All Things in Moderation

Vital Statistics:

Stocks have a “risk-on” feel as we round out the second quarter. Bonds and MBS are down.

Personal Incomes rose 0.4% in May, according to the BEA. Personal Outlays (spending) rose 0.1%. On the inflation front, the PCE Price Index rose 0.1% MOM and 3.8% YOY. If you strip out food and energy, the PCE Price Index rose 0.3% MOM and 4.6% YOY.

The annual increase in the PCE Price Index ex-food and energy (the core rate) is the Fed’s most important inflation indicator. If you look at the highlighted line below, it has bumped back and forth between 4.7% and 4.6% this year.

This report probably doesn’t change anything in the Fed’s thinking. They are going to hike 25 basis points in July.

The BEA has a good charting application which shows the 3 legs for the inflationary stool: goods, housing, and services ex-housing. The dark blue line at the bottom is durable goods, which rose rapidly during 2021 and was the initial driver of inflation. The top orange line is housing, which is about to plateau as home prices peaked around this time last year. The middle line is services ex-housing and that is the portion that the Fed is most concerned about. This part is basically wages. Once housing begins to have year-over-year declines, the headline inflation number will fall. But until the middle line flattens the Fed will remain hawkish.

Pending Home sales fell 2.7% in May, according to NAR. The Northeast saw increases, while the three other regions declined. “Despite sluggish pending contract signings, the housing market is resilient with approximately three offers for each listing,” said NAR Chief Economist Lawrence Yun, “The lack of housing inventory continues to prevent housing demand from being fully realized.”

We are pretty much back to the bad old days of the COVID lockdowns and the Great Recession. The bright side is that we are seeing increased homebuilding activity.

Consumer Sentiment rose in June, according to the University of Michigan Consumer Sentiment Survey. Inflationary expectations decreased, falling to 3.3% in June versus 4.2% in May. This is certainly encouraging and we know the Fed pays close attention to this statistic. Longer-run inflationary expectations remain at 3%, which is where they have been for the past couple years. Prior to the pandemic, longer-term inflationary expectations were in the 2.2%-2.6% range.

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Vital Statistics:

Stocks are higher this morning after a positive GDP revision. Bonds and MBS are down.

The heads of the Federal Reserve, ECB, Bank of England and Bank of Japan participated in a panel on monetary policy yesterday and Jerome Powell stressed that rates are still going up and will be at these levels for some time. He sees another couple of 25 basis point hikes this year. “We feel there’s more tightening power to do… we believe there’s more restriction coming,” Powell said. A good part of the reason is due to the strong labor market, he said. “Though policy is restrictive, it may not be restrictive enough” and it hasn’t been restrictive for very long, he said.

The point about not being restrictive for long is important. For most of 2022, the Fed Funds rate was well below the inflation rate, which means that real interest rates were negative which is incredibly stimulating to the economy.

The central bankers were asked about how they can increase their credibility to the markets, and Jerome Powell, Christine Lagarde and Andrew Bailey stressed their resoluteness to fight inflation and bring the target back down to 2%. The outlier was Bank of Japan Governor Kazuo Ueda who basically said the BOJ would print more money, which drew chuckles from the crowd. When the panelists were asked to discuss lags in monetary policy, most talked about how some of the rate hikes had yet to be felt. Meanwhile Ueda joked that in Japan, the lag has been decades. The Bank of Japan has been fighting deflation since 1990.

Finally, Jerome Powell said that he didn’t envision the Fed returning to its 2% inflation target until 2025. So, unless there is an economic shock coming don’t look for rate cuts any time soon. The hope for people in the mortgage space is that MBS spreads begin to narrow as volatility subsides in the bond market.

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First quarter GDP was revised upward from 1.3% to 2.0% in the final revision. The increase in real GDP in the first quarter reflected increases in consumer spending, exports, state and local government spending, federal government spending, and nonresidential fixed investment that were partly offset by decreases in private inventory investment and residential fixed investment. The PCE price index was revised downward slightly from 4.2% to 4.1%. The core rate, which excludes food and energy was revised downward from 5.0% to 4.9%.

In terms of industries, health care / social assistance was the biggest contributor to GDP while finance / insurance was the biggest laggard.

The Federal Reserve released the results of its stress tests for the US banking sector yesterday. They showed that the top 23 banks have sufficient capital to absorb a half a trillion hit and still extend credit. While many banks have unrealized losses on their investment portfolios, the scenarios envision falling interest rates, which will reverse some of these losses.

Interestingly, the report didn’t mention Silicon Valley Bank or Signature Bank. The stress tests didn’t envision the scenario we had earlier this year when rates would rise in an inflationary environment.

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Vital Statistics:

Stocks are lower this morning as market darling Nvidia is down pre-market. Bonds and MBS are flat.

Chip stocks are down this morning after a report that the Biden Administration is considering curbs on AI chip exports to China. The recent rally in the stock market has been incredibly narrow, focusing on a few AI-driven stocks.

Jerome Powell is speaking on a panel of central bankers in Europe this morning. I don’t expect anything market-moving, but just be aware.

Mortgage Applications increased 3% last week as purchases and refinances increased by the same amount. “Mortgage rate changes varied across loan types last week, with the 30-year fixed rate increasing slightly to 6.75 percent. The spread between the jumbo and conforming rates widened to 16 basis points, the third week in a row that the jumbo rate was higher than the conforming rate. To put this into perspective, from May 2022 to May 2023, the jumbo rate averaged around 30 basis points less than the conforming rate,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications increased for the third consecutive week to the highest level of activity since early May but remained more than 20 percent lower than year ago levels. New home sales have been driving purchase activity in recent months as buyers look for options beyond the existing-home market. Existing-home sales continued to be held back by a lack of for-sale inventory as many potential sellers are holding on to their lower-rate mortgages.”

Truist has upgraded Boise Cascade and Louisiana Pacific on a bullish bet for building materials. The homebuilding sector has been seeing activity lately as potential homebuyers are stuck with picked-over existing homes and are looking at new construction. Builders are using buydowns and upgrades to entice buyers. Separately, Wedbush upgraded Beazer Homes this morning.

The Fed will release the results of bank stress tests after the close today. The markets will focus particularly hard on the regional banks.

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Stocks are higher this morning on no real news. Bonds and MBS are down.

New home sales rose 12% MOM in May to a seasonally-adjusted annual rate of 763,000. This is up 15.5% compared to May of last year. The median new home price fell 7.6% on a YOY basis to 416,300. The average sales price fell 6.6% to 487,000. It looks like the affordability issue has caused builders to focus more on lower-priced properties than luxury houses.

Home prices rose 0.7% MOM in April, according to the FHFA House Price Index. They were up 3.1% on a YOY basis. That said, we did see YOY declines in the West and the Mountain states.

Separately, the Case-Shiller Home Price Index reported an annual decrease of 0.2% in April. “The ongoing recovery in home prices is broadly based. Before seasonal adjustments, prices rose in all 20 cities in April (as they had also done in March). Seasonally adjusted data showed rising prices in 19 cities in April (versus 14 in March)…. If I were trying to make a case that the decline in home prices that began in June 2022 had definitively ended in January 2023, April’s data would bolster my argument. Whether we see further support for that view in coming months will depend on the how well the market navigates the challenges posed by current mortgage rates and the continuing possibility of economic weakness.”

We did see some big declines in certain MSAs: -12.4% in Seattle, -11% in San Francisco, -6.6% in Las Vegas, -5.6% in San Diego, -6.1% in Phoenix.

Did fraudulent PPP (Paycheck Protection Plan) loans artificially inflate home prices? According to new research, it may have happened.

Pandemic fraud facilitated by FinTech lenders exhibited significant geographic concentration, which makes it a unique setting to examine the effects of excess local stimulus cashflow on local purchases and prices. We first examine effects on a highly immovable local good—housing. At the individual level, fraudulent PPP loan recipients significantly increase their home purchase rate after receiving the loan the program compared to non-fraudulent PPP recipients. At the zip code level, house prices in high fraud zip
codes increase 5.7 percentage points more than in low fraud zip codes within the same county, with similar effects even after controlling for land supply, prior house price growth, teleworkability, population density, net migration, distance to central business district, and previous rates of remote work. This effect is entirely driven by fraudulent loans from FinTech lenders, and non-fraudulent lending has no such effect. Matching, synthetic controls, and an instrumental variables identification strategy based on social connections to distant zip codes yield similar results. Outside of the housing market, local PPP fraud also predicts consumer spending at the census tract level in 2020 and 2021 with a return to normal in 2022.

Consumer confidence improved in June, according to the Conference Board. Interestingly, there is a big divergence between the Present Situation Index, and the Expectations Index. The present situation index (how things actually are right now) is at 155 while the expectations index is 79. The chart below is more or less the average of the two. Inflationary expectations fell to 6% (still way above what the Fed would like to see), however this was the lowest since December 2020.

“Although the Expectations Index remained a hair below the threshold signaling recession ahead, a new measure found considerably fewer consumers now expect a recession in the next 12 months compared to May. Meanwhile, on a six-month moving average basis, plans to purchase autos and homes have slowed, after picking up earlier in 2023. This may reflect rising costs to finance big-ticket items as the Fed continues to raise interest rates. Meanwhile, vacation plans within the next six months continued to flag, led largely by declines in plans to travel domestically. This is an important indicator of desires to spend on services ahead, which may be a signal that post-pandemic ‘revenge spending’ on travel may have peaked and is likely to slow over the rest of this year.”

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Vital Statistics:

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

The upcoming week will contain housing data, with the FHFA House Price Data, Case-Shiller, the third revision of first quarter GDP and Personal Incomes / Outlays which will contain the PCE inflation number. Jerome Powell will also speak on Wednesday.

The regional bank crisis has had some effects on the homebuilding sector, according to research from the NAHB. Loans for land acquisition / development and spec single family construction have become more scarce. In multi-family the effect is even more pronounced. Multi-family construction has been hitting on all cylinders and the number of buildings with 5 or more units is at a record.

The regional bank contagion may be a factor in this, however I suspect declining real estate prices are the bigger component. Commercial real estate is particularly problematic, and this is probably the driver.

Jerome Powell’s comments last week pretty much stuck the fork in bets for rate cuts this year. While the comments didn’t impact the July futures all that much, the December futures now predict that the Fed Funds rate at the end of the year will be 25 basis points higher than it is now. Interestingly, they are not predicting the two hikes that the dot plot predicted.

It wasn’t that long ago, that the futures were handicapping a Fed Funds rate around 4.5%. The Fed has instituted a drastic tightening policy, the likes of which we haven’t seen in 40 years. Historically tacking on 500 basis points of tightening would cause a recession, and we simply haven’t seen one yet.

Why haven’t we seen a recession yet? The biggest reason is the labor market, which has remained remarkably resilient. Companies had a difficult time finding workers during the COVID-19 pandemic and are probably reluctant to let them go. Second, companies took advantage of low rates to refinance their existing debt, and now they are paying rates that are pretty much close to the inflation rate. This is the equivalent of free money. And don’t forget the government has been handing out money like candy since COVID began and that spigot will eventually get turned off one way or another.

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Vital Statistics:

Stocks are lower this morning as investors fret about a potential slowdown. Bonds and MBS are up.

US businesses continued to expand in May, albeit at a slower pace, according to the S&P flash PMI. Manufacturing is in a contraction, while services are still expanding. Inflationary conditions continue to ease, with with firms increasing prices at the slowest pace since October 2020. Manufacturers are cutting prices to boost sales, while services price increases appeared to have recently peaked.

The Index of Leading Economic Indicators declined again in May, signaling that a recession is in the cards. “The US LEI continued to fall in May as a result of deterioration in the gauges of consumer expectations for business conditions, ISM® New Orders Index, a negative yield spread, and worsening credit conditions,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “The US Leading Index has declined in each of the last fourteen months and continues to point to weaker economic activity ahead. Rising interest rates paired with persistent inflation will continue to further dampen economic activity. While we revised our Q2 GDP forecast from negative to slight growth, we project that the US economy will contract over the Q3 2023 to Q1 2024 period. The recession likely will be due to continued tightness in monetary policy and lower government spending.” The index has been emitting a recession signal for the past six months or so.

The yield curve continues to invert, with the 2s-10s trading close to -100 basis points. An inverted yield curve is generally a recessionary signal. The inversion is worse than the 2020 recession and the Great Recession. The last time we were at these levels was in the early 1980s when Paul Volcker instituted his drastic Fed tightening to break the back of 1970s inflation:

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Vital Statistics:

Stocks are lower as we await another day of testimony from Jerome Powell. Bonds and MBS are down after the Bank of England hiked rates by 50 basis points.

Jerome Powell testified in front of the House yesterday, and will speak to the Senate today. His overarching message is that the fight against inflation is not done, and there will be more rate hikes this year. They will remain data-dependent and are aware that the effects of past rate hikes are not fully reflected in the economy yet. Democrats worried about a recession while Republicans worried about bank regulation overreach.

Atlanta Fed President Raphael Bostic thinks the Fed should stand pat:

“My baseline is that we should stay at this level for the rest of the year” to assess the impacts of the Federal Reserve’s rate-hiking cycle on the real economy, Atlanta Fed President Raphael Bostic told Yahoo Finance in an interview Wednesday.

“I actually think that we are still at the very early stages of our monetary policy tightening, starting to influence the economy in a significant way. I just feel like we have a little bit of time to just let that play out and see exactly how much the economy is responding to our policy,” he said.

Existing Home Sales were basically flat in May, rising only 0.2%. On a year-over-year basis, sales were down 20%. The median home price fell 3.1%, while inventory remains tight. “Mortgage rates heavily influence the direction of home sales,” said NAR Chief Economist Lawrence Yun. “Relatively steady rates have led to several consecutive months of consistent home sales.”

Homebuilder KB Home reported earnings last night. Revenues rose 3% while gross margins fell from 25.3% to 21.1%. Average selling prices were flat. The decrease in margins in the context of flat average selling prices means that KB had cost pressures and used all sorts of concessions to move the merchandise.

Rising mortgage rates have been a major headache for the builders because many buyers can no longer afford the homes they ordered at current rates. Instead of cutting prices, builders are finding other ways (below market mortgage rates, free upgrades etc.) to give more value to the buyer without impacting the comps. The cancellation rate rose on a year-over-year basis however it did decline from Q1.

Overall, the company does see things improving for the sector overall: “The improvement in demand we started to see in February was sustained throughout our second quarter, as we achieved monthly sequential increases in our net orders, resulting in an overall absorption pace of 5.2 net orders per month, per community. Operationally, our divisions are executing well, driving reductions in both build times and direct construction costs as well as opening new communities. We believe our orders, starts and production are well-balanced and, with the sequential increase in our backlog at quarter-end, we are well-positioned to achieve our revenue target for 2023.”

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Vital Statistics:

Stocks are lower as we await Jerome Powell’s semiannual Humphrey-Hawkins testimony. Bonds and MBS are down.

Jerome Powell heads to the Hill this morning to testify in front of Congress. Here are his prepared remarks. He discussed the hawkish pause and the Fed’s mindset:

In light of how far we have come in tightening policy, the uncertain lags with which monetary policy affects the economy, and potential headwinds from credit tightening, the FOMC decided last week to maintain the target range for the federal funds rate at 5 to 5-1/4 percent and to continue the process of significantly reducing our securities holdings. Nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year. But at last week’s meeting, considering how far and how fast we have moved, we judged it prudent to hold the target range steady to allow the Committee to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, we will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. We will continue to make our decisions meeting by meeting, based on the totality of incoming data and their implications for the outlook for economic activity and inflation, as well as the balance of risks.

Mortgage applications increased 0.5% last week as purchases rose 2% and refinances decreased 2%. “The 30-year fixed mortgage rate declined for the third consecutive week to 6.73 percent, while other mortgage rates saw mixed results. Purchase applications increased, driven by a 2 percent gain in conventional purchase applications and a 3 percent increase in FHA purchase activity,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “First-time homebuyers account for a large share of FHA purchase loans, and this increase is a sign that while buyer interest is there, activity continues to be constrained by low levels of affordable inventory. Refinance applications continued their decline after the previous week’s increase, with the refinance share of applications just below 27 percent.”

The homebuilders have been on a tear this year, despite all of the pain in the mortgage market. The S&P SPDR Homebuilder ETF (XHB) has outperformed the S&P 500 by 12% YTD:

We had an upside surprise in housing starts yesterday, and new home purchase applications rose 16% in May, according to the MBA.

“Purchase activity for newly built homes was strong in May, with builders continuing to bring homes to the market and buyers keen to act on available units,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Applications for purchase loans were up on a monthly basis and increased annually for the fourth consecutive month. Our estimate of new home sales also jumped in May, up 16 percent to the fastest pace of new home sales in 15 months.”

Added Kan, “The new home sales segment continues to gather momentum, growing at a pace of 5 percent compared to a year ago, while existing-home sales in recent months continue to experience annual declines of more than 20 percent on a non-seasonally adjusted basis. These results were also broadly in line with the Census data showing an uptick in residential housing starts and permitting in recent months.”

Homebuilding is an early-stage cyclical industry, which usually leads the economy out of a recession. Investors are piling into the homebuilding stocks in anticipation of a recession and rate cuts. Note homebuilder KB Home reports after the close today. The Atlanta Fed bumped up its Q2 GDP Now estimate to 1.9% on the strong housing starts number.

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Vital Statistics:

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

The week ahead won’t have much in the way of market-moving data, but we will have plenty of Fed-Speak, with Jerome Powell speaking on Wednesday and Thursday.

Housing starts rose to 1.63 million in May, which was way above expectations. The number was 5.2% above April, but still 12.7% below May of 2022. The Street was looking for 1.4 million, so this was an upside surprise. Both multi (5+ units) and single-family saw big increases. Building Permits rose to 1.49 million.

While this is a big uptick in starts, we still are not back to levels we saw in mid-2022.

Downtown areas are struggling to get back on their feet after COVID. Office vacancy rates are way up, and municipal bonds are beginning to waver as declining revenues make them more risky. The beneficiary of this phenomenon are the suburbs which are seeing renewed interest. Apartments under construction are at record levels, and I wonder how many are in the cities.

The improvement in construction is good news for the mortgage business, and Goldman is out there with a positive call on a couple mortgage companies: AGNC Investment and Rithm Capital. AGNC is a mortgage REIT which invests in spec pools while Rithm is New Rez, Caliber and Shellpoint.

The bull case for AGNC is based on narrowing MBS spreads, which is a function of interest rate volatility. The ICE MOVE Index, which is sort of like a VIX for bonds, is at the bottom of its tightening cycle range. The lower it goes, the more attractive MBS are against Treasuries.

Rithm has agency MBS exposure, servicing and origination. Rithm was one of the only mortgage REITs that reported an increase in book value per share over 2022.

Any decline in interest rate volatility will be driven by more certainty about the Fed. The Fed’s tightening cycle appears to be winding down, but it is interesting to see just how far behind the curve they were in 2022. I discussed this in my Substack piece: Week in Review: Plotting the Fed Funds Forecast over time. For almost all of 2022, the real Fed Funds rate (i.e. the Fed Funds rate minus inflation) was highly negative, which means that monetary policy was still highly expansionary even in the context of a tightening regime.

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Vital Statistics:

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

The Fed’s decision to hold rates steady yet forecast two more rate hikes appears inconsistent, at least to ex-Treasury Secretary Larry Summers.

“This meeting felt like it was driven as much by the internal political dynamics of the Fed, as by any consistent and coherent reading of the economic situation and that was a bit disturbing to me…I found the Fed’s action a little bit confusing. I understand the arguments for not hiking this at this meeting. But those arguments wouldn’t point towards signaling two further rate increases, they wouldn’t point towards significantly revising the forecasts towards a stronger economy and more inflation…I understand the arguments for having gone the other way,” Summers continued. “But I don’t really understand the internal consistency of an approach of pausing at this meeting, but then signaling two further rate hikes down the road and signaling that they no longer expect unemployment to increase nearly as much as they used to expect it.”

I am not sure what “internal political dynamics” refers to in this context given that the vote was unanimous. The minutes from the meeting will make interesting reading when they come out in a few weeks.

Consumer sentiment improved in June, according to the University of Michigan Consumer Sentiment Survey. Sentiment is improving, however it is still low on a historical basis;

Inflationary expectations for the next year improved dramatically, falling from 4.2% in May to 3.3% in June. Longer-term expectations remain persistently in a 2.9%-3.1% range.

Mortgage credit decreased in May, according to the MBA’s Mortgage Credit Availability Index. “Mortgage credit availability decreased for the third consecutive month, as the industry continued to see more consolidation and reduced capacity as a result of the tougher market. With this decline in availability, the MCAI is now at its lowest level since January 2013,” said Joel Kan, Vice President and Deputy Chief Economist. “The Conforming index decreased almost 4 percent to its lowest level in the history of the survey, which dates back to 2011. The Jumbo index fell by 1.5 percent last month, its first contraction in three months, as some depositories assess the impact of recent deposit outflows and reduce their appetite for jumbo loans…Additionally, lenders pulled back on loan offerings for higher LTV and lower credit score loans, even as loan applications continued to run well behind last year’s pace. Both Conventional and Government indices saw declines last month, and the Government index fell by 3.8 percent to the lowest level since January 2013. In a market where a significant share of demand is expected to come from first-time homebuyers, the depressed supply of government credit is particularly significant.”

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