All Things in Moderation

Vital Statistics:

Stocks are higher this morning as we round out September. Bonds and MBS are up after an awful month for the asset class.

It is looking more and more like we might get a government shutdown over the weekend. These things generally are more symbolic than anything because the vast majority of government spending is on autopilot and immune to a shutdown. For most people the only impact is that the Park Service closes down the monuments in DC.

Personal Incomes rose 0.4% MOM in August, according to the BEA. Personal incomes were driven upward by increased compensation and investment income. Personal spending rose 0.4%, which was a big deceleration from the July number of 0.9%.

The PCE Price Index rose 0.4% MOM and 3.5% YOY. If you exclude food and energy the PCE Price Index rose 0.1% MOM and 3.9% YOY. The annual increase in the core PCE was the lowest since June of 2021.

The inflation numbers were a touch below expectations, although we will get plenty of additional data before the November FOMC meeting.

Delinquencies on consumer loans are ticking up. 30-60 day DQs rose to 0.84%, an increase from 0.65% a year ago. We are seeing DQs rise across the board, with credit cards and auto loans leading the way.

Mortgage delinquencies are still near record lows, however. “Overall U.S. mortgage delinquencies remained near a record low in July, with the share of homes entering that status or progressing to later stages either unchanged or lower. Since most borrowers have substantial amounts of home equity, those who have locked in low mortgage rates that do enter later stages of delinquency will most likely not experience foreclosures. And while home equity gains have slowed from their former rapid pace, CoreLogic projects that home price growth will pick up over the next year. Borrowers should continue to build equity over the coming months, even if at a more moderate rate.”

Consumer sentiment decreased in September, according to the University of Michigan Consumer Sentiment Survey. Importantly, inflationary expectations continue to moderate, with year-ahead inflation declining to 3.2% from 3.5% and long-run inflation declining to 2.8%. The long-run rate had been stuck in a 2.9% – 3.1% range ever since the pandemic, so this is a good sign.

We are still above pre-pandemic levels with inflationary expectations. Prior to the pandemic, the two-year average for 2.3% – 3% for the year-ahead number and 2.2% – 2.6% for the long-run number. This is good news, however rising energy prices are going to support the headline number for a while.

Filed under: Economy | 5 Comments »

Vital Statistics:

Stocks are flat this morning on no real news. Bonds and MBS are down again. Jerome Powell will speak after the market closes.

It is looking more and more like we will get some sort of government shutdown soon. The last time we had a government shutdown, the IRS wasn’t sending out tax transcripts, which delayed some closings.

Global sovereign yields are shooting higher this morning, led by the UK, with an 18 basis point pickup. The German Bund yield is up 12 basis points despite a better-than-expected inflation report. Rising energy prices aren’t helping things, and all of this is translating into relentlessly higher Treasury yields and mortgage rates.

Bank earnings in a couple weeks will be interesting to say the least.

Gross Domestic Product rose 2.1% in the second quarter, in the third revision. Consumption was revised downward, while non-residential fixed investment was revised upward. The PCE Price index rose 2.5% in the second quarter, while the PCE Price Index ex-food and energy rose 3.7%. Separately, initial jobless claims fell to 204k.

Chicago Fed President Austan Goolsbee said “The Fed has the chance to achieve something quite rare in the history of central banks — to defeat inflation without tanking the economy.” He went on further to say: “The unwinding of supply shocks, the composition of demand returning to more stable patterns, and Fed credibility are central to why I think it might be possible today to reduce inflation while avoiding a deep recession.”

He also said that he is ready to change the focus of the Fed from “how high” the Fed Funds rate goes to “how long” it stays restrictive. Goolsbee is a voting member.

Pending Home Sales fell 7.1% in August, according to the National Association of Realtors. Year-over-year, transactions are down 18.7%. “Mortgage rates have been rising above 7% since August, which has diminished the pool of home buyers,” said Lawrence Yun, NAR chief economist. “Some would-be home buyers are taking a pause and readjusting their expectations about the location and type of home to better fit their budgets…The Federal Reserve must consider the sharply decelerating rent growth in its consideration of future monetary policy. There is no need to raise interest rates. “Moreover, the government shutdown will disrupt some home sales in the short run due to the lack of flood insurance or delays in government-backed mortgage issuance,” said Yun.

How buydowns can help improve the affordability problem.

Filed under: Economy | 8 Comments »

Vital Statistics:

Stocks are higher this morning on stronger-than-expected durable goods orders. Bonds and MBS are flat.

Durable Goods orders rose 0.2% in August based on higher defense spending. If you strip out defense spending, durable goods orders fell 0.7%. July’s numbers were revised downward. Non-defense core capital goods orders (which is a proxy for business capital investment) fell 2.9%.

Minneapolis Fed President Neel Kashkari said that a government shutdown / drawn-out strike with the UAW could act to lower inflation and reduce the need for the Fed to hike further. “If these downside scenarios hit the U.S. economy, we might then have to do less with our monetary policy to bring inflation back down to 2% because the government shutdown or the auto strike may slow the economy for us,” he said in an interview. “I’m not hoping for that, but there’s an interaction there.”

The Senate advanced legislation which could help prevent a government shutdown, however House Speaker Kevin McCarthy is still dealing with members who want increased funding for the border. Another major sticking point is funding for Ukraine.

Generally speaking these government shutdowns are more show than substance. The Park Service will close off some monuments in DC and that will be about it. They usually have little to no economic effect beyond pushing some growth from one quarter to the next.

Mortgage Applications fell 1.3% last week as purchases decreased 2% and refis fell 1%. “Mortgage rates moved to their highest levels in over 20 years as Treasury yields increased late last week. The 30-year fixed mortgage rate increased to 7.41 percent, the highest rate since December 2000, and the 30-year fixed jumbo mortgage rate increased to 7.34 percent, the highest rate in the history of the jumbo rate series dating back to 2011,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Based on the FOMC’s most recent projections, rates are expected to be higher for longer, which drove the increase in Treasury yields. Overall applications declined, as both prospective homebuyers and homeowners continue to feel the impact of these elevated rates. The purchase market, which is still facing limited for-sale inventory and eroded purchasing power, saw applications down over the week and 27 percent behind last year’s pace. Refinance activity was down over 20 percent from last year and accounted for approximately one third of applications. Many homeowners have little incentive to refinance.”

Filed under: Economy | 9 Comments »

Vital Statistics:

Stocks are lower this morning after Chinese developer Evergrande called off talks with creditors and looks set for bankruptcy. Bonds and MBS are down.

The upcoming week has quite a bit of data, with house prices / new home sales on Tuesday, GDP on Thursday, and PCE inflation data on Friday. We will also get some Fed-Speak.

There was an interesting interview in Housing Wire with Doug Duncan, chief economist at Fannie Mae. MBS spreads are a huge topic these days, and he was discussing who will be the marginal buyer to step up and replace the Fed’s buying.

Kim: Spreads in the mortgage space are wide. What are the reasons for that? 

Duncan: There are several reasons for that. If that business flow for a time period helps them cover the variable costs, then it can be effective.

For one thing, no fixed-income investor thinks that mortgage-backed securities with 7% mortgage rates will be there when the Fed finishes the inflation fight. They’re going to cut rates and that will prepay. So you’re having to encourage investors with wider spreads to accept that. 

It’s also the case that the Fed is running its portfolio off because they don’t talk about it much. But somebody has to replace the Fed, and the Fed is not an economic buyer. That is they weren’t buying for risk-return metrics; they were buying to affect the structure of markets. So they are a policy buyer.

They were withdrawing volatility from the market, and they were lowering rates to benefit consumers. When [the Fed] is replaced, it’s likely to be by a private investor who’s going to have yield expectations. They may require wider spreads than the Fed because the Fed is not an economic buyer.

While I believe he is correct in that the new buyer of MBS will require a higher spread than the Fed, which had no such requirements, I think he overstates the effect the Fed’s buying had on MBS spreads in the first place. Take a look at the chart below, which is the 30 year fixed rate mortgage rate minus the 10 year.

This is not exactly MBS spreads, but it is a close enough approximation. The thing that sticks out to me is that MBS spreads in the era of QE are not that much different than they were before the real estate bubble. If the Fed’s massive buying of MBS didn’t make that dramatic of a difference, how is slowly letting the portfolio run off going to do it?

Once the Fed is out of the way with rate hikes, we should see a dramatic drop in bond market volatility as the uncertainty over monetary policy disappears. Since fixed income investors are looking at option-adjusted spreads (OAS), as volatility dries up in the bond market, we should see MBS become more attractive to other credit-risk free assets. Yes, prepays might increase, but rates have to fall a lot to trigger any sort of refi boom.

From 12/31/99 – 12/31/06, the difference between the 10 year and the average 30 year fixed rate mortgage was 1.79%. This was pre-Fed intervention. If spreads return to that level, we would be looking at a 30 year fixed rate mortgage around 6.3%, or 100 basis points lower than here.

Filed under: Economy | 27 Comments »

Vital Statistics:

Stocks are higher as markets digest the Fed’s hawkish language from Wednesday. Bonds and MBS are flat.

The 10 year briefly touched 4.5% in the overnight session, which is the highest level since 2007. A combination of rising oil prices, economic resilience in the US and massive government supply is pushing yields higher.

The Fed Funds futures are still predicting a roughly 40% chance of one more rate hike in 2023, taking to heart Jerome Powell’s language of “proceeding carefully” on rate hikes going forward. The December 2024 Fed Funds futures moved up their forecast by about 25 basis points after the Fed meeting.

December 2024 futures:

The average interest rate on US credit cards is over 22%, according to recent data. About 37% of credit card cap out their interest rate at 29.99%. At those sort of levels, it is easy to get trapped in credit card debt. At some point even with mortgage rates where they are, a cash-out debt consolidation refi could make sense for people.

The US economy experienced stagnation in output at the end of the third quarter according to the S&P Flash PMI. The US economy put up the worst performance since February as demand fell. Pricing pressures remain, largely driven by rising energy prices, while backlog gets worked off. We still aren’t seeing layoffs yet, but as demand flags, that should begin to happen.

“PMI data for September added to concerns regarding the trajectory of demand conditions in the US economy following interest rate hikes and elevated inflation. Although the overall Output Index remained above the 50.0 mark, it was only fractionally so, with a broad stagnation in total activity signalled for the second month running. The service sector lost further momentum, with the contraction in new orders gaining speed.

“Subdued demand did not translate into overall job losses in September as a greater ability to find and retain employees led to a quicker rise in employment growth. That said, the boost to hiring from rising candidate availability may not be sustained amid evidence of burgeoning spare capacity and dwindling backlogs which have previously supported workloads.

“Inflationary pressures remained marked, as costs rose at a faster pace again. Higher fuel costs following recent increases in oil prices, alongside greater wage bills, pushed operating expenses up. Weak demand nonetheless placed a barrier to firms’ ability to pass on
greater costs to clients, with prices charged inflation unchanged on the month.”

Filed under: Economy | 19 Comments »

Vital Statistics:

Stocks are higher as we await the Fed decision at 2:00 pm. Bonds and MBS are up.

Fed-whisperer Nick Timaros of the WSJ discussed what to look for in the Fed decision today. While no increase is expected at this meeting, the big question will be the dot plot for this year and next. Timaros believes it is possible that the dot plot will still predict one more rate hike this year, however fewer members will lean that way.

It is easier for the Fed to signal one more rate hike and fail to deliver than it would be for the Fed to send the all-clear signal and then raise rates. The other big question will be how many rate cuts the dot plot signals for next year. The dot plot from June is below:

The June plot sees one more rate hike this year, and then about 100 basis points in cuts in 2024.

Mortgage Applications rose 5.4% last week as purchases 2% and refis increased 15%. “Mortgage applications increased last week, despite the 30-year fixed mortgage rate edging back up to 7.31 percent – its highest level in four weeks,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications increased for conventional and FHA loans over the week but remained 26 percent lower than the same week a year ago, as homebuyers continue to face higher rates and limited for-sale inventory, which have made purchase conditions more challenging. Refinance applications also increased last week but are still almost 30 percent lower than the same week last year.”

Separately, Joel Kan expects mortgage rates to fall into the 6% range by the end of the year and into the 5% range in 2024. I agree with him and I believe the driver is going to be a decline in interest rate volatility which will positively impact MBS spreads. Below is a chart of the Bank of America / ICE bond market volatility index (MOVE) and you can see it jumped in early 2022 which coincided with the Fed’s liftoff. Uncertainty over Fed policy is a driver of volatility, and volatility is probably the biggest driver of MBS prices as it drives convexity forecasts.

I am accepting ads for this blog if you would like to make an announcement, highlight something your company is offering or want more visibility. I also offer white-label services which give you the ability to use this content for your own daily emails. The blog has over 5,000 followers and an open rate around 50%. Please feel free to reach out to brent@thedailytearsheet.com if you would like to discuss this further.

Filed under: Economy | 25 Comments »

Vital Statistics:

Stocks are lower this morning as we begin the Fed meeting. Bonds and MBS are down small.

Housing starts fell 15% MOM and 11% YOY to a seasonally-adjusted annual rate of 1.28 million, which was the lowest since June of 2020. This was way below the street estimate of 1.43 million. Building permits increased to 1.54 million which was up 7% MOM and down 3Q% YOY.

While single-family starts fell, the big story has been the collapse in multi-fam, which has fallen off a cliff recently due to high rates and a glut of new supply already under construction.

High mortgage rates continue to dampen building confidence. Rising rates and prices are causing builders to cut prices or offer incentives. We have already seen builders subsidizing mortgage loans by offering below-market rates in order maintain the sales price.

Shortages remain an issue with skilled construction laborers in short supply, along with buildable lots, transformers, and now insurance.

Recessionary pressures are increasing in housing, according to First American Financial. “Mortgage rates increased in August, which means we expect the housing recessionary pressures to continue in the near-term until mortgage rates stabilize,” First American Chief Economist Mark Fleming said. “However, industry forecasts predict that mortgage rates will moderate later in the year if the Federal Reserve stops further monetary tightening and provides investors with more certainty. Mortgage rate stability, even if the stabilization occurs at a higher level, is the key to a housing recovery.”

Some good news on the inflation front: single family rent growth dropped to a 3 year low in July, rising only 3.1%. This is a return to pre-pandemic levels of growth.

“While U.S. single-family rent growth has now reverted to its long-term average of about 3%, three U.S. metros recorded annual cost decreases in July,” said Molly Boesel, principal economist for CoreLogic. “However, because the SFRI peaked in these metros in July 2022, the annual decreases represent a plateauing of costs rather than larger weaknesses in single-family rental markets.”

“But even with the small annual decreases in rent growth,” Boesel continued, “the gains of the past few years are unlikely to be totally erased in the near future. For example, Miami recorded a 0.6% decline in annual rent growth in July 2023, but the gain since July 2020 has registered 55%.”

Filed under: Economy | 9 Comments »

Vital Statistics:

Stocks are lower as we head into Fed Week. Bonds and MBS are down. The 10 year has the highest yield in 16 years.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The consensus seems to be a hawkish pause, where the Fed maintains the current Fed Funds rate and signals one more hike in the dot plot. Investors will also be looking at clues for when the Fed will start cutting rates. We will also get a new set of economic projections and the path for future inflation will loom large.

“You’d be hard pressed to find someone who thinks (the Fed will) hike this week but our expectation is that they keep the door open for another hike later this year which the dot plot will continue to reflect,” Deutsche Bank’s Jim Reid said. “Our economists believe other parts of the SEP are likely to undergo meaningful revisions, particularly for 2023.”

“Stronger growth (2023 could double to 2%, 2024 could increase around 25bps to 1.3%) and lower unemployment should counterbalance softer inflation (2023 revised down but core forecasts for 2024 likely to be unchanged). So the meeting is likely to see a confident pause but one where further tightening is seen as the risk.”

In economic news, we will get housing starts, existing home sales and the Index of Leading Economic Indicators.

Homebuilder confidence slipped in August, according to the NAHB Housing Market Index. Rising rates and affordability constraints remain the biggest issues.

The Atlanta Fed’s GDP Now index sees Q3 growth at 4.9%. This still seems way out of step with most economists which are closer to 3%.

Filed under: Economy | 2 Comments »

Vital Statistics:

Stocks are lower after the United Auto Workers went on strike against all three big auto makers. Bonds and MBS are down.

Consumer sentiment fell in September, according to the University of Michigan Consumer sentiment Survey. Since consumer sentiment surveys are highly influenced by gasoline prices, this isn’t much of a surprise. Importantly, inflationary expectations for the next year declined from 3.5% in August to 3.1%. Long-run inflationary expectations also fell to 2.7%, which is below the 2.9% -3.1% range we have been stuck in.

Prior to the pandemic, year-ahead inflationary expectations were in the 2.3% – 3.0% range and long-run inflationary expectations were in the 2.2% – 2.6% range. This is good news for the Fed, and we know the Fed pays close attention to the UMich numbers.

ICE and Black Knight have completed their sale of Optimal Blue and Empower to Constellation Software. This sale was a required divestiture in order for the two companies to complete their merger. ICE will hold a conference call in two weeks to discuss their going-forward plan.

Homebuyers are canceling deals at the highest rate in a year as rising mortgage rates kill affordability. “I’ve seen more homebuyers cancel deals in the last six months than I’ve seen at any point during my 24 years of working in real estate. They’re getting cold feet,” said Jaime Moore, a Redfin Premier real estate agent in Reno, NV. “Buyers get sticker shock when they see their high rate on paper alongside extra expenses for maintenance, repairs and closing costs. Many of them would rather back out, even if it means losing their earnest money. A lot of sellers are also willing to let buyers slip away because they don’t want to concede to repair requests.”

Industrial production rose 0.4% MOM, according to the Fed. Manufacturing output rose 0.1%. As is typical these days, the prior month’s numbers were revised downward. Capacity Utilization increased. Separately, manufacturing activity picked up in New York State, according to the Empire State Manufacturing Survey.

Filed under: Economy | 14 Comments »

Vital Statistics:

Stocks are higher this morning after the European Central Bank hiked rates by 25 basis points and crude oil rose above $90 a barrel. Bonds and MBS are flat.

The European Central Bank raised its key interest rate by 25 basis points to 4%. It also signaled that it has wrapped up its tightening cycle: “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” the ECB said in a statement.

Inflation in the Eurozone is 5%, which is much higher than the US. where PCE inflation is around 3.3%. Both the US and the ECB have a 2% inflation target. The Fed Funds futures continue to predict no changes at the September meeting next week and about a 40% chance of one more hike this year.

Inflation at the wholesale level rose 0.7% on a month-over-month basis, driven by higher energy prices. Gasoline accounted for about 60% of the increase. On a year-over-year basis, inflation at the wholesale level rose 1.6%. If you strip out food and energy, wholesale inflation rose 0.2% MOM and 2.2% YOY.

Retail Sales rose 0.6% in August, according to the Census Bureau. This was up 2.5% on a year-over-year basis. July’s numbers were revised downward from 1.0% to 0.7% (downward revisions seem to be a theme these days). These numbers are not adjusted for price changes, so it seems that consumer spending is waning as higher interest rates bite. The resumption of student loan payments isn’t going to help either.

The United Auto Workers will go on strike at 11:59 pm tonight if there is no agreement with the automakers. The UAW wants a 46% increase in hourly pay and a 4-day workweek (with pay for 5 days). Ford has offered 20%, while GM is offering 18%. The two sides remain pretty far apart. UAW President Shawn Fain said there would be “strategic strikes” which implies it won’t be a full-out strike against the automakers.

Regardless, in the short term a strike will be a damper for economic growth, however if the automakers accede to the UAW’s demands it will be bad news for inflation going forward as it will help cement the wage-price spiral.

Median household income fell 2.3% to $74,580 in 2022, according to the Census Bureau. This was driven by a 7.8% increase in the cost of living, which was the highest since 1981. The Census Bureau used a new inflation index as well, so past numbers might not be comparable.

The median house price to median income ratio sits at around 5.6x, which is an elevated number given how high mortgage rates are.

Filed under: Economy | 4 Comments »