All Things in Moderation

Vital Statistics:

Stocks are up big after Chinese President Xi Jinping made a speech that emphasized dialogue and opening up the Chinese markets. Bonds and MBS are flat.

In a speech to the Boao Forum, Chinese President Xi Jinping warned against returning to a “Cold War mentality” and pledged to make progress on imports, foreign ownership limits, and intellectual property. This have always been the sticking points with the Chinese, and while they may just be empty words, they are being taken optimistically this morning.

Inflation at the wholesale level increased in March, as the PPI came in a little higher than expected. The headline number rose 0.3%, while the core rate rose 0.4%. Higher metals prices (in response to tariff announcements) drove the increase.

Small Business Optimism remains in the top 5% historically, according to the NFIB. Lower taxes are driving the increase in sentiment. Improved earnings were the second best reading in 30 years. Biggest problem: Quality of Labor. In fact, 21% of all respondents considered the inability to find qualified labor their biggest headache. A net 33% reported increasing compensation, the highest number since 2000. Perhaps we might start seeing a bit of a move in wage inflation, however the biggest predictor of wage inflation – the quits rate – hasn’t gone anywhere in years. We’ll get an update on the quits rate Friday.

The CFPB has initiated no enforcement actions since Mick Mulvaney took over, according to consumer advocates. Prior CFPB Chairman Richard Cordray preferred to “regulate by enforcement action” which is the more aggressive approach to take with banks. Mick Mulvaney, in a memo to his staff, promised to end the Bureau’s pattern of “pushing the envelope” and “looking for excuses” to bring lawsuits. The enforcement action is one of two ways for the Bureau to regulate – the other is via supervisory means – in other words confidential discussions with the banks involved. Richard Cordray preferred to use only the enforcement action, which the industry disliked. The best analogy would be driving down an expressway with no speed limit signs. The only way to find out if you are going over the limit is when you (or someone else) gets a ticket. Regulators generally loathe to put out “bright lines” for fear that the industry will go right up to the line, and then figure out how to game it. Mulvaney is backing off from that approach.

That said, as any compliance officer can tell you, the CFPB is the not only agency to worry about. The individual states also have jurisdiction and can do much of what the CFPB did. New Jersey (one of the most creditor-unfriendly states out there) has just set up its own version of the CFPB, nominating ex-DiBlasio attorney Paul Rodriguez to run the Director of Consumer Affairs. “Rodriguez’s selection highlights the Administration’s efforts to fill the void left by the Trump Administration’s pullback of the Consumer Financial Protection Bureau (CFPB), fulfilling one of Governor Murphy’s promises to create a “state-level CFPB” in New Jersey.”

Perhaps due to the increased regulatory scrutiny in DC (and elsewhere) big banks are getting back in the subprime business, although they are doing it indirectly. Big bank loans to non-bank financial firms in the business of subprime auto, etc are up sixfold since 2010. For example, Exeter, which does sub-600 FICO auto loans is owned by Blackstone and has a line of credit from Wells and Citi.

Delinquencies remain elevated in areas hit hard by the hurricanes, but early stage delinquencies are back to normal levels, according to CoreLogic. The 30+ DQ rate came in at 4.9% in January, down 0.2% YOY. The foreclosure rate fell to 0.6% from 0.8% a year ago.

Homebuyer sentiment rebounded in March, according to the Fannie Mae Home Purchase Sentiment Index. Of course people may want to buy, but there isn’t much around in the way of inventory. Overall, people are reasonably optimistic on the economic front as well.

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Vital Statistics:

Stocks are up to start the week after a pretty lousy session on Friday. Bonds and MBS are flat.

The week after the jobs report is usually pretty data-light, however we will get the Producer Price Index and the Consumer Price Index on Tuesday and Wednesday.

Friday’s jobs report should allay investor fears that the Fed is behind the curve, at least according to PIMCO’s Mohammed El-Arian. The light payroll number was probably weather-driven and the 3 month average is around 200k, which is solid and respectable. Wage growth came in as expected. Investors should take comfort that the Fed is probably not at risk of making a policy mistake due to an overheating economy. His view is that there is a 65 / 35 percent chance the Fed will stick the landing, meaning that economic growth will continue to more broadly expand and that markets will adapt to the higher volatility associated with normal monetary policy.

An example of higher volatility: corporate bond spreads. The end of 2017 was characterized by extremely low volatility in the stock and bond markets. When volatility falls, risk premiums contract. We saw corporate credit spreads reach pre-crisis levels. Since the beginning of the year, they are back to widening. Bad news for corporate bond funds, which have been beset by widening spreads and higher rates.

The story of the past couple of years has been “subprime auto.” The chickens are coming home to roost on this trade, and we are starting to see some subprime auto finance companies go bankrupt. Indeed, when you talk about the effects of low volatility in the market, things like this come to mind. With rates being held down by Fed actions, investors inevitably reach for yield. For a while, you could get a lower rate on a 6 year auto loan than you could on a 30 year fixed rate mortgage. This is insane when you take into account that the value of the collateral underlying a mortgage is 90% sure to increase over time, while the value of the collateral underlying the car loan is 100% sure to depreciate over time. That said, this won’t be a repeat of 2008 economically.

Mortgage credit got tighter in March, according to the MBA’s Mortgage Credit Availability Index. It was most pronounced in government lending, which could have been explained by some of the weakness and illiquidity we were seeing in the higher coupon Ginnie securities. Ginnie investors have been burned by higher prepay speeds and have been reluctant to buy the higher coupon securities. This makes the higher note rates (which is where the lower credit scores usually reside) cut off from the rest of the market.

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Vital Statistics:

Stocks are lower after Trump announced more tariffs against China. Bonds and MBS are flat.

Jobs report data dump:

• Payrolls up 103,000 (below expectations)
• Unemployment rate 4.1% (above expectations)
• Labor Force Participation Rate 62.9% (increase of 0.1%)
• Average Hourly Earnings up 0.3% / 2.7% (in line with expectations)

Another month where the ADP number (increase of 241k) and the BLS number (increase of 103k) were a mile apart. Weather may have played a part in the low payrolls number, as the Midwest and East Coast were hit by a number of snowstorms that knocked out power early in the month. Construction employment fell, which kind of supports that theory. Wage inflation remains in check for the most part. The employment-population ratio was flat at 60.4%. Overall, a disappointing report, but the weather makes me want to put an asterisk next to it.

The NFIB reports that almost a third of small businesses raised wages to attract and / or retain employees last month, which was the highest percent since 2000.

Forget about the old picture of the Rust Belt – decaying small towns that peaked in the 1950s and crashed during the 1970s. Things have changed. When you think of Detroit, you now think of Quicken Loans, and places like Elkhart Indiana are unable to keep $90,000 SUVs in stock because the town is booming with factory workers making $68,000 on average. At full production, workers are making $90k, and foremen are making 6 figures. The unemployment rate is basically zero – a town of 50,000 people has 9.500 unfilled job openings. Despite what some economists think about employers having market power and exhibiting monopsonist behavior (hard to believe dozens of employers in a single locality could collude), the laws of supply and demand do in fact apply to the labor market.

CFPB Acting Director Mick Mulvaney responded to Elizabeth Warren’s letter that posed about 100 questions about how the agency is being run. Suffice it to say, she believes the agency isn’t being aggressive enough. Mulvaney’s response was basically to say that he doesn’t have to respond, and doesn’t intend to. “When I served on the House Committee on Financial Services as a Member of Congress, I was frequently frustrated with what I perceived to be a lack of responsiveness, transparency and accountability at the Bureau,” Mulvaney wrote. “I encourage you to consider the possibility that the frustration you are experiencing now, and that which I had a few years back, are both inevitable consequences of the fact that [the Dodd-Frank Act] insulates the Bureau from virtually any accountability.” The saga continues..

Donald Trump announced plans for another $100 billion in tariffs against China last night, and China responded with plans to retaliate. As of now, this is still in the trash-talking phase. Larry Kudlow says negotiations haven’t even begun yet.

Treasury has issued a set of recommendations for modernizing the Community Reinvestment Act. Probably the biggest change would be to move the focus from where bricks and mortar branches are to where the banks actually lend. This would bring the law up to date with the concept of less branches and more online banking. The other recommendation is to bring in more standardization and more certainty into what the government is looking for in examinations. In other words, make the law less arbitrary.

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Vital Statistics:

Stocks are lower this morning on trade war fears. Bonds and MBS are up.

While the drop in the futures is pretty dramatic, the market is basically just giving back the end-of-day ramp yesterday after the Administration said there is nothing imminent with Amazon. We are coming out of a long period of low volatility in the stock market, and volatility begets volatility. The silver lining is that Treasuries love stock market volatility, so they stand to benefit at the margin.

Mortgage Applications fell 3.3% last week as purchases fell 2% and refis fell 5%. “Heading into the holiday weekend, mortgage application volume fell a bit both for purchase and refinance volume,” said MBA Chief Economist Mike Fratantoni. “Mortgage rates were little changed for the week, despite the increase in financial market volatility. Potential homebuyers may be a little rattled by the swings in the stock market the past few weeks, but the job market continues to strengthen, which should power demand through the spring season. The main uncertainty remains whether enough listings will be available to meet this demand.”

Factory orders increased 1.2% in February, a bit lower than the Street estimate of 1.7%.

The ISM Non-Manufacturing Index dipped in March to 58.8 last month. Interesting comment from a builder: “The unbelievable amount of market volatility in construction-related materials that started with lumber continues with the tariffs on steel and aluminum. Accurate, long-term planning has become incredibly difficult, as distributors that historically held costs for at least 30 days are now, in some cases, committing to only seven days, as prices can change drastically in that time.”(Construction). Increasing housing starts has been a manana story forever, and it looks like that might be the case again this year.

Street estimates for Friday’s payroll number might be too low, at least if you look at the ADP number, which came in way stronger than expected at 241,000. The Street is looking for an increase of 175k in Friday’s report. While the ADP number doesn’t track the BLS number as tightly as you think it should (it actually tracks the revised number, not the preliminary one), it does indicate that trade issues haven’t affected employment, at least not yet. Manufacturing payrolls increased by 29k (strongest in 3 years), but remember that there are winners and losers in a trade war with China. For every steelworker, there are many more who work for a manufacturer that uses steel as an input. Construction employment was up smartly as well.

Wilbur Ross said that the US may end up negotiating with China on trade. In other words, all of this is simply a negotiating tactic.

Regardless of the payroll number, the main focus is wage inflation these days, so even if you get a big payroll number you might not see much of a reaction in the bond market if average hourly earnings are only up a little (consensus is 0.3% MOM / 2.7% YOY). Higher wages are fighting to chart below, which is the employment-population ratio. The most striking feature is how dramatic the Great Recession was. Most of the 30 increase in the ratio which was driven by women entering the workforce was given back.

The Fed has a model which looks at demographics and that ratio, which predicts a drop in the ratio due to the retirement of the baby boomers. In fact, that model shows that we are much closer to full employment than the chart above suggests.

Lennar reported first quarter earnings this morning. It it hard to read too much into the numbers: there are tax charges from tax reform and a partial quarter for the CalAtlantic deal, so the increases in orders, backlog, average selling prices, etc aren’t really comparable to other builders. Lennar also launched a second multi-family fund, while it is looking to sell Rialto, its commercial real estate arm.

San Francisco Fed Chairman John Williams has been nominated to take over the NY Fed. This makes him Vice Chairman of the FOMC as well.

Vehicle sales rebounded last month, which should boost Q1 GDP estimates.

Spotify went public yesterday without the services of an investment bank. Not sure that we are quite ready to write the epitaph for investment banking, but this is a big deal.

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Vital Statistics:

Stocks are rebounding after yesterday’s bloodbath. Bonds and MBS are down small.

No economic data today. Neel Kashkari speaks at 9:30 this morning.

The replacement for LIBOR begins trading today, when the New York Fed begins listing its new Secured Overnight Financing Rate. The NY Fed will also publish a couple other rates: the Broad General Collateral Rate and the Tri-party General Collateral Rate. Details can be found here. The appeal of SOFR will be that it is based on arms-length transactions and not quotes from banks that may or may not be real.

Prepayment speeds collapsed in early 2018 as rates rose, according to Black Knight Financial Services. Prepayment speeds are generally a proxy for refi activity, which has dried up as more of the refi opportunities are out-of-the-money. From this point onward, refi activity will be driven by home price appreciation more than interest rates. As home prices rise, the opportunity will be cash-outs, FHA with MI to conventional without MI, and ARMS into 30 year fixed. As the yield curve flattens, the relative decrease in the monthly initial ARM payment decreases.

Home equity topped $5.4 trillion last quarter and beat the record set in 2005. 75% of that is in mortgages that are out-of-the-money, or below the current 30 year fixed rate mortgage.

Home Prices rose 1% in February and are up 6.7% YOY, according to CoreLogic. They are forecast to be flat in March and up 4.7% YOY. Much of the torrid growth has been in the West / Mountain states, especially WA, NV, ID, and UT. Affordability has fallen and home price appreciation is expected to slow going forward. About half the MSAs are now overvalued, as home price appreciation and mortgage rates have outstripped income growth.

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Vital Statistics:

Stocks are lower this morning after investors come back from the long Easter weekend. Bonds and MBS are up.

The big event will be the jobs report on Friday. The Street is looking for 167,000 jobs, which seems small, however weather-related effects in the Northeast and Midwest are undoubtedly driving some of that. The consensus for wage growth is 0.2% MOM and 2.7% YOY. This number is the one that matters the most as far as the bond market. Until the report bonds will probably take their cue from the equities market, zigging when stocks zag.

Inflationary pressures can come from strange places. In the US, spot trucking freight rates are up 28% as driver shortages and new technology limit hours. So far, retailers and producers have not passed this cost on to consumers, but at some point they will. Even long-term rates, which are more stable than spot rates, are up 12%. Note that this is with moderate diesel prices – it isn’t fuel driven.

Trade tensions with China are increasing, as the Chinese imposed some restrictions on US agricultural exports which kick in today. China is urging more trade talks to prevent further damage. A trade war will have a push-pull effect on the US economy: on one hand, higher tariffs on imported goods will increase inflation, however trade wars also act as a damper on economic activity which should keep the Fed at bay. Since inflation remains well below the Fed’s target I suspect they will focus more on the depressing effects on a trade war than they will on the potential inflationary pressures of one.

The Fed studied how student loan debt impacts homeownership and found that as student loan debt increases, the person’s likelihood of owning a home decreases. This shouldn’t be much of a surprise, but it does show that the increase in salary from having a college education isn’t offsetting the increase in debt, at least when you look at debt to income ratios.

For new graduates looking for a job, head to the Midwest. There are more job openings there than there are unemployed workers.

Construction spending increased 0.1% MOM and 3% YOY in February, according to Census. This was a touch below consensus. Residential construction increased 0.1% MOM and 5% YOY.  The National Association of Homebuilders conducted a study on where the construction workers are in the US, and unsurprisingly most of them are out West, where the fastest growth appears to be.

Manufacturing eased slightly in March, according to the ISM report, however it is still quite strong. The potential tariffs are beginning to concern businesses. One quote from the report: “Much concern in the industry regarding the steel and aluminum tariffs recently [imposed]. This is causing panic buying, driving the near-term prices higher and [leading to] inventory shortages for non-contract customers.” (Machinery). Others mentioned it will take a few weeks to gauge the impact of tariffs. That said, the reading of 59.3 is usually associated with real GDP growth pushing 5%, so it is still a strong report despite the decrease.

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Vital Statistics:

Stocks are higher this morning on end of month / quarter window dressing. Bonds and MBS are up.

Stocks are set to break a 9 quarter winning streak. The market leaders – the FAANG stocks – have been taking a beating as Facebook gets hit on data issues, and Amazon finds itself in the Administration’s doghouse.

The bond market will close early today, at 2:00 pm EST. Get your locks in early, as secondary marketing types will probably build in a margin cushion to protect themselves over the long weekend.

Personal Income rose 0.4% in February, while personal spending rose 0.2%. The Personal Consumption Expenditure Index rose 0.2% MOM and 1.8% YOY. The core PCE index (the Fed’s preferred measure of inflation) was up 0.2% MOM and 1.6% YOY. The core PCE numbers were a touch higher than the Street was looking for, and everything else was in line. The savings rate rose. Bonds are rallying a bit on the report.

Initial Jobless Claims fell to 215,000 last week, barely missing the late February number of 210,000. We haven’t seen these levels since the early Carly Simon’s “Your’e So Vain” topped the charts. When you take into account population growth the number is even more dramatic.

The FHFA announced that Fannie and Freddie will be issuing a new uniform mortgage backed security beginning in June of 2019. “The transition to the new, common security requires planning, investment, and preparation by a wide variety of market participants,” said FHFA Director Melvin L. Watt. “We have now set the specific date that the Enterprises will start issuing the UMBS and I urge the industry to get ready now to ensure smooth, successful implementation.” This will help bring Fannie and Freddie pricing more in line with each other.

Is fintech reaching parts of the market that have not been fully served by traditional banks and lenders? The Philly Fed finds some evidence that it does, particularly in areas where there is high lender concentration (i.e. only a few banks) and areas that don’t have much in the way of banks.

Barclay’s Bank agreed to pay $2 billion in civil penalties to settle an investigation concerning RMBS issued during the bubble years. “In general, the borrowers whose loans backed these deals were significantly less credit-worthy than Barclays represented,” the Justice Department said in a statement Thursday. Barclay’s had committed to keep the settlement under $2 billion in 2016, but the Obama Justice Department balked.

A Reuters poll of 75 bond strategists suggests that fears of oversupply in the Treasury market are overblown. They are looking for an increase of 40-50 basis points in the 10 year bond yield in 2018. Considering that we are already up 30 basis points this year, we probably aren’t looking at major increases from here – maybe we will find a range of 2.8% to 3% and bounce around.

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Vital Statistics:

Stocks are lower this morning following yesterday’s sell-off. Bonds and MBS are up on the risk-off trade.

The market leaders (in other words the FAANG stocks) are getting taken to the woodshed on Facebook is down about 20% from mid-February. Is it time to rename the index fAANG?

Mortgage applications rose 4.8% last week as purchases rose 3% and refis rose 7%. Despite the jump in refis we are still at lows not seen for a decade.

Q4 GDP was revised upward by 40 basis points to 2.9% in the third and final revision. The Street was looking for an upward revision of 20 bps. Consumption was bumped up 20 bps to 4%, while the price index was unchanged at 2.3%. Inventory was increased as well. For 2017, GDP increased 2.3% compared to 1.7% in 2016.

Pending Home Sales rose 3.1% in February, according to NAR. Despite the gain, it is still over 4% lower than a year ago. That said, February 2017 was exceptionally strong. Expect to see a decrease in March, at least in the Northeast, after a series of storms.

Home Price appreciation continues as the Case-Shiller Home Price Index increased 6.3% YOY in January. Seattle led the group, increasing almost 13%, followed by San Francisco and Las Vegas. All MSAs reported year-over-year gains. The smallest increases were in the Washington DC and some of the Midwest.

Increasing real estate prices are pushing up home equity, which grew over $15,000 on average in the fourth quarter, according to CoreLogic.  It was biggest in California, where it jumped $40,000. This is the biggest increase in 4 years, and should bump up consumer spending. Since home equity is considered more permanent than stock market equity, it should affect consumer spending more.

Consumer confidence slipped a little in March, but is still at elevated levels. The tax cuts are helping to offset some of the losses in the stock market. Generally speaking, consumer confidence indices are inverse S&P indices, so expect them to fall if this sell-off continues.

As the Spring Selling Season takes shape, we are seeing the biggest home price appreciation at the middle and lower tiers of the market, where there is the biggest supply problem. While mortgage rates are rising, so far they aren’t making a dent in housing demand. Surprisingly, Moody’s thinks the tax new tax law will dampen home price appreciation about 4% over the next few years, due to the changes in the mortgage interest deduction (which will pretty much only affect the high end in certain states) and increased interest rates due to rising deficits. Perhaps. At any rate, I think the supply / demand imbalance is the biggest driver of home prices, and that will probably get worse before it gets better.

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Vital Statistics:

Stocks are higher this morning on optimism that a trade war with China can be averted. Bonds and MBS are down.

We will have a short week, with the bond market closed on Friday. On Thursday, we will have an early close. There will be a lot of Fed-speak this week, although not much in the way of market-moving reports.

Economic growth picked up in February according to the Chicago Fed National Activity Index. Production and employment-related indicators drove the increase.

San Francisco Fed Chairman John Williams is the front-runner to replace William Dudley at the New York Fed. Policy-wise he is considered a centrist, although not necessarily a markets guy. He is a long-term macro sort of guy – he doesn’t keep a Bloomberg terminal on his desk – which makes him somewhat of an odd pick to run the NY Fed which is all about markets.

Speaking of the NY Fed, it is set to launch its replacement for LIBOR next week – the SOFR (or secured overnight funding rate). Regulators are looking for a replacement for LIBOR after it was found that banks were manipulating it in order to help their own proprietary positions. LIBOR is a reference rate for many adjustable rate mortgages, as well as lines of credit so its replacement will affect the mortgage industry. The big difference between the two is that LIBOR is set based on the forecast of bankers, while SOFR will be based on actual transactions in the money markets. This makes it much less susceptible to manipulation.

Bond market observers will be watching as the Fed auctions off almost $300 billion in paper this week, with the biggest 2 year auction since 2014. Amid weakening demand for US Treasuries, the results could buffet rates a bit. Note China has threatened to stop buying US Treasuries in response to tariffs.

Mortgage banking profits fell in the fourth quarter to $237 a loan from $929 in the third quarter. This was the lowest reading since Q1 when it hit $224. Higher costs and decreasing volumes drove the decrease. Margins also fell as banks cut margins in a more competitive environment. 56% of the firms in the study reported positive pre-tax profit in the quarter, down from 77% in the prior quarter.

California is mulling a new idea to increase the supply of homes on the market, by giving a tax break to people 55 and older who downsize and move to a new county. Many homeowners are reluctant to move because they will get hit with higher property taxes on the new property.

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