All Things in Moderation

Vital Statistics:

Stocks are higher this morning after a court blocked Trump’s sweeping tariffs. Bonds and MBS are down small.

A Federal Court ruled that the President does not have the authority to impose such sweeping tariffs under the International Emergency Economic Powers Act of 1977. The Administration will appeal the decision, but it sounds like tariffs are dead in the water as of now. The Administration could instead re-impose tariffs under a different justification, the Section 301 of the Trade Act of 1974, which allows for tariffs that counter unfair foreign trade practices. He used the latter as justification for tariffs against China during his first administration, and it is thought to be on more solid legal ground.

Bonds are selling off on this news, which is counterintuitive, however it seems to be part of a global risk-on trade. Overall this news is good for bonds, and if this truly is the end of mass tariffs, the Fed is out of excuses to keep rates high. Overall this should be bond bullish and we should see rates work their way lower over the summer.

The FOMC minutes were released yesterday, and they confirmed the higher for longer story.

Participants observed that, even though swings in net exports had affected the data, the available data indicated that economic activity had continued to expand at a solid pace and labor market conditions continued to be solid, but inflation remained somewhat elevated. Participants assessed that the tariff increases announced so far had been significantly larger and broader than they had anticipated. Participants observed that there was considerable uncertainty surrounding the evolution of trade policy as well as about the scale, scope, timing, and persistence of associated economic effects. Significant uncertainties also surrounded changes in fiscal, regulatory, and immigration policies and their economic effects. Taken together, participants saw the uncertainty about their economic outlooks as unusually elevated. Overall, participants judged that downside risks to employment and economic activity and upside risks to inflation had risen, primarily reflecting the potential effects of tariff increases.

In other words, the -0.2% decrease in Q1 GDP is being dismissed as tariff-driven, and is not a consideration for cutting rates. They noted that inflation’s downtrend had been uneven, spiking a touch at the end of 2024. Trump’s shock and awe tariff announcement caught them by surprise, and therefore they are being cautious. The FOMC meeting was May 6 and 7, so this was prior to the May 12th delay on tariffs.

With respect to policy:

In considering the outlook for monetary policy, participants agreed that with economic growth and the labor market still solid and current monetary policy moderately restrictive, the Committee was well positioned to wait for more clarity on the outlooks for inflation and economic activity. Participants agreed that uncertainty about the economic outlook had increased further, making it appropriate to take a cautious approach until the net economic effects of the array of changes to government policies become clearer.

Participants noted that monetary policy would be informed by a wide range of incoming data, the economic outlook, and the balance of risks. In discussing risk-management considerations that could bear on the outlook for monetary policy, participants agreed that the risks of higher inflation and higher unemployment had risen. Almost all participants commented on the risk that inflation could prove to be more persistent than expected.

Participants emphasized the importance of ensuring that longer term inflation expectations remained well anchored, with some noting that expectations might be particularly sensitive because inflation had been above the Committee’s target for an extended period. Participants noted that the Committee might face difficult tradeoffs if inflation proves to be more persistent while the outlooks for growth and employment weaken.

Despite the pause in tariffs, the Fed remains resolute in its plan to hold off on getting to neutral policy as long as it can. The Fed is risking a recession and seems content to err on the side of being too tight for too long. This puts pressure on Trump to cut deals, as time is not on his side. The longer the Fed tightens, the greater the chance the economy slips into a recession. For those in the mortgage business, this means the famine might last a few more months, but the longer the Fed waits to ease, the more likely it will have to cut deeply and quickly.

I wonder if the Trade Court ruling, which enjoins Trump’s tariffs will factor into the Fed’s decision-making. Presumably, a suspension of tariffs would mean the Fed has the runway to get to r-star and lower rates by 100 basis points.

Q1 GDP was revised upward from -0.3% to -0.2% in the second revision. Investment was revised upward, while consumer spending was revised downward. In the graph below, you can see what the Fed was talking about when they characterize the number as “tariff-driven.”

The drag on GDP was the sharp increase in imports, which subtract from GDP. This was presumably consumers and businesses accelerating purchases to get in before price increases. Similarly, the big jump in investment (which added to GDP) was also tariff-driven as businesses were building inventory ahead of price increases.

The PCE Price Index was unchanged at 3.6%. Excluding food and energy, the PCE Price Index was revised downward to 3.4%.

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Vital Statistics:

Stocks are flattish this morning after the House narrowly passed the budget bill. Bonds and MBS are down.

Bonds got smacked yesterday after a disappointing 20 year bond auction, which caused more selling in the stock market. MBS spreads widened as well. Bond investors are also monitoring the progress of the latest budget bill and how much it is expected to add to the national debt. The bond vigilantes are back.

Institutional Risk Analyst author Chris Whalen gave a good analysis of FHFA Chairman Bill Pulte’s address to the MBA. Pulte discussed how Democrats (especially Elizabeth Warren) were complaining about the removal of members of the Board of Directors for Fan and Fred. ““The boards of the GSEs don’t have a fiduciary duty to the Enterprises,” he noted. “They have a fiduciary duty to the conservatorship.” He then went on to say that the boards were “fake” and slowed the management of the Enterprises because they have no real function so long as the GSEs are under government control.”

The Biden Administration had added “layers of bureaucracy” in their management of the GSEs. Pulte said that FHFA intends to undo this. “If its not in the law, not in the actual statute, then it needs to go. We will do what Congress has told us to do, but if its not in the law, then we are not going to do it. What has happened in the last many years is that the FHA Director came up with these ideas and they would try to legislate from the bench, so to speak.”

Pulte also indicated that any move to release the GSEs from conservatorship would come from Trump. He also indicated that manufactured homes should have a bigger role in creating affordable housing, given their $100k – $150k cost to build. That said, manufactured homes are hard to finance because the land underneath them is usually leased and these homes depreciate about 3% – 5% a year.

Meanwhile, Trump has said he is giving “very serious consideration” to privatizing Fan and Fred. In a post on Truth Social, he said “Fannie Mae and Freddie Mac are doing very well, throwing off a lot of CASH, and the time would seem to be right,” Trump said, without providing further details. The equity of the GSEs is probably around $350 billion or so, which the government would love to access. Raising that amount of equity would dwarf by magnitudes the largest IPOs ever, so that might be a bridge too far.

FHFA Director Bill Pulte is jawboning FICO about rising costs to pull credit.

Economic activity slowed in April, according to the Chicago Fed National Activity Activity Index, which is a meta-index of some 80+ economic indicators. Production and income indices (think the Fed manufacturing indices and ISM numbers) fell, probably due to tariffs. Employment was flat, while sales and consumption indicators fell modestly. The baseline in the index is historical trend growth, so a negative number does not mean a decline, just that the index numbers is below historical 3% (or so) growth.

In other economic news, Initial Jobless Claims fell to 227k from 229k. So far we are seeing little-to-no impact of the tariff shock in the labor market numbers.

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Vital Statistics:

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

The CPI report yesterday should have caused a rally in bond yields, but it didn’t. The business press is working overtime to associate the increase in inflation (from a 0.1% decrease in March to a 0.2% increase in April) to tariffs, but if you look at the detailed expenditure categories, you would be hard pressed to find evidence of tariffs in the expected categories:

• Apparel -0.2%
• New Vehicles 0.0%
• Toys 0.3%
• IT 0.3%
• Motor Vehicle Parts -0.1%
• Household furnishings and supplies 0.2%.
• Tools, hardware, outdoor equipment and supplies 0.1%

About half the increase in inflation last month was shelter, and that continues to moderate as the 20% increase in home prices in 2021 and 2022 fades into the background. Asking rents are also flatlining which means shelter’s days as a driver of inflation are largely over.

IMO the market is taking a wait-and-see approach to tariff-driven inflation, but so far the evidence of it is negligible-to-nonexistent, notwithstanding the wishcasting from the media.

Mortgage applications increased 1.1% last week as purchases rose 2% and refis fell .4%. “Last week saw steadier mortgage rates, as the FOMC meeting played as predicted, and market movements led to a small two-basis point increase in the 30-year conforming rate to 6.86 percent,” said Mike Fratantoni, MBA’s SVP and Chief Economist. “Refinance volume was little changed for the week, with a small increase in government refinances, and a decrease in conventional refinances. The news for the week was the growth in purchase applications, up 2.3 percent and almost 18 percent higher than last year’s pace. Despite the economic uncertainty, the increase in home inventory means there are additional properties to buy, unlike the last two years, and this supply is supporting more transactions.”

Mortgage delinquencies increased in the first quarter of 2025, according to the MBA. The delinquency rate of 4.04% increased 6 basis points from the fourth quarter and 10 basis points from a year ago. “There were mixed results for mortgage performance in the first quarter of 2025 compared to the end of 2024. Delinquencies on conventional loans increased slightly, while mortgage delinquencies on FHA and VA loans declined,” said Marina Walsh, CMB, MBA’s Vice President of Industry Analysis. “Foreclosure inventories increased across all three loan types, and particularly for VA loans. Despite certain segments of borrowers having difficulty making their mortgage payments, the overall national delinquency and foreclosure rates remain below historical averages for now.” 

Added Walsh, “The percentage of VA loans in the foreclosure process rose to 0.84 percent, the highest level since the fourth quarter of 2019. The increase from the previous quarter marks the largest quarterly change recorded for the VA foreclosure inventory rate since the inception of MBA’s survey in 1979.”

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Vital Statistics:

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

As expected the Fed maintained interest rates at current levels and highlighted the increased risks to the economy. “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Uncertainty about the economic outlook has increased further. The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”

Despite the negative GDP print in Q1, Powell was generally constructive on the economy: “Following growth of 2.5 percent last year, GDP was reported to have edged down in the first quarter, reflecting swings in net exports that were likely driven by businesses bringing in imports ahead of potential tariffs. This unusual swing complicated GDP measurement last quarter. Private domestic final purchases, or PDFP—which excludes net exports, inventory investment, and government spending—grew at a solid 3 percent rate in the first quarter, the same as last year’s pace.”

On the subject of tariffs: The new Administration is in the process of implementing substantial policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation. The tariff increases announced so far have been significantly larger than anticipated. All of these policies are still evolving, however, and their effects on the economy remain highly uncertain. As economic conditions evolve, we will continue to determine the appropriate stance of monetary policy based on the incoming data, the outlook, and the balance of risks. If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer term inflation expectations well anchored.”

Note that the market-based inflationary expectations are still well-anchored. This is reflected in TIPS breakeven inflation measures over a year out. Consumer sentiment surveys however see inflation returning to 2021 levels. There is a big partisan schism in that data, with Republicans more sanguine and Democrats more alarmed. If the consumer sentiment surveys are polling more Democrats than Republicans it would explain the difference between TIPS and survey data.

The Fed’s concern with inflationary expectations lies in the behavior it promotes in consumers and workers. If it causes consumers to buy more goods in order to beat the price increases, it could create shortages, which would increase prices (inflation). If it causes workers to negotiate higher salaries it would increase wage inflation. If it doesn’t cause these things then its effect is much more benign.

The biggest driver of inflation in 2021 and 2022 was shelter inflation as home prices rose some 20%. Given the affordability issues this time around, another gap up in home prices seems unlikely, especially since the Fed won’t be buying scads of MBS, pushing down rates.

The reaction in the Fed Funds futures was to further decrease the chance for a rate cut in June. The Fed Funds futures now see only a 17% chance of a 25 basis point rate cut. A couple of weeks ago, it was a better-than-50% chance. The December futures see 3 rate cuts this year, which means monetary policy will remain above r-star for the rest of the year.

The Bank of England cut its short term interest rate to 4.25%, making the US the highest interest rate economy of the big developed economies. Separately, Trump announced a trade deal with the UK is imminent.

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