All Things in Moderation

Vital Statistics:

	Last	Change
S&P futures	3,990	0.75
Oil (WTI)	77.28	-0.28
10 year government bond yield		3.97%
30 year fixed rate mortgage		6.78%

Stocks are flat as we await further Jerome Powell testimony. Bonds and MBS are flat.

Jerome Powell testified in front of the Senate yesterday and braced the markets for a 50 basis point hike in March. In his prepared remarks, Jerome Powell raised the possibility for a faster pace of tightening:

Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.

This puts a lot of weight on the Consumer Price Index next Tuesday. The reaction in the bond market was muted on the long end (the 10 year didn’t do much) but we saw the 2 year yield increase by 22 basis points to 5.09%. The 2s – 10s spread hit a negative 103 basis points, which is the most inverted yield curve since just before the 81-82 recession, which was a doozy.

The Fed Funds futures now see a 50 basis point hike at the March meeting:

Deutsche Bank strategist Jim Reid talked said that if history is any guide, yield curve inversions like this signal a recession is imminent: “Bear in mind that on all the previous occasions that the 2s10s has been more than -100bps inverted since data is available from the early 1940s (1969, 1979, 1980 and 1981) a recession has either been underway, or has occurred within a maximum of 8 months,” Reid said. “To highlight the rarity of such an occurrence, there have only been 7-month end closes lower than -100bps in 80 years of available data. So we are in rarefied air.”

As I discussed in my Substack piece over the weekend, a recession in the context of a strong labor market is entirely possible, and has happened in the past.

Speaking of the labor market, the ADP Employment Report said that the private sector added 242,000 jobs in February. The bad news for the bond market is that annual pay increased 7.2%. “There is a tradeoff in the labor market right now,” said Nela Richardson, chief economist, ADP. “We’re seeing robust hiring, which is good for the economy and workers, but pay growth is still quite elevated. The modest slowdown in pay increases, on its own, is unlikely to drive down inflation rapidly in the near term.”

The 242,000 increase is higher than the Street’s 220,000 forecast for Friday’s jobs report. The 7.2% wage increase is way higher than the 4.7% annual increase in average hourly earnings.

Mortgage applications increased 9% last week as purchases and refis rose the same amount. “Mortgage rates continued to increase last week. The 30-year fixed rate rose to 6.79 percent – the highest level since November 2022 and 270 basis points higher than a year ago,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Even with higher rates, there was an uptick in applications last week, but this was in comparison to two weeks of declines to very low levels, including a holiday week. Comparing the application indices from a year ago, purchase applications were still down 42 percent, and refinance activity was down 76 percent. Many borrowers are waiting on the sidelines for rates to come back down.”

On the heels of the FTC’s announcement of a lawsuit to block the ICE / Black Knight merger, the companies revised the terms of the deal and announced they have reached an agreement to sell Empower to Constellation Software, a Canadian firm. Constellation is kind of a Berskhire Hathaway of IT solutions – a decentralized collection of disparate providers of mission-critical software. The company has a market cap of $35 billion, so it can be considered a real buyer.

The deal was re-cut to lower the number of ICE shares issued. The spread is still gargantuan at 24% gross (the new deal is worth roughly $75 a share and Black Knight is trading at $60.69) which indicates the deal still has an antitrust problem and the divestiture won’t satisfy the regulators. As part of the deal, ICE has agreed to litigate with the FTC to get the deal done.

Supposedly ICE’s asking price for Empower is something like $400 million. I think ICE paid $11 billion for Ellie Mae’s which is mainly Encompass so this gives you an idea of how far valuations of mortgage assets have fallen over the past couple years.

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