All Things in Moderation

Vital Statistics:

Stocks are lower this morning after Chinese developer Evergrande called off talks with creditors and looks set for bankruptcy. Bonds and MBS are down.

The upcoming week has quite a bit of data, with house prices / new home sales on Tuesday, GDP on Thursday, and PCE inflation data on Friday. We will also get some Fed-Speak.

There was an interesting interview in Housing Wire with Doug Duncan, chief economist at Fannie Mae. MBS spreads are a huge topic these days, and he was discussing who will be the marginal buyer to step up and replace the Fed’s buying.

Kim: Spreads in the mortgage space are wide. What are the reasons for that? 

Duncan: There are several reasons for that. If that business flow for a time period helps them cover the variable costs, then it can be effective.

For one thing, no fixed-income investor thinks that mortgage-backed securities with 7% mortgage rates will be there when the Fed finishes the inflation fight. They’re going to cut rates and that will prepay. So you’re having to encourage investors with wider spreads to accept that. 

It’s also the case that the Fed is running its portfolio off because they don’t talk about it much. But somebody has to replace the Fed, and the Fed is not an economic buyer. That is they weren’t buying for risk-return metrics; they were buying to affect the structure of markets. So they are a policy buyer.

They were withdrawing volatility from the market, and they were lowering rates to benefit consumers. When [the Fed] is replaced, it’s likely to be by a private investor who’s going to have yield expectations. They may require wider spreads than the Fed because the Fed is not an economic buyer.

While I believe he is correct in that the new buyer of MBS will require a higher spread than the Fed, which had no such requirements, I think he overstates the effect the Fed’s buying had on MBS spreads in the first place. Take a look at the chart below, which is the 30 year fixed rate mortgage rate minus the 10 year.

This is not exactly MBS spreads, but it is a close enough approximation. The thing that sticks out to me is that MBS spreads in the era of QE are not that much different than they were before the real estate bubble. If the Fed’s massive buying of MBS didn’t make that dramatic of a difference, how is slowly letting the portfolio run off going to do it?

Once the Fed is out of the way with rate hikes, we should see a dramatic drop in bond market volatility as the uncertainty over monetary policy disappears. Since fixed income investors are looking at option-adjusted spreads (OAS), as volatility dries up in the bond market, we should see MBS become more attractive to other credit-risk free assets. Yes, prepays might increase, but rates have to fall a lot to trigger any sort of refi boom.

From 12/31/99 – 12/31/06, the difference between the 10 year and the average 30 year fixed rate mortgage was 1.79%. This was pre-Fed intervention. If spreads return to that level, we would be looking at a 30 year fixed rate mortgage around 6.3%, or 100 basis points lower than here.

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Vital Statistics:

Stocks are higher as markets digest the Fed’s hawkish language from Wednesday. Bonds and MBS are flat.

The 10 year briefly touched 4.5% in the overnight session, which is the highest level since 2007. A combination of rising oil prices, economic resilience in the US and massive government supply is pushing yields higher.

The Fed Funds futures are still predicting a roughly 40% chance of one more rate hike in 2023, taking to heart Jerome Powell’s language of “proceeding carefully” on rate hikes going forward. The December 2024 Fed Funds futures moved up their forecast by about 25 basis points after the Fed meeting.

December 2024 futures:

The average interest rate on US credit cards is over 22%, according to recent data. About 37% of credit card cap out their interest rate at 29.99%. At those sort of levels, it is easy to get trapped in credit card debt. At some point even with mortgage rates where they are, a cash-out debt consolidation refi could make sense for people.

The US economy experienced stagnation in output at the end of the third quarter according to the S&P Flash PMI. The US economy put up the worst performance since February as demand fell. Pricing pressures remain, largely driven by rising energy prices, while backlog gets worked off. We still aren’t seeing layoffs yet, but as demand flags, that should begin to happen.

“PMI data for September added to concerns regarding the trajectory of demand conditions in the US economy following interest rate hikes and elevated inflation. Although the overall Output Index remained above the 50.0 mark, it was only fractionally so, with a broad stagnation in total activity signalled for the second month running. The service sector lost further momentum, with the contraction in new orders gaining speed.

“Subdued demand did not translate into overall job losses in September as a greater ability to find and retain employees led to a quicker rise in employment growth. That said, the boost to hiring from rising candidate availability may not be sustained amid evidence of burgeoning spare capacity and dwindling backlogs which have previously supported workloads.

“Inflationary pressures remained marked, as costs rose at a faster pace again. Higher fuel costs following recent increases in oil prices, alongside greater wage bills, pushed operating expenses up. Weak demand nonetheless placed a barrier to firms’ ability to pass on
greater costs to clients, with prices charged inflation unchanged on the month.”

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Vital Statistics:

Stocks are higher as we await the Fed decision at 2:00 pm. Bonds and MBS are up.

Fed-whisperer Nick Timaros of the WSJ discussed what to look for in the Fed decision today. While no increase is expected at this meeting, the big question will be the dot plot for this year and next. Timaros believes it is possible that the dot plot will still predict one more rate hike this year, however fewer members will lean that way.

It is easier for the Fed to signal one more rate hike and fail to deliver than it would be for the Fed to send the all-clear signal and then raise rates. The other big question will be how many rate cuts the dot plot signals for next year. The dot plot from June is below:

The June plot sees one more rate hike this year, and then about 100 basis points in cuts in 2024.

Mortgage Applications rose 5.4% last week as purchases 2% and refis increased 15%. “Mortgage applications increased last week, despite the 30-year fixed mortgage rate edging back up to 7.31 percent – its highest level in four weeks,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications increased for conventional and FHA loans over the week but remained 26 percent lower than the same week a year ago, as homebuyers continue to face higher rates and limited for-sale inventory, which have made purchase conditions more challenging. Refinance applications also increased last week but are still almost 30 percent lower than the same week last year.”

Separately, Joel Kan expects mortgage rates to fall into the 6% range by the end of the year and into the 5% range in 2024. I agree with him and I believe the driver is going to be a decline in interest rate volatility which will positively impact MBS spreads. Below is a chart of the Bank of America / ICE bond market volatility index (MOVE) and you can see it jumped in early 2022 which coincided with the Fed’s liftoff. Uncertainty over Fed policy is a driver of volatility, and volatility is probably the biggest driver of MBS prices as it drives convexity forecasts.

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Vital Statistics:

Stocks are lower this morning as we begin the Fed meeting. Bonds and MBS are down small.

Housing starts fell 15% MOM and 11% YOY to a seasonally-adjusted annual rate of 1.28 million, which was the lowest since June of 2020. This was way below the street estimate of 1.43 million. Building permits increased to 1.54 million which was up 7% MOM and down 3Q% YOY.

While single-family starts fell, the big story has been the collapse in multi-fam, which has fallen off a cliff recently due to high rates and a glut of new supply already under construction.

High mortgage rates continue to dampen building confidence. Rising rates and prices are causing builders to cut prices or offer incentives. We have already seen builders subsidizing mortgage loans by offering below-market rates in order maintain the sales price.

Shortages remain an issue with skilled construction laborers in short supply, along with buildable lots, transformers, and now insurance.

Recessionary pressures are increasing in housing, according to First American Financial. “Mortgage rates increased in August, which means we expect the housing recessionary pressures to continue in the near-term until mortgage rates stabilize,” First American Chief Economist Mark Fleming said. “However, industry forecasts predict that mortgage rates will moderate later in the year if the Federal Reserve stops further monetary tightening and provides investors with more certainty. Mortgage rate stability, even if the stabilization occurs at a higher level, is the key to a housing recovery.”

Some good news on the inflation front: single family rent growth dropped to a 3 year low in July, rising only 3.1%. This is a return to pre-pandemic levels of growth.

“While U.S. single-family rent growth has now reverted to its long-term average of about 3%, three U.S. metros recorded annual cost decreases in July,” said Molly Boesel, principal economist for CoreLogic. “However, because the SFRI peaked in these metros in July 2022, the annual decreases represent a plateauing of costs rather than larger weaknesses in single-family rental markets.”

“But even with the small annual decreases in rent growth,” Boesel continued, “the gains of the past few years are unlikely to be totally erased in the near future. For example, Miami recorded a 0.6% decline in annual rent growth in July 2023, but the gain since July 2020 has registered 55%.”

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Vital Statistics:

Stocks are lower as we head into Fed Week. Bonds and MBS are down. The 10 year has the highest yield in 16 years.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The consensus seems to be a hawkish pause, where the Fed maintains the current Fed Funds rate and signals one more hike in the dot plot. Investors will also be looking at clues for when the Fed will start cutting rates. We will also get a new set of economic projections and the path for future inflation will loom large.

“You’d be hard pressed to find someone who thinks (the Fed will) hike this week but our expectation is that they keep the door open for another hike later this year which the dot plot will continue to reflect,” Deutsche Bank’s Jim Reid said. “Our economists believe other parts of the SEP are likely to undergo meaningful revisions, particularly for 2023.”

“Stronger growth (2023 could double to 2%, 2024 could increase around 25bps to 1.3%) and lower unemployment should counterbalance softer inflation (2023 revised down but core forecasts for 2024 likely to be unchanged). So the meeting is likely to see a confident pause but one where further tightening is seen as the risk.”

In economic news, we will get housing starts, existing home sales and the Index of Leading Economic Indicators.

Homebuilder confidence slipped in August, according to the NAHB Housing Market Index. Rising rates and affordability constraints remain the biggest issues.

The Atlanta Fed’s GDP Now index sees Q3 growth at 4.9%. This still seems way out of step with most economists which are closer to 3%.

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Vital Statistics:

Stocks are lower after the United Auto Workers went on strike against all three big auto makers. Bonds and MBS are down.

Consumer sentiment fell in September, according to the University of Michigan Consumer sentiment Survey. Since consumer sentiment surveys are highly influenced by gasoline prices, this isn’t much of a surprise. Importantly, inflationary expectations for the next year declined from 3.5% in August to 3.1%. Long-run inflationary expectations also fell to 2.7%, which is below the 2.9% -3.1% range we have been stuck in.

Prior to the pandemic, year-ahead inflationary expectations were in the 2.3% – 3.0% range and long-run inflationary expectations were in the 2.2% – 2.6% range. This is good news for the Fed, and we know the Fed pays close attention to the UMich numbers.

ICE and Black Knight have completed their sale of Optimal Blue and Empower to Constellation Software. This sale was a required divestiture in order for the two companies to complete their merger. ICE will hold a conference call in two weeks to discuss their going-forward plan.

Homebuyers are canceling deals at the highest rate in a year as rising mortgage rates kill affordability. “I’ve seen more homebuyers cancel deals in the last six months than I’ve seen at any point during my 24 years of working in real estate. They’re getting cold feet,” said Jaime Moore, a Redfin Premier real estate agent in Reno, NV. “Buyers get sticker shock when they see their high rate on paper alongside extra expenses for maintenance, repairs and closing costs. Many of them would rather back out, even if it means losing their earnest money. A lot of sellers are also willing to let buyers slip away because they don’t want to concede to repair requests.”

Industrial production rose 0.4% MOM, according to the Fed. Manufacturing output rose 0.1%. As is typical these days, the prior month’s numbers were revised downward. Capacity Utilization increased. Separately, manufacturing activity picked up in New York State, according to the Empire State Manufacturing Survey.

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Vital Statistics:

Stocks are higher this morning after the European Central Bank hiked rates by 25 basis points and crude oil rose above $90 a barrel. Bonds and MBS are flat.

The European Central Bank raised its key interest rate by 25 basis points to 4%. It also signaled that it has wrapped up its tightening cycle: “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” the ECB said in a statement.

Inflation in the Eurozone is 5%, which is much higher than the US. where PCE inflation is around 3.3%. Both the US and the ECB have a 2% inflation target. The Fed Funds futures continue to predict no changes at the September meeting next week and about a 40% chance of one more hike this year.

Inflation at the wholesale level rose 0.7% on a month-over-month basis, driven by higher energy prices. Gasoline accounted for about 60% of the increase. On a year-over-year basis, inflation at the wholesale level rose 1.6%. If you strip out food and energy, wholesale inflation rose 0.2% MOM and 2.2% YOY.

Retail Sales rose 0.6% in August, according to the Census Bureau. This was up 2.5% on a year-over-year basis. July’s numbers were revised downward from 1.0% to 0.7% (downward revisions seem to be a theme these days). These numbers are not adjusted for price changes, so it seems that consumer spending is waning as higher interest rates bite. The resumption of student loan payments isn’t going to help either.

The United Auto Workers will go on strike at 11:59 pm tonight if there is no agreement with the automakers. The UAW wants a 46% increase in hourly pay and a 4-day workweek (with pay for 5 days). Ford has offered 20%, while GM is offering 18%. The two sides remain pretty far apart. UAW President Shawn Fain said there would be “strategic strikes” which implies it won’t be a full-out strike against the automakers.

Regardless, in the short term a strike will be a damper for economic growth, however if the automakers accede to the UAW’s demands it will be bad news for inflation going forward as it will help cement the wage-price spiral.

Median household income fell 2.3% to $74,580 in 2022, according to the Census Bureau. This was driven by a 7.8% increase in the cost of living, which was the highest since 1981. The Census Bureau used a new inflation index as well, so past numbers might not be comparable.

The median house price to median income ratio sits at around 5.6x, which is an elevated number given how high mortgage rates are.

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Vital Statistics:

Stocks are lower after the CPI came in hotter than expected. Bonds and MBS are down.

The Consumer Price Index rose 0.6% MOM and 3.7% YOY based on rising energy prices. Ex-food and energy, prices rose 0.3% MOM and 4.3% YOY. The monthly numbers were 0.1% higher than expectations. Bonds initially sold off on the report, but seem to be crawling back to flat on the day.

Gasoline rose 10.6% MOM, which was the big contributor to the headline number. Transportation services was the big contributor to the core number, which I assume is being driven by energy prices.

Mortgage applications fell 0.8% last week as purchases rose 1.3% and refis fell 5.4%. “Mortgage applications decreased for the seventh time in eight weeks, reaching the lowest level since 1996,” said Joel Kan, a Mortgage Bankers Association economist, in a release. “Given how high rates are right now, there continues to be minimal refinance activity and a reduced incentive for homeowners to sell and buy a new home at a higher rate.”

Mortgage Credit Availability increased in August, according to the MBA. An increase means that standards are loosening. That said, mortgage credit availability is still extremely tight with the index stuck at levels we saw a decade ago.

“Credit availability in August increased slightly but remained close to the very low levels last seen in January 2013,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The overall increase was driven by an increased number of loan programs that included parameters such as cash-out refinances and mid-range credit scores. The conforming index dropped to its lowest level since 2011, while the jumbo index increased after three monthly declines. Industry capacity continues to decline as lenders reduce staffing and simplify their product offerings to reduce costs and raise profitability. While this dynamic has led to lower credit availability, it has also provided some lenders with new opportunities to expand some of their product offerings, and we saw some of that growth in the jumbo space last month.”

Home prices 8.7% quarter-over-quarter and 2.8% year-over-year according to the Clear Capital Home Data Index. The best performing region was the Northeast, while the slowest was the West Coast. Tight inventory is supporting home prices despite higher mortgage rates. The list of top-performing MSAs reads like a laggard list since 2008: places like Rochester NY, Cleveland OH, and Pittsburgh PA were some of the fastest-growing regions.

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Vital Statistics:

Stocks are higher this morning as we head into a big week for data. Bonds and MBS are down.

The upcoming week will be dominated by the CPI and the PPI inflation reports. Since we have the September FOMC meeting next week, we won’t have any Fed-speak. We will also get retail sales and consumer sentiment. Homebuilder Lennar reports earnings on Thursday.

Not residential real estate related, but important nonetheless. The contract between the United Auto Workers and the big automakers expires on September 14. This will be a new test for union strength in a tight labor market. I wrote about the changes in the labor market and the potential effects on inflation in my latest Substack article: Unions and the 2% inflation target. Check it out and please consider subscribing.

Home prices peaked in June of 2022 and apartment rents are beginning to level off as well. Rent growth rose just 0.28% year-0ver-year in August. Apartment supply is set to explode with about 1 million units under construction. We are seeing big declines in places like Austin, Phoenix, Atlanta and Las Vegas.

Multi-fam housing starts are beginning to decline as high interest rates discourage construction.

Interesting article about how mortgage lenders treat student loan debt. The Obama-era student loan repayment plan allows borrowers to limit their student loan repayments to just 10% of discretionary income. This means that their DTI ratios are actually higher than they appear. Don’t forget student loan payments are resuming as well.

Nick Timaros of the Wall Street Journal (who has a reputation for understanding the Fed better than most) thinks the psychology of the Fed is changing. For the past year, the Fed has been unanimous that the risk to the economy is tightening too little, not too much. The balance of risks is changing, and more FOMC members are worrying about tightening too much, potentially causing a recession or financial turmoil,

“The risk of inflation staying higher for longer must now be weighed against the risk that an overly restrictive stance of monetary policy will lead to a greater slowdown than is needed to restore price stability,” said Boston Fed President Susan Collins in a speech last week. “This phase of our policy cycle requires patience.”

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Vital Statistics;

Stocks are lower this morning as higher interest rates dampen investor sentiment. Bonds and MBS are down.

Bonds didn’t like the stronger than expected ISM report yesterday, and Susan Collins stressed that the Fed will have to hold rates at restrictive levels for longer.

While the Fed Funds futures don’t see another rate hike at the September meeting, they do see a roughly 50% chance for another rate hike sometime this year.

Nonfarm productivity rose 3.5% in the second quarter of 2023, which was a touch below street expectations of 3.6%. This was driven by a 1.9% increase in output and a 1.5% decrease in hours worked. Unit labor costs rose 2.2%, which was driven by a 5.7% increase in compensation and a 3.5% increase in productivity.

Note that these are second quarter numbers, so they are pretty old.

Mat Ishbia (the CEO of United Wholesale) urged the FHFA to intervene with the buybacks being issued by Fannie and Freddie. “They are making billions, and lenders are barely scraping by, but they continue to make them buy back loans for small reasons here, little things that happened on a loan that maybe are not impacting the borrower’s success in that loan,” Ishbia said.  “The industry is up in arms and is very frustrated with the amount of repurchases Fannie Mae and particularly Freddie Mac are pushing back on lenders,” Ishbia said. “A lot of trade groups, a lot of people are talking about it, and it’s impacting lenders, impacting mortgage people, and impacting consumers at the end of the day as well.”

The average principal and interest payment on a mortgage rose to $2,306. This number excluded taxes and insurance. This is a 60% increase (or about $871) over the past two years, driven by rising rates and home prices. This affects cash-out refis as well.

“Rates aren’t just hampering prospective homebuyers, though. While tappable equity levels have returned to near- record highs, rising rates are having a clear impact on how – and how much – equity mortgage holders are willing to withdraw from their homes. All in – including first-lien cash-out refis and second-lien home equity loans and lines – we saw mortgage holders withdraw $39B in equity from their homes in Q2 2023. That’s up slightly from Q1’s $37B, but only about half the volume of Q2 2022, before interest rates began to climb. Historically, from 2010-2021, mortgage holders pulled out just under 1% of available equity each quarter. But over the last three quarters, that share has fallen to 0.4%, which suggests rising rates have resulted in a roughly 55% decline in equity withdrawals. In essence, over the last 15 months, there’s been nearly $200B less equity withdrawn – and reinjected into the broader economy – than might otherwise have been, due in large part to elevated interest rates.”

Even though mortgage rates are super-high, is holding credit card debt which costs 20% a better option than a cash-0ut refinance at 7.5%?

The Fed released its Beige Book yesterday, and the key word was “modest.” In Fed-speak, “modest” = “meh.” Economic growth was “modest” in July and August. On the subject of prices, they said: ” Most Districts reported price growth slowed overall, decelerating faster in manufacturing and consumer-goods sectors. However, contacts in several Districts highlighted sharp increases in property insurance costs during the past few months. Contacts in several Districts indicated input price growth slowed less than selling prices, as businesses struggled to pass along cost pressures. As a result, profit margins reportedly fell in several Districts.

Does this sound like we are getting 5.6% GDP growth in Q3?

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