All Things in Moderation

Vital Statistics:

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

The upcoming week will have some important inflation data with the consumer price index and the producer price index. We will also kick off earnings season with the big banks reporting on Friday. Investors will be particularly interested in whether the banks take provisions on their commercial real estate portfolios. Interestingly, we don’t have much Fed-speak despite the fact the the quiet period for the July meeting starts next week.

The Fed Funds futures are pricing in a 92% chance of a 25 basis point hike at the July meeting. The December futures are pricing in a roughly 1-in-3 chance for another 25 basis point hike by the end of the year.

Chicago Fed President Austan Goolsbee thinks the US can avoid a recession while still defeating inflation: “What the Fed’s overriding goal right now is to get inflation down. We’re going to succeed at it and to do that without a recession would be a triumph,” Goolsbee told CNBC’s Steve Liesman during a “Squawk on the Street” interview. “That’s the golden path, and I feel like we’re on that golden path. So I hope we keep putting off the recession to forever. Let’s never have a recession again.”

This sort of thinking: that that Fed can “fine tune” the economy and override the business cycle goes back to the 1960s. Goolsbee’s professors at the University of Chicago probably taught him that this is impossible since the Fed has an information lag. Regardless, economic central planning – i.e. industrial policy – seems to be back in vogue, and with it comes the idea that the Fed can engineer away the business cycle. Color me skeptical.

Housing affordability is a big problem right now, with affordability back at the levels we saw during the ’04-’06 housing bubble. Affordability is a function of three things: house prices, mortgage rates and incomes. The most effective lever is mortgage rates, but we need the Fed out of the way. “The Fed has engineered a massive increase in interest rates in order to combat high inflation. We expect it to cut the federal-funds rate aggressively in the coming years, driving the [Federal funds] rate down from 5% currently to below 2% by 2025,” wrote economists at Morningstar. “Once the Fed wins the battle against inflation, its priority will shift to jump-starting economic growth, which will require much lower interest rates, in our view.” Morningstar predicts that interest rates will stay low long-term due to demographic trends such as an aging population and depressed fertility rates.

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Vital Statistics:

Stocks are flattish after a the jobs report. Bonds and MBS are up small.

The economy added 209,000 jobs in June, according to the Employment Situation Report. This was more or less in line with expectations and much lower than the ADP report yesterday. The unemployment rate slipped to 3.6%, while average hourly earnings increased 0.4% MOM and 4.4% YOY. Job openings fell 500k to 9.8 million. After declining for two months, the quits rate increased to 2.6%, which is leading indicator for wage growth.

Wage inflation is the Fed’s biggest concern now, and it seems to have plateaued around this level for the past several months after declining in the second half of 2022. Pre-pandemic, average hourly earnings were increasing at around 3.5%, so we still have some ways to go in order to get back to a level the Fed is comfortable with.

The 10 year bond yield is off slightly from yesterday’s highs, but we are still solidly above 4%. The two year is up as well, trading at 4.97%.

If you look closely at the chart above, despite the increases in rates, the yield curve remains highly inverted. The distance between the two lines indicates yield curve inversion. The bigger the distance, the more inversion. The labor data is indicative of a roaring economy, but the yield curve is blaring recessionary signs.

Lock volume increased 31% in June according to the MCT Rate Lock Index. “We saw originations towards the end of May slow down, so this is likely a summertime pickup in originations”, said Andrew Rhodes, Senior Director and Head of Trading at MCT. “Rates, housing supply, and affordability will continue to be the forces behind the lack of new originations.”

The ISM Services Index increased in June, which was the sixth consecutive expansion. New orders and business activity increased, while prices moderated. “There has been an uptick in the rate of growth for the services sector. This is due mostly to the increase in business activity, new orders and employment. Increased capacity, backlog reduction and continued improvements in logistics have impacted delivery times (resulting in a decrease in the Supplier Deliveries Index). The majority of respondents indicate that business conditions remain stable; however, they are cautious relative to inflation and the future economic outlook.”

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Vital Statistics:

Stocks are lower this morning after the FOMC minutes from June indicated that some members wanted to hike rates. Bonds are down, and the 10 year has a 4-handle on it again.

The FOMC minutes were released yesterday, and the market reacted to the revelation that the unanimous decision to pause was not without some opposition:

Some participants indicated that they favored raising the target range for the federal funds rate 25 basis points at this meeting or that they could have supported such a proposal. The participants favoring a 25 basis point increase noted that the labor market remained very tight, momentum in economic activity had been stronger than earlier anticipated, and there were few clear signs that inflation was on a path to return to the Committee’s 2 percent objective over time.

Separately, Dallas Fed President Laurie Logan said it would’ve been “entirely appropriate” to raise the benchmark lending rate at the Fed’s June meeting. However, she said “in a challenging and uncertain environment, it can make sense to skip a meeting and move more gradually.”

The July Fed Funds futures are close to a lock for another 25 basis point hike at the July meeting in 3 weeks.

The private economy added almost half a million jobs in June, according to the ADP Employment Report. This is well above the 213k the Street is looking for in tomorrow’s jobs report. “Consumer-facing service industries had a strong June, aligning to push job creation higher than expected,” said Nela Richardson, chief economist, ADP. “But wage growth continues to ebb in these
same industries, and hiring likely is cresting after a late-cycle surge.” As usual, leisure / hospitality was the biggest contributor to job growth, adding 232k jobs, while construction added 90k. White collar and manufacturing jobs fell. Wage growth fell to 6.4% from 6.6% for job stayers, and fell to 11.2% for job changers. Job changers received the lowest annual increase since October 2021.

In other labor-related indicators, announced job cuts fell 49% to 40,709 according to Challenger and Gray. Tech, retail and finance have seen the most job cuts this year. Initial Jobless Claims remain low at 248k.

Mortgage Applications fell 4.4% as purchases fell 5% and refis fell 4%. “Mortgage applications fell to their lowest level in a month last week as rates for most loan types increased. As mortgage-Treasury spreads remained wide, the 30-year fixed rate increased to 6.85 percent, the highest rate since the end of May,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications decreased for the first time in a month, as homebuyers remained sensitive to rate changes. Rates are still over a percentage point higher than a year ago, and housing affordability is still a challenge in many parts of the country. However, the average loan size for a purchase application declined to $423,500 – its lowest level since January 2023. This was likely driven by reduced purchase activity in some high-price markets and more activity in some of the lower price tiers as buyers searched for more affordable options.” The composite index is at the lowest levels since 1997.

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Vital Statistics:

Stocks are lower this morning on the escalating chip war between the US and China. Bonds and MBS are up small.

There isn’t much in the way of economic data this morning, but we will get the June FOMC minutes at 2:00 pm today. It will be interesting to see the Fed’s thoughts on commercial real estate and any potential impacts on the banking sector. Office is definitely a problem, and we have seen some pain in retail as well.

Manufacturing contracted in June for the 8th consecutive month, according to the ISM Manufacturing Report. The weakness was across the board, with new orders, production, prices and employment all in contraction. “Demand remains weak, production is slowing due to lack of work, and suppliers have capacity. There are signs of more employment reduction actions in the near term. Seventy-one percent of manufacturing gross domestic product (GDP) contracted in June, down from 76 percent in May. More industries contracted strongly, however, as the share of manufacturing GDP registering a composite PMI^® calculation at or below 45 percent — a good barometer of overall manufacturing weakness — was 44 percent in June, compared to 31 percent in May,” says Fiore.

PeerStreet has filed for bankruptcy. The company built a marketplace for individual loans however rising rates killed the company. It went from 281 employees to 28 over the past year.

Construction spending rose 0.9% MOM and 2.4% YOY to a seasonally adjusted annual rate of $1.93 trillion. Interestingly, residential construction was down over 11% on a year-over-year basis. Single family construction was down 11.6% while multi-family was up 20%.

I talked about whether we are finally seeing the turn in homebuilding in my latest Substack posting.

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