Morning Report: Existing home sales fall 10/20/17

Vital Statistics:

Last Change
S&P Futures 2565.8 5.3
Eurostoxx Index 390.2 1.1
Oil (WTI) 51.0 -0.3
US dollar index 86.7 0.2
10 Year Govt Bond Yield 2.35%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.9

Stocks are higher after the Senate passed a budget resolution which allows tax reform to go forward. Bonds and MBS are down.

Existing Home Sales increased 0.7% in September, according to the National Association of Realtors. This is down 1.5% YOY. September’s number was only slightly higher than August, which was the lowest reading in a year. The median home price rose 4.2% to 245,100. Inventory is still a big problem, down YOY at 4.2 month’s worth from 4.5 a year ago. The first time homebuyer was 29% of sales, which was a drop. There is a complete dearth of listings at the low end of the market.

The Senate passed a budget resolution last night on party lines (with Rand Paul voting against) which allows tax reform to go forward on a simple majority. There are still a couple of differences between what the House and Senate are willing to accept. The House wants to see revenue-neutral tax reform, while the Senate is willing to accept an increase in the deficit. The House version includes spending cuts to offset the tax cuts, while the Senate version envisions additional revenue from allowing more oil production in Alaska. They hope to have a deal by the end of the year.

General Electric missed earnings badly this morning, however this appears to be a bit of a kitchen sink release for the new CEO. Regardless, the stock is down 6% this morning. GE historically has been a bellwether for the entire stock market, but today the FAANGs run the show.

The next Fed nominee is reportedly a horse race between Jerome Powell and John Taylor. Trump is expected to make his announcement in the next couple of weeks. Insiders say that Powell is the favorite of the two. Both nominees are more hawkish than Janet Yellen, which means rates will go up faster and higher, at least at the margin. In all honesty, the practical differences between Yellen and these nominees is not all that large. It probably won’t make any difference to the economy.

The increasing digitization of real estate transactions has increased the risk of fraud. Scammers are issuing emailed instructions to change wire transfer destinations on closing day. The best step buyers can take is simply to be aware of the potential for fraud and to verify everything, especially changes in wiring instructions.

The latest CoreLogic Market Pulse takes a look at the effects of the hurricanes on local real estate markets. They estimate that 70% of the flood damage in the Houston area is uninsured. This will be a nightmare for loan servicers. Separately, Black Knight Financial Services is seeing about a 9% jump in past-due mortgages due to the hurricanes. In fact, September had the first year-on-year increase in delinquencies since 2010.

Morning Report: Reflections on the Crash of 1987 10/19/17

Vital Statistics:

Last Change
S&P Futures 2547.0 -13.0
Eurostoxx Index 388.1 -3.5
Oil (WTI) 51.2 -0.9
US dollar index 86.5 -0.2
10 Year Govt Bond Yield 2.31%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.9

Stocks are lower this morning on overseas weakness. Bonds and MBS are down small.

Initial Jobless Claims fell to 220,000 last week which was the lowest since we still had a military draft. If you correct for population growth, the number is even more impressive. Note that last week included the Columbus Day holiday, so the number should be taken with a grain of salt.

The Conference Board Index of Leading Economic Indicators slipped in September for the first time in a year as hurricanes depressed activity. The main source of weakness was in the labor market and residential construction.

The Fed’s Beige Book summary of economic conditions reported that activity was between “modest” and “moderate” for all of the 12 districts in September. Hurricane-related disruptions were reported as a drag on the economy. The labor market remains tight, with shortages in many industries, including construction, health care, and transportation. While wage growth overall remains soft, we are seeing some evidence of wage pressure increasing in these areas, as firms are adding signing bonuses, overtime, and other non-wage benefits.

The trend of larger houses and smaller outdoor spaces is being reversed, as materials costs are making larger homes unaffordable for many buyers. The average square footage of outdoor space has increased 7,048 square feet. Yard sizes peaked in the mid 70s, at around 12,000 feet before bigger and bigger houses became the norm. Since 1973, the average size of a single family home increased 62% to 2,467 square feet.

For an example of rising materials costs (aka sticks and bricks) here is a chart of lumber futures going back to the mid 80s. We are at prices not seen since the bubble.

lumber futures

You see some of this in the suburbs of Manhattan, where luxury homes languishThis home was first listed at $17.35 million in 2 years ago, cut to $11.5 million and still hasn’t sold. It was taken off the market in September. All real estate is local, and the Northeast is pretty much the opposite of the West Coast, where demand is overwhelming supply.

Brian Montgomery, Donald Trump’s nominee to run the FHA, represented banks for years, helping them fight penalties imposed by the agency. Many on the left are worried that he will be unable to think solely from the perspective of the public interest. The government wants to see more FHA lending, but the Obama Administration’s use of the False Claims Act (which awards treble damages) has driven the business to smaller non-bank lenders. HUD Chairman Ben Carson recognizes the issues with FHA lending, and wants to see a more balanced approach.

Today is the 30 year anniversary of the Crash of 1987, where markets fell 23% in one day. Many people blamed program trading and wonder if the same thing could happen today as high frequency traders dominate the market. That is certainly a possibility, however high frequency traders usually step away from the markets once volatility kicks up, so they probably wouldn’t force stocks down, the way portfolio insurance did in the mid 80s. The biggest risk today is that liquidity will vanish at the worst possible time. Technology and regulation have reduced stock trading commissions and bid / ask spreads to almost nothing, and have driven the market-maker and stock specialist (the “traffic cops” who helped maintain an orderly market) out of business.  IMO, flash crashes we have seen will probably be the model this time around, where volume becomes so light that a few market sell orders can drive stocks down to nothing. We saw this happen before, where well-known, profitable and solvent companies were driven to a penny a share. The next crash will be an interesting test whether exchange traded funds are all they are cracked up to be as well, especially if we see a big divergence between NAV and trading prices.

The Crash of 87 also ushered in the Greenspan Put, which got its name after Fed Chairman Alan Greenspan assured the markets that the Fed stood by ready to provide liquidity as needed in the aftermath of the crash. This probably prevented the crash from turning into a wholesale financial crisis, however that policy became more or less codified to where the Fed began to ease whenever asset markets had a hiccup. It prevented a recession in the mid-90s, which could have occurred after any one of financial hiccups, whether the MBS implosion in 1994, Long Term Capital Management, or the Asian Financial Crisis. The idea that the Fed would save the day with interest rate cuts or more liquidity whenever asset prices fell became known as the Greenspan Put, which had the effect of lowering risk premiums and making investors more willing to pay high multiples or earnings. Stocks became a “can’t miss” proposition. (Remember the talking heads on CNBC? Don’t worry about P/E ratios – just buy “quality” companies.) The poster child of this theory was Cisco Systems, which hit a high of over $77 a share in early 2000 and is less than half that today, over 17 years later.

Cisco

The Greenspan Put also set the stage for the residential real estate bubble of the mid 00s. Years of easy money found its way into different asset classes, especially the residential real estate market. Nobody wanted to talk about Cisco any more, they were too busy flipping condos in Las Vegas. Rock bottom interest rates had investors reaching for yield, which made for an insatiable appetite for mortgage backed securities. We all know how that ended. And even today, people are willing to tie up their money for 30 years lending to the US government at 2.8% while we have a Federal reserve hell-bent on creating inflation. Or they are invested in auto asset backed securities, lending for 8 years at 3.2% for an asset that depreciates like sushi. It is strange to think how this state of affairs was largely the unintended consequence of well-intentioned Fed policy in the aftermath of the Crash of 1987.

Morning Report: Housing starts fall 10/18/17

Vital Statistics:

Last Change
S&P Futures 2561.0 4.0
Eurostoxx Index 392.0 1.5
Oil (WTI) 52.1 0.2
US dollar index 86.8 0.2
10 Year Govt Bond Yield 2.33%
Current Coupon Fannie Mae TBA 102.96
Current Coupon Ginnie Mae TBA 104.188
30 Year Fixed Rate Mortgage 3.86

Stocks are lower on no major news. Bonds and MBS are down small.

Housing starts fell in September, as hurricane effects probably had an effect. Starts fell 4.7% from August, but are up 6.1% on an annual basis. Weather probably doesn’t explain all of it, however as building permits were also down on month-over-month basis. Permits were also down on year-over-year basis. Housing starts fell in the North, South, and Midwest, but rose in the West. Permits rose in the Northeast and Midwest and fell in the South and West. We should probably see some improvement in these numbers as the flood waters recede and people rebuild.

Mortgage applications rose 3.6% on an adjusted basis for the holiday-shortened week. Purchases rose 4% while refis rose 3%. The MBA said that mortgage rates decreased by 2 basis points overall last week. This was the first increase in the applications index in over a month.

Treasury Secretary Steve Mnuchin predicts the stock market will slump if tax reform isn’t passed this year. Since Democrats are uniformly against tax reform, it will have to be modest in order to pass it under a straight majority in the Senate. “There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done,” Mnuchin said in the “Politico Money” podcast interview. “To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done you’re going to see a reversal of a significant amount of these gains.” Note that there are some procedural hurdles to get this done. It all comes down to earnings. If there are no changes in taxes at the corporate level, then the forward earnings estimates are too high, which means the multiple is higher than people think.

The Senate has a tentative deal to save Obamacare and the cost reduction subsidies, however the White House is lukewarm on it, and many in the House are outright hostile to anything that props up Obamacare.

Trump is expected to name his nominee to be the next Fed Chairman by early November. The expected nominees are John Taylor, Kevin Warsh, Gary Cohn, Jerome Powell, or Janet Yellen. Trump meets with Yellen this week. Note a Reuters poll of economists think Powell will get the nod.

One puzzling aspect of the current economy is the labor market and the lack of wage growth. Theory says that if the unemployment rate is as low as it is now, we should be seeing bidding wars for workers and general wage hikes across the board. The leading indicator for wage growth – the JOLTS quit rate – has been flat for 2 years. What is going on? The first (and biggest) is that the unemployment rate is sending a false signal about how tight the labor market is. While there is some tightness in the labor force, particularly in skilled labor, most people are not in the hot sector, and are reluctant to leave. Second, many could still be trapped in homes with negative equity, unable to move to where the jobs are. And finally, many are just not willing to move, for whatever reason. I think the answer is the first one: Our unemployment rate stops counting the unemployed at 6 months, which may have been a reasonable thing to do 30 years ago, but not today. The employment to population ratio is probably a better indicator. And according to that, we still have a ways to go. Note that demographic trends will play a part here as well. The low ratios in the 50s and 60s are explained by a lack of women in the labor force. And some of the drop in recent years is due to the retirement of the baby boomers, however their kids (the Millennials) should be replacing them.

employment to population ratio

Morning Report: Taylor for Fed Chairman? 10/17/17

Vital Statistics:

Last Change
S&P Futures 2555.0 -1.3
Eurostoxx Index 391.2 -0.2
Oil (WTI) 52.1 0.2
US dollar index 86.7 0.2
10 Year Govt Bond Yield 2.31%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.86

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

Neel Kashkari speaks at 10:00 am. The Fed funds futures are pricing in a 93% chance of a rate hike at the December meeting.

Industrial Production increased 0.3% in September as the effects of the hurricanes probably depressed the number by 0.25%. Capacity Utilization rebounded from August but is still lower than where it has been most of the year. Manufacturing capacity utilization is around 75%, which is 3% below its longer-term average.

Small business optimism fell in September, as the hurricanes in Florida and Texas took their toll. Job creation fell during the month by .17 workers per firm. We saw firms cutting workers in most census divisions, so this isn’t just a hurricane effect. That said, 19% of firms listed “difficulty in finding qualified workers” as their single most important business problem. This was the second overall issue, with the highest being taxes. Access to credit remains a non-problem as only 1% said their credit needs were not being met. Overall, sentiment declined from a historically high level.

Donald Trump met with John Taylor yesterday, and came away very impressed. Kevin Warsh had been seen as the front-runner, however he has attracted criticism from economists on the left, particularly Paul Krugman. Taylor is known for the Taylor Rule which sets the proper Fed Funds rate based on what his model tells him. He is probably more hawkish than Warsh, and certainly more than Janet Yellen, who Trump will interview this week. A Reuters poll of economists has Jerome Powell as the most likely choice.

Tax reform has the potential to make the mortgage interest deduction irrelevant for most homeowners. Note that many articles will breathlessly say the MID is “threatened,” however in reality it will just become irrelevant, as the standard deduction will increase and most people will be better off taking the standard deduction instead of itemizing. You can’t really call it “threatened.” Currently about 30% of the homes in the US are valuable enough to take the MID. Under tax reform, that number should drop to 5%, according to Zillow.

A warning? Credit card delinquencies have risen for the third month in a row, as lenders have pushed the envelope credit-wise to increase revenues. Both JP Morgan and Citi reported 14%-15% increases in DQs for the third quarter.

The Census Bureau reported that building permits for the first 8 months of the year are up 7.5% compared to the first 8 months of 2016. Where are the most expensive places to build? The Left Coast, where it costs roughly $164 a square foot to build a spec house. The national average is $101. New England is second at $147, while the cheapest is the West South Central (TX, OK, AR and LA) at $81 a square foot.

A trailer in New York City just went for $150,000.

Morning Report: Janet Yellen is constructive on the economy 10/16/17

Vital Statistics:

Last Change
S&P Futures 2554.8 2.0
Eurostoxx Index 391.7 0.3
Oil (WTI) 52.3 0.8
US dollar index 86.4 0.1
10 Year Govt Bond Yield 2.90%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.86

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

Janet Yellen discussed the strong economy on Sunday, and again hinted that we will see another rate hike in December. The hurricanes will probably depress growth slightly, but the economy should rebound by year’s end. The consumer is still pretty strong, according to Friday’s retail sales report. Persistently slow inflation has been a surprise, however.

Manufacturing was strong in the NY area according to the Empire State Manufacturing Survey. The index came in at 30, which is the highest reading in 3 years. An increase in shipments and hiring drove the increase, which is one data point that shows the increase in sentiment indicators is actually translating into more business.

Boston Fed President Eric Rosengren thinks we might see 3-4 rate hikes in 2018. This assumes that employment continues to rise and inflation begins to pick up. Friday’s consumer price index report was weak, however with core inflation rising 0.1% MOM and 1.7% YOY, below the Fed’s 2% inflation target.

This week is the 30 year anniversary of the Crash of 87, and given the run up in the market, people are looking for another one. A lot will depend on earnings season, which is just starting. Given that the market is now dominated by high frequency traders that basically turn off their machines once volatility spikes you could see selling into a vacuum. Cheap commissions and sub-penny bid/ask spreads have pretty much eliminated the market-makers and the NYSE specialist from the game.

Average home sizes are falling in the US after rising for pretty much 3 decades. The average square footage decreased to 2420 square feet from the record of 2520 set in 2015. The Baby Boomer McMansion trend has run its course and builders are beginning to focus on starter homes in order to attract the Millennials.

Morning Report: JP Morgan kicks off earnings season 10/12/17

Vital Statistics:

Last Change
S&P Futures 2549.3 -3.8
Eurostoxx Index 389.9 -0.3
Oil (WTI) 50.6 -0.7
US dollar index 86.5 0.1
10 Year Govt Bond Yield 2.35%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.9

Stocks are lower as third quarter earnings season begins with results from the banks. Bonds and MBS are flat.

JP Morgan reported better than expected earnings this morning, posting a 7% increase in net income. Higher lending revenues offset lower trading revenues. Mortgage origination was flat YOY, but revenue dropped 17%, which means margins are falling. The stock is flat pre-open.

Initial Jobless Claims came in at 243k last week, historically a very low number. For those wondering about places like Puerto Rico, their number is estimated.

Wholesale inflation remains close to the Fed’s target rate of 2%, according to the Producer Price Index. The PPI rose 0.4% MOM and 2.6% YOY, however if you strip out food, energy, and trade services, it rose 0.2% MOM and 2.1% YOY.

The FOMC minutes really didn’t provide much in the way of additional information. There was some discussion that low inflation might not just be a temporary phenomenon, which was interpreted as dovish by some observers. The 10 year didn’t react to the minutes, but the dollar sold off a tad. The December Fed Funds futures decreased the implied probability of a rate hike by a couple points.

Kevin Warsh is now the favorite of economists to run the Fed after Janet Yellen’s term. He is a Wall Street type who worked for Morgan Stanley during the crisis and has been critical of monetary policy since then. He is generally regarded as more hawkish than Yellen, and will definitely be less of a regulatory hawk than she is. Paul Krugman (Dr. Cowbell) threw a little shade Warsh’s way.

Donald Trump is re-thinking the state and local tax deduction after it turns out that about 30% of people making between 50k and 150k a year could be hit with a tax increase under the new plan. The state and local tax deduction (along with the mortgage interest deduction) are two immensely popular deductions which have managed to survive numerous assaults over the years. House Republicans in blue states, like Peter King of NY, will not support tax reform if it means giving many of their constituents a tax hike. If the state and local tax deduction remains, something else has to give, which will probably mean the estate tax (something loathed by the right) remains.

Congress is preparing legislation to subject the credit bureaus to Federal cybersecurity inspections, and to end the use of social security numbers in credit reporting by 2020. The bill will also require the credit agencies to provide free credit freezes.

How tight is the housing market? So tight that people will put up with living in haunted houses.

Morning Report: Awaiting the FOMC minutes 10/11/17

Vital Statistics:

Last Change
S&P Futures 2545.8 -2.8
Eurostoxx Index 389.4 -0.8
Oil (WTI) 50.9 -0.1
US dollar index 86.5 -0.1
10 Year Govt Bond Yield 2.35%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.9

Stocks are lower this morning as we await the FOMC minutes. Bonds and MBS are flat.

There were 6.1 million job openings at the end of August, little changed from the prior month. The quits rate (which is a number the Fed watches closely) was unchanged at 2.1%. The quits rate is a leading indicator for wage growth.

Chicago Fed President Charles Evans said yesterday that a December hike is not a sure thing, and that he hoped for an “honest discussion” on whether it was time to hike rates again. He said the Fed should not treat the 2% inflation target as a ceiling, and should be comfortable with higher than 2% inflation given that it has undershot the target for so long. He was also bullish on the economy in general: “Global growth has really solidified,” which has helped the U.S. economy, he said. “I suspect the wage story is improving.”

The FOMC minutes will be released at 2:00 PM EST today. They probably won’t be market-moving, although we could see some adjustment in the December rate hike probabilities, which currently stands at a 93% chance of a rate hike.

Mortgage applications fell 2.1% last week as purchases fell .1% and refis fell 4%. Mortgage rates increased 4 basis points to 4.16%.

Donald Trump plans to adjust his tax reform plan over the next few weeks. With Democrats uniformly in opposition, Republicans have a narrow path to get this across the line. The issue with the tax plan is that it could raise taxes for people in the $50k-$150k range who live in high tax states. There are enough Blue State Republicans in the House to kill it. In the Senate, Trump has a strained relationship with Bob Corker and John McCain, which means he has no margin for error. Rand Paul has also said that any tax hikes on middle and upper middle class incomes is unacceptable. Tax reform is looking like a long shot, especially since 2018 will be all about posturing for midterms.

Blackrock’s Larry Fink said that his biggest fear is an over-aggressive Fed. He considers this to be a low-probability event, however. His fear is that we could see an inversion of the yield curve, which happens when longer-term interest rates are lower than shorter term interest rates. Historically, that has been a recessionary signal. It is more than a theoretical possibility: the yield curve almost always flattens during a tightening cycle, and the technical mechanics of unwinding QE also would encourage the curve to flatten. What does that mean for mortgage rates? Probably nothing, but at the margin it would favor 30 year fixed rate mortgages over ARMs.

CoreLogic estimates that 172,000 homes could be at risk from the wildfires in Napa and Santa Rosa. Mother Nature has made life miserable for servicers this fall, however the effects probably won’t begin to be felt until the end of the year.

Canada is trying to figure out what to do with their housing bubble. The median house price in Vancouver is currently at 1.6 million (or about 20x income). To put that number into perspective, the US bubble peaked at 4.8x. Vancouver’s market is probably tied most closely to China’s and will burst once that one does.

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