All Things in Moderation

Vital Statistics:

Stocks are higher this morning after the jobs report. Bonds and MBS are flat.

Jobs report data dump:

• Nonfarm payrolls up 130,000, lower than expectations, and the ADP report
• Unemployment rate 3.7%, unchanged
• Labor force participation rate 63.2%, unchanged
• Employment-population ratio 60.9%
• Average hourly earnings up 0.4% MOM / 3.2% YOY, above expectations

Overall, a disappointing report given the big ADP number, but the ADP generally predicts the final numbers, which means this data probably gets revised upwards. The employment-population ratio continued to edge up, which is good, although we still are nowhere near pre-crisis levels. This indicates that wage growth will remain in a Goldilocks range: enough to beat inflation, but not too hot to worry the Fed.

The Trump Administration released its GSE reform plan. The plan states that ” the existing Government support of the secondary market should be explicitly defined, tailored, and paid-for, and the GSEs’ conservatorships should come to an end, subject to the preconditions set forth in this plan.” The government’s guarantee should “stand behind significant first-loss private capital and would be triggered only in exigent circumstances.” “Single-family guarantors should be required to maintain a nationwide cash window through which small lenders can sell loans for cash, and also should be prohibited from offering volume-based pricing discounts or other incentives to their lender clients.” The government support for the GSEs under the preferred stock purchase agreement would be replaced with an explicit, paid for guarantee backed by the US government for paying principal and interest on MBS. The plan would end (or at least modify) the “net worth sweep” which would allow the GSEs to rebuild capital. The GSEs would still have a role to promote affordable housing. FNMA stock is looking down about 6% on the open.

Michael Burry, of The Big Short fame, sees a bubble in indexing and passive investment ETFs. Passive investments now account for half of the stock market as more investors pile into these low-fee investment vehicles. “Trillions of dollars in assets globally are indexed to these stocks,” Burry said. “The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.” Certainly the leveraged ETFs – the triple long and triple short types – will become hopelessly illiquid in a market distortion. Burry runs a hedge fund, so he is talking his book a little but like all investment crazes, the more money that goes into the asset class, the more marginal each incremental trade becomes. Eventually, you might see a return to active stock management as they begin to outperform, especially small caps.

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Vital Statistics:

Stocks are up this morning after China and the US supposedly have scheduled an October meeting. Bonds and MBS are down on the risk-on trade.

We have quite a bit of strong data this morning, starting with the ADP jobs report, which came in at 195,000. This was much higher than the 149k the Street was looking for, and the 158k expected for tomorrow’s jobs report. This was the highest number in 4 months. Manufacturing added 8,000 jobs, so we aren’t seeing any sort of trade-driven pull-back in that sector. Construction added 6,000 jobs. Where are jobs shrinking? tech and mining.

Challenger and Gray released their layoffs report, which backed up the ADP report of job cuts in tech. The layoff report is based on press releases, not actual job cuts. US employers announced 53,480 job cuts last month, of which 10,000 were due to trade war issues. That said, most of the job cuts were in retail. “Employers are beginning to feel the effects of the trade war and imposed tariffs by the U.S. and China. In fact, trade difficulties were cited as the reason for over 10,000 job cuts in August,” said Andrew Challenger, Vice President of Challenger, Gray & Christmas, Inc. “We are continuing to see investor concerns shaking confidence in the market, and employers appear to be cutting workers in response to a slowdown in demand for their products and services,” he added.

In other economic data, productivity in the second quarter was unchanged at 2.3% and unit labor costs were revised upward to 2.6%. The Street was expecting a downward revision in productivity. Hourly compensation was revised upward to a 4.9% increase. Initial jobless claims came in at 216k.

We had a slew of Fed-speak yesterday, with a wide range of opinions, from John Williams of the NY Fed avoiding the dovish bent versus St. Louis President James Bullard advocating for 50 basis points. FWIW, the market is virtually unanimous in its forecast of a 25 basis point cut at the September 17-18 meeting.

Despite falling rates and rising home prices, bidding wars for properties hit an 8 year low in August, according to Redfin. “Despite remaining near three-year lows, mortgage rates have failed to bring enough buyers to the market to rev up competition for homes this summer,” said Redfin chief economist Daryl Fairweather. “Recession fears have been enough to spook some would-be buyers from making the big financial commitment of a home purchase. But assuming a recession doesn’t arrive this fall or winter, consumers will likely adjust to the new ‘normal’ of continued volatility in the stock and global markets, and the people who need and want to make a move will take advantage of low mortgage rates. As a result, I still expect homebuying competition to pick back up in the new year.”

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Vital Statistics:

Stocks are lower this morning on trade issues. Bonds and MBS are flat.

The holiday-shortened week ahead looks to be relatively quiet, with the exception of a spate of Fed-speak on Wednesday and the jobs report on Friday. The September Fed Funds futures are pricing in a 100% chance of another 25 basis point cut, and the Fed seems to be in market-following mode, so the data should take a backseat.

Manufacturing activity slipped in August, according to the ISM Manufacturing Survey, which came in at 49.1, well below expectations. This was the first contraction in the manufacturing sector since mid-2016. The level for the ISM typically corresponds with 1.8% GDP growth.

Separately, construction spending rose 0.1%, which was lower as well, however the previous month’s drop was revised upward from -1.3% to -.7%.

Home prices rose .5% MOM / 3.6% YOY in July, according to CoreLogic. Home price appreciation slowed in 2018 as rates rose. That effect will reverse over the next year, and Corelogic expects annual home price appreciation rates to settle in around 5%. Tight supply, especially amongst starter homes will support prices, as well as a robust labor market and a move out of urban areas to the suburbs. About 37% of the US housing stock in the top 100 MSAs is overvalued. This metric is based on wage growth and housing supply.

Hurricane Dorian is expected to miss direct landfall, however it is slow-moving and dumping a lot of rain. Coastal areas will be at risk of flooding as the storm parallels the Eastern Seaboard this week.

The WSJ has an interesting article this morning about thinning liquidity in the markets. Late summer is often characterized by thinning liquidity, which means fewer active investors are trading, which causes exaggerated market movements when a big buyer or seller wants to execute an order. They mention what has been going on in the Treasury market:

Some analysts point to high-frequency traders. They have dominated the government-bond market, making up a big chunk of trading activity compared with slower counterparts, according to JPMorgan analysts. These traders withdrew last month, the firm said, suggesting that they amplified turbulence. Investors said liquidity worries are even more pronounced in riskier corporate bonds.

“As you go further down the credit spectrum, it starts to get a bit more volatile,” said Gautam Khanna, a fixed-income portfolio manager at Insight Investment. “Liquidity is definitely thinner in this market than it has been.”

This might help explain why mortgage rates have lagged the move in Treasuries. In essence, high frequency traders help establish a liquid market, where it is easier for large investors such as banks, sovereign wealth funds, pension funds, etc to trade large positions. When these high frequency traders withdraw, bid / ask spreads widen, and volatility increases. Here is the issue: MBS investors hate volatility because it makes their portfolios hard to hedge, and adds uncertainty about prepayment speeds. This causes them to be more conservative with respect to the prices they are willing to pay for mortgage backed securities, which flows through to mortgage rates falling less than the move in Treasuries would predict. Below is a chart of 10 year Treasury futures volatility. You can see the spike in the index beginning in August, which corresponds with the dramatic drop in rates, and the exit of high frequency traders from the market.

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Vital Statistics:

Stocks are up ahead of the 3 day weekend. Bonds and MBS are flat.

No word yet from SIFMA regarding an early close, so assume the bond market is open all day.

Personal incomes rose 0.1% in July, which was a deceleration from the previous few months. June was revised upward from 0.4% to 0.5%. Disposable personal income rose 0.3%, and spending rose 0.6%, which came in above expectations. The core PCE index (the Fed’s preferred measure of inflation) rose 0.2% MOM and 1.6% YOY, which is below their 2% target. The headline PCE rose 0.2% / 1.4%.

Consumer sentiment fell in August according to the University of Michigan Consumer Sentiment Survey.

Pending Home Sales fell 2.5% in July, according to NAR. “Super-low mortgage rates have not yet consistently pulled buyers back into the market,” said Lawrence Yun, NAR chief economist. “Economic uncertainty is no doubt holding back some potential demand, but what is desperately needed is more supply of moderately priced homes.” Regionally, they declined 1.6% in the Northeast and fell 3.4% on the Left Coast.

As bond yields have fallen, mortgage rates have not kept up as investors have been sweating prepayment speeds in the MBS market. The biggest issues have been rate volatility, which negatively impacts mortgage backed security pricing, along with fears we are entering a new refinance cycle. Also, many mortgage bankers set their staffing levels for the year back in late 2018, when it looked like we were in a tightening cycle and volumes would be much lower. “Do not expect much, if any of a drop in mortgage rates in the coming weeks,” said Mitch Ohlbaum, president, Macoy Capital Partners in Los Angeles. “It’s not because they shouldn’t, it’s because the lenders are already beyond capacity with refinances and frankly do not want any more volume.” There is probably some truth to that, but that is fixable. The volatility in the Treasury market and convexity risk is killing MBS investors. The classic example of a MBS investor is Annaly, a mortgage REIT, which has gotten clocked this year and cut its dividend.

PIMCO is advising the Fed to “aggressively cut rates” given the recent economic data suggests a slowdown. Their point is that recent data is “understating” the extent of the slowdown. They raise the point that labor market momentum has decelerated more than forecasters were predicting. Of course, at 3.7% unemployment, we are pretty much at or close to full employment. Wages are generally a lagging indicator, but this morning’s personal income disappointment was partially driven by a decrease in asset income, which probably just reflects falling interest rates.

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Vital Statistics:

Stocks are up this morning after China said it wouldn’t immediately retaliate on tariffs set to take effect this weekend. Bonds and MBS are down.

The second revision to Q2 GDP was unchanged at 2.0%. Consumption drove the increase in GDP as durable goods consumption was up 13% and non-durables were up 7%. Core PCE inflation was unchanged at 1.7%. Despite the chronic housing shortage, residential investment was down again for the sixth straight quarter. Investment and trade made negative contributions to the index.

Initial Jobless Claims came in at 215,000 right in line with expectations.

The MBA reported that net gains per loan increased to $1,675, compared to $285 in the first quarter. This was the best number since the third quarter of 2016. “With anticipated increases in prepayment activity, we saw hits to servicing profitability resulting from mortgage servicing right markdowns and amortization,” Walsh said. “Nonetheless, the profitability on the production side of the business generally outweighed servicing losses.” Average pretax production profit rose to 64 basis points, while secondary marketing income fell to 287 basis points, down from 308 in the first quarter.

Treasury is looking at the idea of ultra-long term government bonds, with 50 or 100 year terms. “If the conditions are right, then I would anticipate we’ll take advantage of long-term borrowing and execute on that,” Mnuchin said in the Bloomberg News interview on Wednesday.

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Vital Statistics:

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

Global bond yields continue to head lower, and a larger percentage of the world’s sovereign yields are negative. Note that Germany has passed negative 70 basis points on the Bund, and France is not too far behind at negative 44 basis points. Japan is at negative 27 basis points. Even some of the ne’er-do-wells of Europe – Italy and Spain – have lower yields than we do. It is important to keep this chart in mind when you hear the business press push the “inverting yield curve means a recession is imminent” narrative. They inevitably ignore the fact that US bonds don’t trade in a vacuum and investors will sell negative yielding bonds to buy something positive.

Mortgage applications fell 6.2% last week as purchases fell 4% and refis fell 8%. Rates increased about 4 basis points for a 30 year conforming loan. Mortgage rates continue to lag the moves in the overall bond market. “U.S. Treasury yields were volatile over the course of the week, as the ongoing trade dispute between the U.S. and China continued to generate uncertainty among investors,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Rates increased for the first time since the week of July 12, but were still 80 basis points lower than the beginning of the year. With rates edging higher, refinances and purchase applications fell, at 8 percent and 6 percent, respectively.”

Consumer confidence remains elevated and close to record highs, according to the Conference Board. We are at levels last seen during the stock market bubble days of the late 90s, and the late 60s when we landed on the moon. Given the retail sales data, this could be one of the best holiday shopping periods in a long time.

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Vital Statistics:

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

Home prices rose 3% YOY and were flat MOM according to the Case-Shiller Home Price Index. “The southwest (Phoenix and Las Vegas) remains the regional leader in home price gains, followed by the southeast (Tampa and Charlotte). With three of the bottom five cities (Seattle, San Francisco, and San Diego), much of the west coast is challenged to sustain YOY gains. For the second month in a row, however, only Seattle experienced outright decline with YOY price change of -1.3%. The U.S. National Home Price NSA Index YOY price change in June 2019 of 3.1% is exactly half of what it was in June 2018. While housing has clearly cooled off from 2018, home price gains in most cities remain positive in low single digits. Therefore, it is likely that current rates of change will generally be sustained barring an economic downturn.”

Meanwhile, houses with conforming loans rose 5% on a YOY basis, according to the FHFA House Price Index. The previously hot markets on the West Coast are cooling, although if you focus on homes at the lower price points, they are still up YOY. Note that many of these indices are looking at data that is a couple of months old. Prices aren’t yet taking into account the big recent drop in rates.

The Trump Administration is set to release its plan on dealing with Fannie and Fred just after Labor Day. The government is eager to shrink its involvement in the mortgage industry and the concern is that asking the GSEs to hold bank-like capital levels will raise costs for homebuyers. The government is likely to reduce the GSE’s footprint by limiting the types of loans they can purchase – especially second homes and cash-out refinances. Another issue is the explicit government guarantee for MBS issued by Fannie and Fred, which will require Congressional involvement. “The report is likely going to have a lot of language about embracing congressional reform and reducing the GSE footprint, which most market participants support. But if the real intent is to end conservatorship administratively, then the MBS market will react very negatively,” said Michael Bright, chief executive of the Structured Finance Association. What that means is that if the Administration privatizes the GSEs without maintaining the government backstop, then MBS prices will fall, and that will raise mortgage rates at the margin.

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Vital Statistics:

Stocks are higher after Trump toned down the rhetoric with China at the G7. Bonds and MBS are flat.

Both the US and China made statements intended to de-escalate the trade war, which is adding a spring in the step of the S&P futures. China supposedly wants to get back to “calm” negotiations, while Trump has mused over canceling the recent new tariffs. On Friday, Trump ordered US companies to start looking for alternatives to China, which he doesn’t really have the power to do. S&P futures sold off on Friday afternoon, and bond yields fell. That said, the market do seem to be adjusting to Trump thinking aloud on Twitter.

Durable Goods orders increased 2.1% in July, which was way more than expectations. Nondefense capital spending ex aircraft (which is a proxy for corporate capital expenditures) rose 0.4%, much higher than the decrease the Street was looking for. For all the handwringing in the business press over the state of the economy and trade, it isn’t showing up in the numbers, at least not yet.

The upcoming week looks to be relatively non-eventful, with only some meaningful data late in the week – the second revision to Q2 GDP on Thursday, and personal income / spending data on Friday. Another rate cut seems baked into the cake for September, so a strong number probably won’t have that big of an impact on markets.

The spread between adjustable-rate mortgages and fixed rate mortgages has been contracting as the yield curve has flattened. This is because the difference in long term rates and short term rates has fallen. Currently the difference between a 30 year fixed and a 5/1 ARM is about 55 basis points, whereas it was closer to 100 basis points during the post-bubble era. If you only plan on living in your home for 5 years or so, ARMs generally make sense, however if you can lock in your rate for 30 years at a similar rate to an ARM, it doesn’t make sense to go adjustable.

Regulators are thinking about raising the threshold where homes require an appraisal, from 250,000 to 400,000. This would be the first increase in the threshold since 1994. About a year ago, the FDIC, OCC and Fed released a proposal which would make the change, and the FDIC just published the final rule.

SUMMARY: The OCC, Board, and FDIC (collectively, the agencies) are adopting a final rule to amend the agencies’ regulations requiring appraisals of real estate for certain transactions. The final rule increases the threshold level at or below which appraisals are not required for residential real estate transactions from $250,000 to $400,000. The final rule defines a residential real estate transaction as a real estate-related financial transaction that is secured by a single 1-to-4 family residential property. For residential real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

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Vital Statistics:

Stocks are lower as we await Jerome Powell’s speech in Jackson Hole. Bonds and MBS are flat.

Jerome Powell speaks at 10:00 am, while the markets are looking to see if the Fed trims its sails to what the Fed Funds futures are saying. Some at the Fed have been throwing cold water on the idea that we have entered an easing cycle, but in an era of negative sovereign yields worldwide the die is probably cast for lower rates regardless of what the Fed does.

New Home Sales fell to 635,000 from an upwardly-revised 728,000 in June. They are up over 4% from a year ago.

The Conference Board Index of Leading Economic Indicators improved last month. “The US LEI increased in July, following back-to-back modest declines. Housing permits, unemployment insurance claims, stock prices and the Leading Credit Index were the major drivers of the improvement,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “However, the manufacturing sector continues exhibiting signs of weakness and the yield spread was negative for a second consecutive month. While the LEI suggests the US economy will continue to expand in the second half of 2019, it is likely to do so at a moderate pace.”

Note that China imposed additional tariffs on $75 billion of US goods overnight. The tariffs would apply to soybeans, small aircraft, and crude oil.

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