump. His at-minimum negligence was shameful, his absence during the riot was shameful, and no one on the right or amongst the MAGA would have demanded less than prison for a Democratic president so negligent.

      But human nature is to expect the people we consider to be on our side to be “the good guys”, and so our narrative tends to be soft on our folks but hard in the other folks even when they do equally bad things, if not precisely the same things.


      • KW:

        With the small exception of the Capitol riot, I expect the Democrats will react as bad or worse in 2024–if Republicans win.

        Why except the Capitol riot? The left does riots better than anyone. See the summer of 2020. See the invasion of Senate offices during Judicial nomination hearings. Hell, see the streets of DC itself in the days both before and after Trump was inaugurated, which Jan 6 concern trolls always conveniently ignore/forget.

        Anyone who breaks out the fainting couches over Jan 6 as some unique threat to the nation is just being willfully ignorant.


        • I’m granting a stimulation for the point of attempting to get an agreed upon apples-to-apples comparison. If that is the distinguishing difference between the evils of Republicans and the virtues of Democrats, than can it be agreed that in general treating every election as if it was stolen is not generally healthy?

          I do not think riots (including within the hallowed halls of our noble rulers) is a uniquely Republican manifestation, nor is that tiny fraction of Trump supporters, much less the right generally, that participated particularly representation of conservatives or Republicans. And had the Democrats done such a thing (and surely they could have they certainly did as much damage and set more things in fire in response to 2016) I have no doubt there would have been much less condemnation from the Democrats than there was from Republicans re: Jan 6th.

          That is, I am not in disagreement, just want to clarify a broader point regarding election denial generally. I think it is a negative irrespective of who does it and the focus should be on irregularities suggesting better processes moving forward, or clearer laws. But politicians constantly asserting that they really won and relitigating elections is as tiresome as those same politicians pretending they didn’t do it, or the vigor with which they insisted the election was stolen from them was not so strong as to be as bad as when the other party does it.

          The primary difference between Jan 6th and when the left has done the same thing is context (presidential election certification rather than SCOTUS or budget battle) and the weirdness about how they were let in and then the congress critters were told the ultra-MAGAs were coming to murder them, and then how the press treated it, and generally the left doesn’t have a Ray Epps type at the root mysteriously encouraging people to break in while the press is entirely incurious about him.

          And so forth.


    • lms:

      It’s really interesting to me that y’all assume Dems will act the way R’s acted after 2020.

      I don’t. I assume they will react the same way the Dems themselves reacted in 2016…by denying the legitimacy of the election and those who got elected.

      Which Dem who was disappointed or thought the results were skewed in some way…………….incited an insurrection. Who?

      And thus the goalposts get moved. Your original comment lamented the possibility that “election deniers” might get elected. If by “election denier” you meant only people who have “incited an insurrection”, name the candidates you were talking about, and explain how they have “incited an insurrection”.


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