All Things in Moderation

Vital Statistics:

Stocks are higher this morning after good numbers out of Apple. Bonds and MBS are down small.

Personal Incomes rose 0.4% in December, in line with expectations. Personal Spending rose 0.7%, which was higher than expectations. Higher spending was driven by energy, transportation and shelter.

The all-important PCE Price Index rose 0.3% MOM and 2.6% YOY. The core rate rose 0.2% MOM and 2.8% YOY. All of the inflation numbers were in line with expectations.

The gradual increase we saw in core PCE last fall seems to be over. Meanwhile, the headline rate has been rising due to higher energy costs.

The bond market took the number in stride, with little movement in the aftermath.

Pending Home Sales fell 5.5% in December, according to NAR. “After four straight months of gains in contract signings, one step back is not welcome news, but it is not entirely surprising,” said NAR Chief Economist Lawrence Yun. “Economic data never moves in a straight line. High mortgage rates have not significantly dented housing demand due to greater numbers of cash transactions.”

“Contract activity fell more sharply in the high-priced regions of the Northeast and West, where elevated mortgage rates have appreciably cut affordability,” said Yun. “Job gains tend to have greater impact in more affordable regions. It is unclear if heavier-than-usual winter precipitation impacted the timing of purchases.”

Fed Governor Michelle Bowman said that progress on inflation was “noticeably” slower than 2023 which warranted a more cautious approach to interest rates. The increase in long-term rates since the Fed started cutting was a “reflection of investors’ concerns about the possibility of tighter-than-expected policy that may be required to address inflationary pressures.”

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Vital Statistics:

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

The Index of Leading Economic Indicators declined 0.1% in December, according to the Conference Board. “The Index fell slightly in December failing to sustain November’s increase,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “Low consumer confidence about future business conditions, still relatively weak manufacturing orders, an increase in initial claims for unemployment, and a decline in building permits contributed to the decline. Still, half of the 10 components of the index contributed positively in December. Moreover, the LEI’s six-month and twelve-month growth rates were less negative, signaling fewer headwinds to US economic activity ahead. Nonetheless, we expect growth momentum to remain strong to start the year and US real GDP to expand by 2.3% in 2025.”

The big negative drivers were weak new orders from the ISM report, the slope of the yield curve, and negative consumer confidence. The big positive components were financial: easing credit conditions and the performance of the stock market.

D.R. Horton reported first quarter earnings. Revenues were down YOY as deliveries fell. Gross margins declined as the company is battling affordablity issues by offering mortgage buy-downs. “Although the level of new and existing home inventories has increased from historically low levels, the supply of homes at affordable price points is generally still limited, and demographics supporting housing demand remain favorable. Despite continued affordability challenges and competitive market conditions, incentives such as mortgage rate buydowns have helped to address affordability and spur demand. Additionally, given our focus on affordable product offerings, we have continued to start and sell more of our homes with smaller floor plans to meet homebuyer demand.”

You would think that with such a dearth of starter homes, D.R. Horton would be plowing cash back into the business. It is not. Over the past 12 months it has used all of its operating cash flow buying back stock and paying dividends, despite the fact that the operating business is generating an ROE approaching 20%. As a general rule, if a company expects to earn higher than its cost of capital on the underlying business, it expands the business. If it doesn’t, it should return that capital to shareholders. It is surprising then that DHI is eschewing profitable business opportunities and instead buying back its own stock.

Donald Trump has ordered “emergency relief” on housing affordability, and plans to attack regulatory costs: “Hardworking families today are overwhelmed by the cost of fuel, food, housing, automobiles, medical care, utilities, and insurance. Moreover, many Americans are unable to purchase homes due to historically high prices, in part due to regulatory requirements that alone account for 25 percent of the cost of constructing a new home according to recent analysis.”

I am not sure how much of that 25% is addressable at the Federal level and how much is local building / environmental codes. That said, it is encouraging that the government is taking a look at the issue.

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Vital Statistics:

Stocks are higher this morning as earnings continue to come in. Bonds and MBS are up.

Housing starts rose 15.8% MOM to a seasonally adjusted annual rate of 1.499 million. This was 4.3% below December 2023’s rate. Building permits fell 0.7% MOM to a seasonally adjusted annual rate of 1.483 million units. Both numbers were well above Street expectations.

Homebuilder sentiment improved modestly to kick off the new year, according to the NAHB. “NAHB is forecasting a slight gain for single-family housing starts in 2025, as the market faces offsetting upside and downside risks from an improving regulatory outlook and ongoing elevated interest rates,” said NAHB Chief Economist Robert Dietz. “And while ongoing, but slower easing from the Federal Reserve should help financing for private builders currently squeezed out of some local markets, builders report cancellations are climbing as a direct result of mortgage rates rising back up near 7%.”

Despite the affordability issues, the use of incentives and price cuts has remained steady since last summer. Sentiment remains strongest in the Northeast and Midwest, while the South and (especially) the West are struggling.

Fed Governor Chris Waller said that the Fed Funds futures might be too hawkish if inflation comes in as expected this year. “As long as the data comes in good on inflation or continues on that path, then I can certainly see rate cuts happening sooner than maybe the markets are pricing in,” Waller said during a “Squawk on the Street” interview with Sara Eisen.

Asked how many that could entail, he responded, “That’s all going to be driven by the data. I mean, if we make a lot of progress, you could do more,” which he said could mean three or four, assuming quarter percentage point increments.

“If the data doesn’t cooperate, then you’re going to be back to two and going maybe even one, if we just get a lot of sticky inflation,” he said.

Right now, the “maybe even one” scenario is the baseline according to the Fed Funds futures.

Interesting quote about how homebuyers are adjusting to the new normal: “My average first-time homebuyer now says $3,500 is comfortable, compared to the $2,000 to $2,500 range previously. Those looking for a family house now say $6,500 to $7,500; previously, $4,500 was the primary target. I’m also seeing more people more comfortable with $8,000 to $10,000 mortgage payments than ever. Honestly, for the first 20 years of my career, I don’t believe I ever had a mortgage payment offered over $10,000, and now I have a few of those each quarter.”

Industrial production rebounded smartly in December, according to the Federal Reserve. For the full year, industrial production rose 0.5%. Capacity utilization rose from 77% to 77.6%.

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Vital Statistics:

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

The bond market is down again today, with UK Gilt yields up 12 basis points this morning. Adding to the pressure on bonds was a lousy auction yesterday, with the 10 year yield hitting the highest level since 2007.

Job openings increased to 8.1 million at the end of December, according to the Bureau of Labor Statistics. This was an increase of 259k from the upward-revised November reading. On the other hand, the quits rate declined to 1.9%, which is a sign of weakness in the labor market.

Given the current bearish psychology of the bond market, bond investors focused on the 8.1 million job openings and ignored the quits rate. The red line is the job openings rate, while the blue line is the quits rate. The job openings rate is higher than pre-pandemic levels, while the quits rate is below pre-pandemic levels.

More indications that the labor market is cooling: The economy added 122,000 jobs last month, according to the ADP Employment Report. This was below expectations, and is less than Street expectations for Friday’s jobs report. “The labor market downshifted to a more modest pace of growth in the final month of 2024, with a slowdown in both hiring and pay gains,” said Nela Richardson, chief economist, ADP. “Health care stood out in the second half of the year, creating more jobs than any other sector.” Indeed, the bulk of the gains came in health care / education and leisure / hospitality. Manufacturing jobs fell.

Pay gains for job stayers fell to 4.6%, the lowest since July of 2021.

Mortgage applications fell 3.7% last week as purchases fell 7% and refis fell 2%. “Applications decreased last week as rising mortgage rates continued to discourage buyers from entering the market and put a damper on purchase activity. The 30-year fixed rate increased for the fourth consecutive week, reaching 6.99 percent – the highest rate since July 2024,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications declined for both conventional and government loans and dropped to the slowest weekly pace since February 2024. Refinance applications increased despite higher rates, but the increase was compared to recent low levels and was driven entirely by an increase in VA refinances, which continue to show weekly swings.”

Adding fuel to the bonfire in the bond market was the ISM Services report, which showed the sector expanding again. “The Services PMI^® in December was boosted primarily by strength in the Business Activity and Supplier Deliveries indexes. Many industries noted that end-of-year and seasonal factors were helping drive business activity or impact inventory management. Some of the increased business activity seems to have been driven by preparation for demand in the new year, or risk management for impacts from ports strikes and potential tariffs. There was general optimism expressed across many industries, but tariff concerns elicited the most panelist comments.”

The prices index increased to 64.4%,which was the highest reading since January of 2024. There might have been some seasonal / end-of-year effects going on, so this is something to watch.

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Vital Statistics:

Stocks are higher as we begin 2025. Bonds and MBS are up.

Mortgage applications fell 22% over the past two weeks, according to the MBA. Refis fell 36%, but were up 10% on a year-over-year basis. Purchase volume fell 48% and was down 17% compared to a year ago. “Mortgage rates moved higher through the last full week of 2024, reaching almost 7 percent for 30-year fixed-rate loans,” said Mike Fratantoni, MBA’s SVP and Chief Economist. “Not surprisingly, this increase in rates – at a time when housing activity typically grinds to a halt – resulted in declines in both refinance and purchase applications.”

For-sale housing inventory rose 0.5% MOM and 12.1% YOY in November, according to Redfin. That said, much of this inventory has been hanging around for a while as sellers refuse to cut prices. Over half the inventory has been on market without a contract for over 60 days. This phenomenon is most concentrated in Florida and Texas, where there has been a lot of building. Rising HOA fees and insurance costs are making people re-thing moving to Florida.

Something to watch for 2025: The Chinese Government Bond yield. As the real estate bust settles in, Chinese government bond yields are collapsing as investors rush to put money in safe assets. China has a massive debt problem, similar to the US in 1929 and Japan in 1989. This will send a deflationary pulse throughout the world and should help to (a) push down yields globally, and (b) push down commodity inflation.

In the 1980s, the Japanese were voracious buyers of US real estate, and for the past 10 years, Chinese investors have been big buyers in the US and Canada. Chinese property investors may be forced to liquidate US holdings in order to cover debts. Since domestic demand in China is collapsing, the country should continue to run trade deficits globally, which means increased demand for sovereign debt, pushing global yields lower.

Just something to think about going forward. Have a happy and prosperous new year.

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