All Things in Moderation

Vital Statistics:

Stocks are higher this morning as we put Q1 into the books. Bonds and MBS are flat.

Personal incomes rose 0.3% in February, according to the BEA. Personal consumption expenditures rose 0.2%.

The Personal Consumption Expenditures Price Index – the Fed’s preferred measure of inflation rose 0.3% month-over-month and 5% year-over-year. Excluding food and energy, the core rate 0.3% MOM and 4.6% YOY.

It looks like the spike in the PCE index in January may have been a one-off, or perhaps a some sort of statistical anomaly. It looks like the January numbers on just about every stat were out of step with the previous and subsequent readings. Q1 seasonal adjustments have always been imperfect (there has been a persistent bias in lower Q1 GDP) and that may have played a part in the January readings.

Regardless, the increase in the month-over-month rate seems to be limited to January and we are back in a period of declining month-over-month inflation. The year-over-year numbers are declining as well and will continue to fall especially as we approach the high water mark for 2022 real estate prices in the summer. This is good news as it takes some of the pressure of the Fed to keep raising rates.

The Spring Selling Season is looking like a bust, at least according to data from NAR. Part of the reason is that homes are taking a longer time to sell. Days on market rose to 54 this year compared to 36 a year ago. Higher rates are impacting demand, and if a home is priced right it will move. “Amid fewer new choices on the market and still rising home prices, home shoppers have shown that they are very rate sensitive, only jumping back in the market when rates dip, and so what happens with rates this spring will likely play a strong role in determining whether the housing market bumps along or picks up speed this year,” said Danielle Hale, chief economist at Realtor.com.

Overall, the competition is lower these days, however this is a function of affordability problems, not due to a balanced market. Median listing prices are still up on a year-over-year basis.

The FDIC is looking to sell Silicon Valley Bank and Signature’s portfolio of underwater MBS are Treasuries. The banks who took parts of these banks had no interest in these bonds as they would have to realize losses on the portfolios. The bond portfolios total about $116 billion.

Consumer sentiment fell in March, according to the University of Michigan Consumer Sentiment Survey. Both the current situation and expectations numbers fell.

Most notably, the year-ahead inflationary expectations index fell from 4.1% to 3.6%, while the long-term expectations were flat at 2.9%.

“Consumer sentiment fell for the first time in four months, dropping about 8% below February but remaining 4% above a year ago. This month’s turmoil in the banking sector had limited impact on consumer sentiment, which was already exhibiting downward momentum prior to the collapse of Silicon Valley Bank. Overall, our data revealed multiple signs that consumers increasingly expect a recession ahead. While sentiment fell across all demographic groups, the declines were sharpest for lower-income, less-educated, and younger consumers, as well as consumers with the top tercile of stock holdings. All five index components declined this month, led by a notably sharp weakening in one-year business conditions.”

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Vital Statistics:

Stocks are higher this morning as investors sense the banking problems of the past few weeks are in the rear view mirror. Bonds and MBS are flat.

The Fed Funds futures now see a coin flip for another 25 basis points hike in either May or June to get to a Fed funds rate of 5%, and then they see the Fed beginning to cut rates. Even if the banking crisis is over, the banks will probably be a bit more conservative in their lending which will act as a brake on the economy. Of course that is the whole point of tight monetary policy, but this adds an additional component.

The economy expanded 2.6% in the fourth quarter, according to the third estimate for GDP. Consumption was revised downward, while the core rate of inflation was revised upward. Corporate profits fell.

The Fed’s tightening policy still has had little to no effect on the labor market. Initial Jobless Claims came in again below 200k, which is extraordinarily low. I plotted the Fed Funds rate versus initial jobless claims. Jobless claims and the Fed Funds rate should correlate, but over the past year they have not.

Pending Home sales rose 0.8% in February, marking the third consecutive increase. “After nearly a year, the housing sector’s contraction is coming to an end,” said NAR Chief Economist Lawrence Yun. “Existing-home sales, pending contracts and new-home construction pending contracts have turned the corner and climbed for the past three months.” Note that activity is still way down from a year ago.

The most affordable regions – the Midwest and South – are leading the activity. As work-from-home becomes more cemented in American culture, we should see more of an evening out between the expensive coastal MSAs and the cheaper Midwest and Southern ones.

The cuts keep coming in the finance industry – Lending Tree announced it is cutting about 13% of its workforce in order to lower operating expenses.

The Fed is considering adding a special assessment to the biggest banks in order to replenish the FDIC insurance fund after covering deposits for Silicon Valley Bank and Signature. Regulators see this as a way to ease pressure on the regional banks.

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Vital Statistics:

Stocks are higher this morning as banking fears recede. Bonds and MBS are down.

Mortgage applications rose 2.9% last week as purchases rose 2% and refis rose 5%. “Application activity increased as mortgage rates declined for the third straight week. The 30-year fixed rate declined to 6.45 percent, the lowest level in over a month,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “While the 30-year fixed rate remained 1.65 percentage points higher than a year ago, homebuyers responded, leading to a fourth straight increase in purchase applications. Home-price growth has slowed markedly in many parts of the country, which has helped to improve buyers’ purchasing power. Purchase applications remain over 30 percent behind last year’s pace, but recent increases, along with data from other sources showing an uptick in home sales, is a welcome development.”

Consumer confidence improved slightly in March, according to the Conference Board. Surprisingly, the bank failures didn’t have much of an impact and the survey was conducted about 10 days after the failure of Silicon Valley Bank. “While consumers feel a bit more confident about what’s ahead, they are slightly less optimistic about the current landscape. The share of consumers saying jobs are ‘plentiful’ fell, while the share of those saying jobs are ‘not so plentiful’ rose. The latest results also reveal that their expectations of inflation over the next 12 months remains elevated—at 6.3 percent. Overall purchasing plans for appliances continued to soften while automobile purchases saw a slight increase.”

That inflationary expectations number for the next 12 months is not good. We know the Fed pays close attention to inflationary expectations in these consumer confidence surveys because this gets baked into the cake with wage negotiations. The 6.3% number does seem pretty far from the 3.8% number we saw in the University of Michigan survey earlier this month.

The New York Fed puts out its own survey of consumer expectations regarding the real estate market. Needless to say, consumers see mortgage rates rising further, although they see rental inflation falling back. Expectations for rental inflation are still elevated compared to historical numbers, but they are better than last year. As Jerome Powell has said numerous times, one of the legs in our 3-legged inflationary stool is real estate and that component of inflation will return to normal by the summer. For a more granular look at rents by MSA, check this study out by Rent.com.

Rising rates have pushed down people’s plans to move to a series low (which started in 2014). This is case of “hate the house, love the mortgage.” This might be driven by pessimism over mortgage rates. The respondents see mortgage rates pushing 9% in the next 3 years and hitting 8.4% this year.

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Vital Statistics:

Stocks are flat this morning as bank fears recede. Bonds and MBS are down.

House prices rose 0.2% month-over-month in January and 5.3% year-over-year, according to the FHFA House Price Index. “U.S. house prices changed slightly in January, continuing the trend of the last few months,” said Dr. Nataliya Polkovnichenko, Supervisory Economist, in FHFA’s Division of Research and Statistics. “Many of the January closings, on which this month’s HPI is constructed, reflect rate locks after mortgage rates declined from their peak in early November. Inventories of available homes for sale remained low.”

The West Coast and Mountain states saw the biggest declines, while the East Coast held up better.

Separately, the Case-Shiller Home Price Index rose 3.8% year-over-year in January. Declines were reported in many West Coast markets including San Diego, San Francisco, Portland, and Seattle. The hottest markets were in Florida and Atlanta. “January’s market weakness was broadly based. Before seasonal adjustment, 19 cities registered a decline; the seasonally adjusted picture is a bit brighter, with only 15 cities declining. With or without seasonal adjustment, most cities’ January declines were less severe than their December counterparts. Financial news this month has been dominated by ructions in the commercial banking industry, as some institutions’ risk management functions proved unequal to the rising level of interest rates. Despite this, the Federal Reserve remains focused on its inflation-reduction targets, which suggest that rates may remain elevated in the near-term. Mortgage financing and the prospect of economic weakness are therefore likely to remain a headwind for housing prices for at least the next several months.”

More evidence that the pain in the mortgage space isn’t going away. Mortgage REIT Invesco Mortgage Capital slashed its dividend as MBS spreads remain wide. Invesco continues to put money into the sector as agency MBS remain the cheapest since 2008. “Our investment portfolio continues to generate strong earnings available for distribution despite the sharp increase in short-term interest rates given a high percentage of our funding is hedged with a relatively low-cost legacy swap portfolio. We reduced our common stock dividend to retain capital and enhance book value by continuing to invest in agency residential mortgage-backed securities (“Agency RMBS”) at historically attractive valuations. We believe this represents a compelling environment for longer-term investors.”

Remember that mortgage REITs like Invesco are the ultimate buyers of the loans that mortgage bankers originate. If MBS are “cheap,” that implies that mortgage rates are lousy compared to the 10 year. This means that mortgage rates can fall quite a bit even if the 10 year goes nowhere. Of course the past decade of QE might be an artificial low in MBS spreads. Much will depend on whether some buyer will step up to replace the Fed as the biggest buyer.

The other driver of wide MBS spreads is interest rate volatility. Since a borrower always has the option to refinance, that option is worth something. The value of that option is a function of interest rate movement (i.e. how close current rates are to the note rate on the mortgage) and also interest rate volatility. The more volatile interest rates are, the more valuable the option. Since the borrower owns that optionality, the MBS investor is “short” that optionality. The increased value of that option is recognized in MBS spreads.

You can see the spike in volatility in the ICE / BofAML MOVE Index, which captures interest rate volatility. Think of it as a VIX for bonds.

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Vital Statistics:

Stocks are higher this morning after First Citizens reached a deal to buy parts of Silicon Valley Bank. Bonds and MBS are down.

First Citizens Bancshares reached a deal with the FDIC to buy Silicon Valley Bank’s deposits and loans. The two banks are roughly the same size in terms of assets and loans. This deal is causing a rally in the regional banks this morning and bonds are getting clobbered. Deutsche Bank is also up this morning.

First Republic is rallying this morning on news that regulators are considering an additional lending facility.

Deposit outflows eased last week, as the top 25 banks gained about $120 billion in deposits, while 850 smaller banks lost $108 billion.

In the upcoming week, we will get housing prices via the FHFA and Case-Shiller numbers, consumer confidence, GDP, personal incomes and outlays, and the University of Michigan consumer sentiment which will have the inflationary expectations numbers. Note that GDP is the final revision of the fourth quarter numbers, so they probably won’t have much of an effect on markets. It is stale data.

Over the weekend, Minneapolis Fed President Neel Kashkari said that the chances of a recession have increased due to the turmoil in the banking sector. “It definitely brings us closer right now” — that was Minneapolis Fed President Neel Kashkari’s response to a question, during a interview, on whether the latest turmoil in the banking sector could bring the U.S. closer to a recession. “What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. And then that credit crunch, just as you said, would then slow down the economy,” he said.

I discussed Neel Kashkari’s comments and also an interesting exchange between ex-Treasury Secretary Larry Summers and ex-Fed President Daniel Turullo in my weekly Substack piece. Check it out, and please consider subscribing.

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Vital Statistics:

Stocks are lower this morning as banking fears spread to Deutsche Bank. Bonds and MBS are up on the flight to safety trade.

Deutsche Bank was down 12% this morning in Frankfurt trading and its credit default swaps surged. We also saw some pressure on regional banks in the US yesterday, which indicates this banking crisis is not over yet. The net result of this will almost certainly be a restriction of credit as banks become more cautious on risk, which will be recessionary.

The Fed Funds futures have reacted sharply to the news, with the May futures seeing no move and the June futures pricing in a 60% chance for a rate cut.

St. Louis Fed President James Bullard spoke this morning. The presentation is here. He refers to the current situation with the banks as similar to events in the past where rising rates caused financial stress, but didn’t tank the economy. He mentioned the Mexican Peso / Orange County crisis of the mid-90s, Continental Illinois in the mid 80s, and Long Term Capital Management in the late 90s as examples. The labor market remains exceptionally strong, however financial stress is increasing.

Durable Goods orders fell 1% in February. Ex-transportation they were flat. Both numbers were below consensus. Core Capital Goods orders (a proxy for business capital expenditures) were flat.

Homebuilder KB Home reported first quarter numbers. Revenues were flat while gross margins contracted due to seller concessions and rising construction costs. Average selling prices rose 2% to $494,500. “As we entered the Spring selling season during the quarter, we began to see an increase in demand. This reflected in part the targeted sales strategies we deployed, together with a stabilizing mortgage interest rate environment. As a result, we achieved a sequential improvement in our net orders in both January and February, and net orders have remained strong in the early weeks of March. Although there are still considerable interest rate and econ

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Vital Statistics:

Stocks are rebounding this morning after yesterday’s Fed-induced sell-off. Bonds and MBS are up.

As expected, the FOMC hiked the Fed Funds target by 25 basis points yesterday. The Fed did discuss the recent turmoil in the banking sector, and they felt that this will restrict credit going forward. At the same time, the labor market has remained unusually tight and inflationary pressures have been stronger than expected. These two things more or less offset each other. The dot plot showed a minimal change in the forecast for the Fed Funds rate:

They also inched down their forecast for GDP growth and unemployment while taking up their forecast for inflation. So far, the Fed is not seeing any decrease in credit from the banking crisis, and therefore they didn’t feel the need to pause or cut rates. They did tweak the language about future rate hikes from “ongoing increases in the target range will be appropriate” to “some additional policy firming may be appropriate” to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

On the banking system, the statement said: “The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity,
hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks”

Lots of market observers are calling for the Fed to pause due to the banking crisis, but the situation is so new that the Fed doesn’t have a read yet on the fallout. Any general restriction of credit will take some time to play out. Global central banks are more or less on the same page, with the ECB hiking 50 bp this week, and the Swiss National Bank hiking 50 this morning, despite the Credit Suisse situation.

The Fed Funds futures now don’t see rate cuts starting until September.

Janet Yellen, while testifying in front of the Senate was asked if the FDIC was considering doing a blanket guarantee of all deposits without Congressional authorization. The response was: “This is not something that we have looked at. It’s not something that we’re considering,” she said. “I have not considered or discussed anything having to do with blanket insurance or guarantees of all deposits.” It is an odd response given the question was specifically about Congressional authorization.

The punch line is that Treasury considers this an isolated case, and not indicative of future policy. Of course that is the only thing they could say. That said, I suspect this opens the door for full coverage of deposits, and FDIC insurance premiums will have to increase to cover the added risk. This will almost certainly exacerbate the situation with the small banks – the big ones can probably absorb the added cost more than the smaller ones who will have to pass on those costs via lower deposit rates. This will create a bank run in slow motion which resembles the disintermediation problem of the 1970s. It will almost certainly drive more consolidation in the banking sector and I wouldn’t be surprised to see a wave of bank mergers similar to the late 90s.

New home sales rose 1.1% MOM to a seasonally adjusted annual rate of 640,000 units. This is still down about 19% from last year. The median price rose slightly to $438k while the average price fell a touch to $499k. As Powell has emphasized, the housing market has been weak, which will start pulling down inflation by summer, but wages remain the driver.

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Vital Statistics:

Stocks are flattish as we await the FOMC decision at 2:00 pm EST. Bonds and MBS are flat as well.

The markets still see a 25 basis point hike at the meeting today. We will get a fresh set of economic forecasts as well as the dot plot. Jerome Powell will hold a press conference at 2:00 pm. We could see a lot of volatility this afternoon.

Existing Home Sales rose 14.5% in February, according to the National Association of Realtors. This ended a 12 month streak of declines. Most notably, the median home price fell by 0.2% to $363,000. Prices rose in the Midwest and the South, while falling in the Northeast and the West. The number of homes for sale came in at 980,000 which represents about a 2.6 month supply at the current sales pace. This is indicative of a tight market; a balanced market is about 6 months’ worth of sales.

“Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines,” said NAR Chief Economist Lawrence Yun. “Moreover, we’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs.”

The first time homebuyer accounted for 27% of sales which is a pretty low percentage. First time homebuyers accounted for 26% in 2022, which was a record low.

Mortgage applications rose 3% last week as purchases rose 2% and refis rose 5%. “Treasury yields declined last week, driven by uncertainty over the health of the banking sector and worries about the broader impact on the economy. Mortgage rates declined for the second week in a row, with the 30-year fixed rate dropping to 6.48 percent, the lowest level in a month,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “However, mortgage rates have not dropped as much as Treasury rates due to increased MBS market volatility. The spread between the 30-year fixed and 10-year Treasury remained wide at around 300 basis points, compared to a more typical spread of 180 basis points.”

MBS spreads are a function of interest rate volatility – when interest rate volatility rises, mortgage backed securities will underperform Treasuries. While the VIX (a measure of stock market volatility) has been relatively muted, the MOVE Index (which is sort of the VIX for bonds) has been spiking:

The spike has been largely due to a massive head fake in the bond market. 2022 ended with a couple of benign CPI prints which convinced the bond market that the Fed was accomplishing its mission and inflation was about dead. The January and February CPI prints (along with a robust January jobs report) caused investors to re-think that forecast and rates spiked. The latest banking crisis has massively increased uncertainty over future Fed moves. The fact that First Republic has been part of the walking wounded is an ominous sign as well that the crisis is still with us.

The punch line is that this uncertainty has caused mortgage backed securities to hold relatively steady while Treasury yields fall. The other problem is that mortgage backed securities have a dark cloud over them given that banks might need to sell them to raise capital.

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Vital Statistics:

Stocks are higher this morning on speculation that First Republic will get a capital injection. Bonds and MBS are down.

First Republic might get a capital injection. The Wall Street Journal reported that the consortium of banks that deposited $30 billion at the troubled bank are looking at converting those deposits into a capital infusion. The news (along with the Credit Suisse merger) has improved sentiment in all of the regional banks, including Western Alliance, PacWest and US Bank.

Janet Yellen is speaking at a banking conference today and is expected to reassure bankers that the Treasury is ready to protect depositors in the event of a system-wide bank run. The punch line is she will tell the American Bankers Association that the US banking system is “sound” and the situation is “stabilizing.” Additional measures to protect depositors “could be warranted.” “The Fed facility and discount window lending are working as intended to provide liquidity to the banking system. Aggregate deposit outflows from regional banks have stabilized.”

That is good news, but ultimately deposit rates are low and people have better options with their money. Banks can either stand pat and watch deposits run away of raise rates and watch net interest margins collapse. Pick your poison.

The FOMC starts its two day meeting today. The Fed Funds futures are forecasting a 80% chance of a 25 basis point hike. Overall, the Fed Funds futures are getting more hawkish as the market bets the banking crisis is over. That might be wishful thinking, but so far the markets are in a risk-on move.

Borrowings at the Federal Home Loan Bank increased by $304 billion last week, while borrowings at the Fed’s discount window increased to $150 billion. It is amazing how close to the bad old days of the 2008 crisis we are. That said, the 2008 crisis was a sea change in how accessing the discount window was perceived. Prior to 2008, accessing the discount window was considered to be an act of desperation, and a bank’s Board of Directors would think long and hard about accessing those funds. It was a signal to the markets that things were unraveling and most bank executives would avoid doing that like the plague. In 2008, we had a slew of investment banks convert to commercial banks in order to gain access and the stigma is now gone. History will judge whether that was a good thing or not.

The dot plot will probably matter way more than whether the Fed hikes 25 basis points or not. The markets see the Fed cutting rates this year, and if the dot plot doesn’t confirm that I think we could see a major sell-off in stocks and bonds.

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Vital Statistics:

Stocks are lower as investors digest the Credit Suisse deal. Bonds and MBS are up.

Credit Suisse was bought by rival UBS over the weekend at less than half of its closing price on Friday. The deal includes a credit line from the Swiss National Bank, which will also share in some of the credit losses if necessary. There is no shareholder vote for either side. The AT1 bonds (sort of like the CRT bonds Fannie and Freddie issued) will get wiped to zero, but the rest of Credit Suisse’s bonds should get paid off. Those bonds were widely held in Swiss pension funds, so that is really who is getting bailed out here.

New York Community Bank has agreed to purchase some of the assets of failed Signature Bank. The branches in New York will be re-branded as Flagstar. It looks like this rescue will cost the FDIC about $2.5 billion.

It still doesn’t look like anyone wants Silicon Valley Bank. A few observers considered Silicon Valley Bank to be in the subprime bank loan business, making loans to companies with good ESG scores that hemorrhaged cash. Regardless of how the Administration tries to spin it, this was a bailout of the US tech sector.

Global central banks have put together a dollar swap facility to improve liquidity in the banking system. It would “serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.”

The week ahead will be all about the Fed meeting on Wednesday. As I discussed in my latest Substack article, the Fed is in a bind here. It is playing with fire if it continues to raise rates, yet inflation is nowhere near fixed. The real estate component of inflation is about played out, but the labor market remains tight.

Here is an excerpt from that piece:

The Fed (and global central banks in general) have painted themselves into a corner. Raising rates have blown up parts of the banking sector and they are playing with fire if they keep hiking. On the other hand, the labor market remains tight as a drum and workers are in the driver’s seat. The Fed was hoping to get unemployment up around 5%. That doesn’t appear to be in the cards. The Fed is probably going to have to start easing despite bad inflation numbers, and there is not a damn thing they can do about it.

Think about this: Treasuries have fallen far enough to blow some holes in banking balance sheets, and real interest rates are still negative. Sovereign Debt is wildly overvalued and valuations are still in bubble territory.

The Fed Funds futures see a 2/3 chance of a 25 basis point hike this week and a 1/3 chance on no hike. They also see that hike being reversed at the June meeting and three rate cuts by December.

The dot plot will be a wild card in this report. In December, the Fed saw the Fed Funds rate above 5% by the end of 2023. The Fed Funds futures see rates about 125 basis points lower. This will be the real wild card in the Fed meeting. If the Fed still has a dot plot that looks like the one below, then markets will have a conniption.

The big question for the mortgage business is what happens to MBS spreads? MBS spreads have blown out since the start of this banking crisis, although that probably has more to do with interest rate volatility than anything. The bond market just got whipsawed big time between the higher-than-expected inflation numbers and then the round of bank failures.

If RMBS were the asset class that blew up a lot of these banks, then it probably means that there will be supply as banks bite the bullet and try and unload paper to put into short term Treasuries. That can’t be good for mortgage rates, although I wonder if there simply isn’t going to be much of a bid in the market for 3% UMBS.

One other thing that is a given is that the party in the MSR space is over. If rates are falling, then servicing valuations will be falling too. There are a lot of people out there marking their servicing portfolios at 5.5x or higher.

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