All Things in Moderation

Vital Statistics:

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

Companies announced 45,510 job cuts in November, according to the Challenger, Gray and Christmas Job Cut Report. This is a 24% increase from October, but is down 41% from a year ago. Year-to-date, job cut announcements are up 11% compared to a year ago.

“The job market is loosening, and employers are not as quick to hire. The labor market appears to be stabilizing with a more normal churn, though we expect to continue to see layoffs going into the New Year,” said Andrew Challenger, labor expert and Senior Vice President of Challenger, Gray & Christmas, Inc.

Tech is the biggest sector cutting jobs, followed by retailers and healthcare. Year-to-date, hiring plans are the lowest since 2015, and seasonal hiring is the lowest in 10 years.

This year has been been the least affordable for housing on record, but it looks like 2024 will be better, according to Redfin. The typical homebuyer earning the median income would have to spend 41% of their income on housing costs to buy the median home. Blame a combination of rising home prices in 2021 and 2022 along with soaring mortgage rates.

“A perfect storm of inflation, high prices, soaring mortgage rates and low housing supply caused 2023 to go down as the least affordable year for housing in recent history,” said Redfin Senior Economist Elijah de la Campa. “The good news is that affordability is already improving heading into the new year. Mortgage rates are coming down, more people are listing homes for sale, and there are still plenty of sidelined buyers ready to take a bite of the fresh inventory. We expect these conditions to continue to improve in 2024.”

The share of median income varies widely by MSA, with California cities like San Francisco requiring 85%, and Midwest cities like Detroit requiring only 18%.

Initial Jobless claims ticked up 1,000 to 220k. On an unadjusted basis they rose by 94k to 294k. It appears that the job market is really a tale of two markets: white collar jobs, where hiring is sluggish and skilled labor where there is still a shortage of workers.

Blackstone Mortgage Trust (BXMT) is a mortgage REIT that focuses on commercial mortgage backed securities and can be seen as kind of a proxy for the problems in commercial real estate. One big short seller is targeting the stock as credit losses are looking to be picking up. As this stock goes, so goes the pain in the banking sector and possible rate cuts.

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Vital Statistics:

Stocks are lower after Moody’s cut China’s debt outlook. Bonds and MBS are up.

Job openings fell to 8.7 million in October, according to the JOLTS report. This was well below Street expectations of 9.4 million. The job openings rate fell to 5.3%, which is down 0.3% MOM and 1.1% YOY. The quits rate was flat at 2.3%.

Job openings fell in health care / social assistance and finance.

Despite the drop in job openings, the ISM Services index expanded at a faster rate in November. “The services sector had a slight uptick in growth in November, attributed to the increase in business activity and slight employment growth. Respondents’ comments vary by both company and industry. There is continuing concern about inflation, interest rates and geopolitical events. Rising labor costs and labor constraints remain employment-related challenges.”

Tappable equity has returned to close to its 2022 peak, according to data from Black Knight. “Despite the resurgence in tappable equity among U.S. mortgage holders, elevated interest rates are making homeowners reluctant to extract that wealth,” Walden said. “Indeed, in recent quarters, equity withdrawal rates have been running at less than half their long-run averages. Mortgage holders extracted a mere 0.41% of tappable equity available at the beginning of Q3. That’s some 55% below the average withdrawal rate seen in the 12 years leading up to the Fed’s most recent tightening cycle. That’s equivalent to $54 billion – $250B over the last 18 months – in ‘missing’ withdrawals that might have otherwise stimulated the broader economy.”

The large amount of equity in homes is also contributing to the low delinquency rate, as troubled borrowers often have 20% equity in their homes and can simply sell the property and move on.

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Vital statistics:

Stocks are lower this morning as we await two speeches from Jerome Powell. Bonds and MBS are down.

Nick Timaros of the WSJ (one of the journalists most plugged in to what the Fed is thinking) says that the hiking cycle is probably over, however the Fed is reluctant to say so. They are even more reluctant to discuss any sort of rate cuts. The fear is that declaring victory too early while the economy is growing and the labor market is tight risks a credibility issue if inflation resurges.

That said, Fed Governor Waller discussed how the Fed could start cutting rates yesterday, saying that as inflation falls, the real rate of interest increases even if the Fed Funds rate stays the same. You can see that in the chart below, which subtracts the annual CPI from the Fed Funds rate.

Right now, the real Fed Funds rate is the highest it has been since 2007, which means monetary policy is pretty restrictive. In March of 2022, the real rate of interest was -8.3%, which is a record. Prior negative rate lows were -4.8% in 1980 and -5% in 1975.

The December Fed Funds futures are pricing in a 0% chance for a rate hike. The March Fed Funds futures are now close to a 50-50 chance for a 25 basis point rate cut.

The US manufacturing sector contracted again in November, according to the ISM Manufacturing Index. “The U.S. manufacturing sector continued to contract at the same rate in November as compared to October, again posting a reading of 46.7 percent. Companies are still managing outputs appropriately as order softness continues.”

“Demand remains soft, and production execution is slightly down compared to October as panelists’ companies continue to manage outputs, material inputs and — more aggressively — labor costs. Suppliers continue to have capacity. Sixty-five percent of manufacturing gross domestic product (GDP) contracted in November, down from 75 percent in October. More importantly, the share of sector GDP registering a composite PMI^® calculation at or below 45 percent — a good barometer of overall manufacturing weakness — was 54 percent in November, compared to 35 percent in October and 6 percent in September. Three of the top six industries by contribution to manufacturing GDP were at or below 45 percent, same as the previous month,” says Fiore.

One of the respondents said the economy is “slowing dramatically.”

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Vital Statistics:

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

House prices rose 0.6% in September, according to the FHFA House Price Index. On an annualized basis, they grew 5.5%. “U.S. house price growth continued to accelerate in the third quarter, appreciating more than in each of the previous four quarters,” said Dr. Anju Vajja, Principal Associate Director in FHFA’s Division of Research and Statistics. “House prices rose in the third quarter in all census divisions and are higher than one year ago, driven primarily by a low supply of homes for sale.”

Applying the 5.5% (actually 5.45%) increase gives us an expected conforming loan limit for 2024 of $765,800. FHFA should make the official announcement in the next week or so.

Home prices rose 2.5 MOM, according to the Case-Shiller Home Price Index, setting a new record. “On a year-to-date basis, the National Composite has risen 6.1%, which is well above the median full calendar year increase in more than 35 years of data. Although this year’s increase in mortgage rates has surely suppressed the quantity of homes sold, the relative shortage of inventory for sale has been a solid support for prices. Unless higher rates or exogenous events lead to general economic weakness, the breadth and strength of this month’s report are consistent with an optimistic view of future results.”

The rally in the bond market has caused the yield curve to steepen its inversion. The 10 year minus the 3 month is -110 basis points, which is less inverted than last spring, but it is a signal that the soft landing / no landing narrative of early fall is fading.

We are starting to see some more casualties in the real estate space. Unicorn real estate company Veev, a maker of modular homes, is reportedly closing up shop. The company had raised $600 million in total, but was unable to raise any more and cannot service the current debt nor can it move the merchandise.

Consumer confidence improved in November, according to the Conference Board. “Assessments of the present situation ticked down in November, driven by less optimistic views on current job availability, which outweighed slightly improved views on the state of business conditions. More consumers said that business conditions were ‘good’ compared to last month, but more also said they were ‘bad.’ Regarding the employment situation, more consumers said that jobs were ‘plentiful’ compared to October, but the number saying jobs were ‘hard to get’ also increased. By contrast, when asked to assess their current family financial conditions (a measure not included in calculating the Present Situation Index), the share reporting ‘good’ rose, and those citing ‘bad’ fell, suggesting consumer finances remain healthy heading into the holiday season.”

Inflationary expectations ticked down from 5.9% to 5.7%, which is a lot higher than U-Mich and breakeven inflation rates in the TIPS market.

There has been a lot of chatter about what to make of the big decline in median new home prices. The median new home price fell 18% compared to a year ago. Does this mean that homebuilders are cutting prices to move the merchandise? And if so, does this portend a big decline in home prices overall?

First of all, median home prices are not necessarily comparable on a year-over-year basis. If a builder sells a bunch of McMansions in one year, and then sells a bunch of starter homes in the next year, the median price is going to fall, but that is due to a change in the product mix, not necessarily market weakness.

There were 439,000 new homes for sale at the end of October, which represents 7.8 months worth of inventory. Historically, 7.8 months represents an oversupplied market, but the overall supply / demand balance in the US is skewed towards undersupply, not oversupply.

The wild card is prices are falling in the previously hot West Coast and Sun Belt markets, and there probably is some localized price cutting happening. Think places like Phoenix, Las Vegas, Austin. That said, if builders were aggressively cutting prices, it would show up in lower gross margins, and that isn’t happening.

So do I think the decline in median new home prices signals overall home price weakness going forward? No.

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Vital Statistics:

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

Markets will close early today, and liquidity should be sparse.

European Central Bank President Christine Lagarde said the ECB can take a pause and observe. “We have already done a lot,” Lagarde said. “Given the amount of ammunition we have used, we can observe very attentively the components of our lives like salaries, profits, like fiscal, like geopolitical developments and certainly the way in which our ammunition is impacting our economic life to decide how long we have to stay there and what decision we have to make”

The national mortgage delinquency rate fell 3 basis points to 3.26%, according to the Black Knight Mortgage Monitor. Active foreclosure inventory rose to 217k, which is well below pre-pandemic levels. Prepays fell to 0.43%.

More evidence that the economy is slowing: The S&P Flash PMI showed the economy barely expanding, with employment falling. US companies cut workers for the first time since June 2020.

“The US private sector remained in expansionary territory in November, as firms signalled another marginal rise in business activity. Moreover, demand conditions – largely driven by the service sector – improved as new orders returned to growth for the first time in four months. The upturn was historically subdued, however, amid challenges securing orders as customers remained
concerned about global economic uncertainty, muted demand and high interest rates. Business uncertainty was also heightened among US firms, as expectations regarding the year-ahead outlook slipped to the weakest since July.

“Businesses cut employment for the first time in almost three-and a-half years in response to concerns about the outlook. Job shedding has spread beyond the manufacturing sector, as services firms signalled a renewed drop in staff in November as cost savings were sought.

“On a more positive note, input price inflation softened again, with cost burdens rising at the slowest rate in over three years. The impact of hikes in oil prices appear to be dissipating in the manufacturing sector, where the rate of cost inflation slowed notably. Although ticking up slightly, selling price inflation remained subdued relative to the average over the last three years and was consistent with a rate of increase close to the Fed’s 2% target.”

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Vital Statistics:

Stocks are higher this morning after good numbers out of Nvidia. Bonds and MBS are flat.

The FOMC minutes showed that the Fed is not considering rate cuts. “Participants generally judged that, with the stance of monetary policy in restrictive territory, risks to the achievement of the Committee’s goals had become more two sided. But with inflation still well above the Committee’slonger-run goal and the labor market remaining tight, most participants continued to see upside risks to inflation.” Note that this meeting took place before the weak CPI number which showed Fed progress on inflation.

The minutes did mention the problems in commercial real estate, which are going to impact bank earnings as provisions for credit losses increase. A lot of CRE loans need to be rolled over next year and many of these projects cannot be refinanced unless LPs put up more capital. If the LPs refuse, the real estate goes to the banks.

Mortgage applications rose 3% last week as purchases increased 4% and refis rose 2%. “U.S. bond yields continued to move lower as incoming data signaled a softer economy and more signs of cooling inflation. Most mortgage rates in our survey decreased, with the 30-year fixed mortgage rate decreasing to 7.41 percent, the lowest rate in two months,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Mortgage applications increased to their highest level in six weeks, but remain at very low levels. Purchase applications were up almost four percent over the week, on a seasonally adjusted basis, as both conventional and government purchase loans saw increases. The average loan size on a purchase application was $403,600, the lowest since January 2023. This is consistent with other sources of home sales data showing a gradually increasing first-time homebuyer share.”

Consumer sentiment fell in November, according to the University of Michigan Consumer Sentiment Survey. Expectations about future conditions remain dour. Unfortunately, consumer expectations for inflation rose again, with consumers seeing year-ahead inflation coming in at 4.5%, which was the highest since April. Long-run expectations rose to 3.2%, the highest since 2011. We know the Fed pays close attention to the inflationary expectations number.

Durable goods orders fell 5.4% in October, according to the Census Bureau. Transportation drove the decrease. If you strip out transportation, durable goods orders were flat. Capital goods orders (a proxy for business capital expenditures) fell 0.1%. All of the durable goods numbers came in below expectations. Separately, Initial Jobless Claims fell to 209k.

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Vital Statistics:

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

Housing starts rose 1.9% MOM to a seasonally adjusted annual rate of 1.37 million. This was still down 4.2% on a YOY basis. Building Permits rose 1.1% MOM to 1.49 million. The mix of housing starts continues to shift from multi-family to single family. There is a glut of apartments under construction and multifamily commercial real estate is becoming an issue.

The National Association of Realtors reports that listings are increasing as mortgage rates fall. The rate “lock-in” effect, which basically says that people are unwilling to move when that means trading a 3.5% mortgage for a 8% mortgage, appears to be easing. Median listing prices are holding up, although it sounds like some of the Western markets which rocketed during the pandemic are seeing a lot of price cuts without homes moving.

NAR Chief Economist Lawrence Yun forecasts that existing home sales will rise 15% in 2024 as mortgage rates fall into the 6% – 7% range by the Spring Selling Season. Based on normal MBS spreads, a 4.4% 10-year should translate into a 6.4% mortgage rate. “The 10-year Treasury yield is at 4.4%, which historically means mortgage rates could be at 6.4%, but they are much higher,” said Yun. “The bond market is forcing the Fed to pivot.”

Ultimately the rate lock-in effect will dissipate as real life intrudes. “Pent-up sellers cannot wait any longer. People will begin to say, ‘life goes on,'” said Yun. “Listings will steadily show up, and new home sales will continue to do well. Existing home sales will rise by 15% next year.”

The Wall Street Journal has a piece this morning on how foreign demand for Treasuries has dissipated. Much of it has to do with foreigners selling Treasuries in order to prop up their own currencies (China in particular). However, there was an interesting note in the piece: China is swapping out its Treasuries for MBS.

“At the same time, China has diversified reserves away from Treasurys and has been investing in bonds backed by U.S. government agencies such as Freddie Mac that offer higher yields than Treasurys. China has bought a net $32 billion of those in the year through August, according to data from the Council on Foreign Relations. “

If this catches on, increased appetite for agency debt, along with a decline in bond market volatility could be the catalyst for decreasing MBS spreads, at long last.

Personal interest payments continue to rise. Hard to see how consumer spending can be sustained in the context of this, especially as the COVID payment suspensions go away.

Interestingly WalMart’s CEO warned of deflation on the earnings conference call yesterday. Haven’t heard that word bandied about in a while – deflation is generally a credit event, not a monetary one – but if retailers are cutting prices to move excess inventory that should be a good sign for inflation.

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Vital Statistics:

Stocks are flat this morning as retailer earnings come in. Bonds and MBS are up.

Industrial production fell 0.6% in October, according to the Federal Reserve. Manufacturing production fell 0.7%. Capacity Utilization fell to 78.9% which is well below its long-term average. This confirms the readings we have been getting out of the ISM surveys – manufacturing is struggling. Separately, the employment market seems to be weakening as initial jobless claims rose to 231k last week.

Hot on the heels of cautious guidance out of Home Depot and Target, Wal Mart sounds the alarm on consumer spending. The CFO said in an interview on CNBC that Wal Mart has been “leaning heavily into promotions,” which should be taken to mean “cutting prices to move the merchandise.” “Our events have been strong,” he said. We’ve been pleased with those. Halloween was good overall. But in the in the last couple of weeks of October, there were certainly some trends in the business that made us pause and kind of rethink the health of the consumer.” Comp sales were strong at 4.9%, but if the consumer is struggling you should expect to see better results out of the discounters and the dollar stores.

There is lots of talk about a soft landing (Google it), and certainly most everyone will prefer that to a hard landing. That said, it is usually a negative sign.

Now lets look at how much the Fed Funds rate increased before these mentions: 1995: 345 basis points, 2000:285 basis points, 2006: 440 basis points, 2018: 243 basis points, 2023: 525 basis points. I know a soft landing is the base case for the government and the big investment banks, but it feels like drawing into an inside straight right now.

What does that mean for rates? They should be going down, but the US has a lot of debt maturing over the next year that needs to be rolled over. And China isn’t buying:

The third quarter was tough for independent mortgage banks according to research from the MBA. Independent mortgage banks lost an average of $1,015 per loan, an increase from the $534 loss in the second quarter. “Net production income has been in the red for six consecutive quarters. MBA forecasts lower industry volume over the next two quarters compared to last quarter, which means a turnaround is unlikely until the second quarter of 2024. One silver lining is that mortgage servicing continues to be a bright spot for many companies. Combining both the production and servicing business lines, roughly half of mortgage companies stayed profitable in the third quarter of 2023. Were it not for mortgage servicing, only about one in three companies would have been profitable.”

Homebuilder sentiment fell in November as rising interest rates dampened affordability.

“The rise in interest rates since the end of August has dampened builder views of market conditions, as a large number of prospective buyers were priced out of the market,” said NAHB Chairman Alicia Huey, a custom home builder and developer from Birmingham, Ala. “Moreover, higher short-term interest rates have increased the cost of financing for home builders and land developers, adding another headwind for housing supply in a market low on resale inventory. While the Federal Reserve is fighting inflation, state and local policymakers could also help by reducing the regulatory burdens on the cost of land development and home building, thereby allowing more attainable housing supply to the market.”

“While builder sentiment was down again in November, recent macroeconomic data point to improving conditions for home construction in the coming months,” said NAHB Chief Economist Robert Dietz. “In particular, the 10-year Treasury rate moved back to the 4.5% range for the first time since late September, which will help bring mortgage rates close to or below 7.5%. Given the lack of existing home inventory, somewhat lower mortgage rates will price-in housing demand and likely set the stage for improved builder views of market conditions in December.”

Mortgage credit availability improved in October, according to the MBA. “Mortgage credit availability rose in October, but the growth was driven by increased activity in the jumbo market. The jumbo index increased by 2.7 percent to the highest level in 14 months – its third straight monthly increase. However, despite the uptick in credit availability recently, we are still close to the lowest levels since 2013. Loan offerings remain narrower as lenders have reduced capacity to cope with the lower origination volumes,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Some lenders responded to the challenging rate environment and offered more ARM products, as mortgage rates increased by over 40 basis points on average in October, reaching almost 8 percent in the second half of the month.”

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Vital Statistics:

Stocks are higher after a weaker-than-expected CPI print. Bonds and MBS are up big.

Inflation was flat month-over-month in October, according to the Bureau of Labor Statistics. The number was driven by an increase in shelter, which was offset by a decline in gasoline. On a year-over-year basis inflation rose 3.2%.

If you strip out food and energy, inflation rose 0.2% month-over-month and 4% year-over-year. Both the headline and the core inflation rates came in below expectations, which drove a big decrease in the 10 year yield, taking it down to the lowest level since late September.

This print, along with the weaker-than-expected jobs report shows that the Fed’s tightening policies are having the desired effect. With UBS introducing a call for 275 basis points in easing next year, the discussion over Fed policy is now starting to consider the possibility that the Fed has over-shot. Given that 525 basis points in rate hikes over 18 months is one of the most aggressive tightening cycles on record, it does need to be part of the conversation.

The Fed Funds futures have taken any further rate hikes off the table. They are forecasting no change at the December and June meetings, and a 28% chance of a cut at the March meeting.

Small Business Optimism declined in October, according to the NFIB. Business is seeing weakened demand, with a net negative 17% of business owner reporting lower sales over the past 3 months. This is down dramatically from September and is the lowest reading since July 2020. Despite the drop in demand, inflation remains the single biggest concern, with a net 30% of small businesses raising prices.

In the commentary, the NFIB discusses how we could have such low sentiment when GDP grew at 4.9% in the third quarter. The first explanation is that the growth rate will be revised downward. That is a possibility. However if you look at the components of GDP growth a lot came from inventory build. Inventory buildup is generally what causes recessions in the first place, as companies cut production in order to move the merchandise which triggers layoffs. Given the data about sales and inventory build the fourth quarter is looking to be weak.

The economy has also been supported by government spending, which is often called “junk GDP” since it is largely artificial and doesn’t represent real, sustainable demand.

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Vital Statistics:

Stocks are lower this morning after Moody’s downgraded the US outlook from stable to negative after the market closed on Friday. Bonds and MBS are down small.

Moody’s downgraded their outlook for the US on Friday from “stable” to “negative,” citing the mounting debt and the rising cost of servicing that debt. “In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues,” the agency said. “Moody’s expects that the US’ fiscal deficits will remain very large, significantly weakening debt affordability.”

The US will have to pass another stopgap measure once we hit the debt ceiling later this week. Given that bond prices are roughly where they were prior to the announcement, the markets appear to be taking this in stride.

The week ahead will have the Consumer Price Index on Tuesday, along with retail sales and housing starts. We will also get a lot of Fed-speak.

UBS is out with a call saying the Fed will cut the Fed Funds rate by 275 basis points next year. Morgan Stanley sees the first rate cut in June, while Goldman sees Q4.

Mortgage delinquencies increased in the third quarter, according to the MBA. “The national mortgage delinquency rate increased in the third quarter from the record survey low reached in the second quarter of this year, with an uptick in delinquencies across all loan types – conventional, FHA, and VA,” said Marina Walsh, CMB, MBA’s Vice President of Industry Analysis. “The increase was driven entirely by a rise in earliest-stage delinquencies – those 30-days and 60-days past due. Later-stage delinquencies – those 90 days or more past due – declined to the lowest level since the first quarter of 2020. The decline in later-stage delinquencies, along with a foreclosure starts rate of 0.14 percent – which is well below the historical quarterly average of 0.40 percent – suggest that distressed homeowners may be utilizing available loss mitigation options that prevent a foreclosure start. Additionally, accumulated home equity may also be enabling some homeowners to sell their homes well before foreclosure becomes a possibility.”

The problems in commercial real estate are coming to a head as the problems in office expand to retail and multi-family. I discussed the state of play in my latest Substack post – please check it out and consider subscribing.

The Wall Street Journal had a story this morning (paywall) about the problems in mezzanine debt, which is like a second mortgage for commercial real estate properties. Foreclosures hit a record this year in the mezzanine space, which is often a canary in the coal mine. It looks like a lot of the creditors are not banks, but hedge funds and asset managers. But with asset prices in free fall, the banks will start to feel the heat.

The problems in commercial real estate might be one reason why the Fed will need to ease sooner rather than later.

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