All Things in Moderation

Vital Statistics:

Stocks are flat on no real news. Bonds and MBS are flat as well.

Small business optimism slipped in September, according to the NFIB. The big driver was a drop in sales expectations, which may have been influenced by the hurricanes in Texas and Florida. The drop was not just concentrated in the affected areas, so it is hard to attribute the drop to simply that. Small business shed an average of .17 workers during the month, and again this was not simply a hurricane effect. Small business optimism is high by historical standards, however and the Atlanta Fed is forecasting a 4.5% jump in GDP growth the fourth quarter of 2017.

Job openings were 6.1 million at the end of September. The quits rate edged up to 2.2%. The quits rate has historically been a leading indicator for wage growth, and a data point the Fed invariably references during their FOMC deliberations.

Tax reform continues to work its way through the committee process. Partisan tensions are already beginning to show. One thing to note: the Senate bill maintains the mortgage interest deduction at $1 million versus the House’s plan to cap it at $500,000. Corporations are digesting a surprise provision that levies an excise tax on payments made to overseas affiliates. Here is the state of play.

Home prices rose 7% YOY, according to CoreLogic. They are up 0.9% MOM. Rental price inflation was about 3%, less than half the increase in the index, which reflects tight inventory conditions. They estimate that about a third of the major metropolitan areas are overvalued. Rental price inflation is lagging as the homeownership rate increases. It hit 63.9% in the third quarter, according to the Census Bureau.

The Bank of England plotted the real risk free rate of interest going back to 1311. It puts into perspective how depressed the current global economy is, when you consider the real rate has been around 4% historically. The blue shaded areas are real rate depressions, and the one starting in the early 1980s has been the second-longest and is most similar to the long depressions of the late 19th century. These periods have been historically associated with low productivity growth, populism, and protectionism. Note that the bounceback from these periods has been sharp: typically you have seen an increase of 315 basis points in the two years after the cycle ends. The late 19th century phase was associated with the birth of Marxism. Is it a coincidence that Millennials are embracing socialism and communism?

JP Morgan estimates there will be 4 rate hikes in 2018. A tightening labor market will drive the increases, however we are seeing commodity price inflation as well, which will eventually flow through to overall inflation. Food and energy prices are increasing, and for the builders, lumber prices are at multi-year highs.

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Vital Statistics:

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

It should be a quiet week with respect to market-moving data and Fed Speak. New York Fed Governor William Dudley speaks at noon today, and that is it for the week. William Dudley is set to retire in mid-2018.

Work on tax reform continues, with both the House and the Senate drafting their own bills. Blue state Republicans (especially in CA, NY and NJ) are fighting to save the state and local tax deductions. The House hopes to vote on the bill next week. My sense is that the path to passage is so narrow that it will be a largely symbolic bill designed more to achieve a legislative victory than to reform taxes. I also think the estate tax will survive in order to save the state and local tax deduction.

White House economic advisor Gary Cohn says that he doesn’t think eliminating the mortgage interest deduction will affect the housing market. “The ability to deduct interest is a component that allows you to buy a bigger house, not what drives you to buy a house,” Cohn said during a Bloomberg Television interview Friday. It will affect the luxury market (especially in areas like the Northeast, where the luxury market is already weak),  but with the median house price around $245,000 limiting the mortgage interest deduction to $500,000 won’t affect most MSAs. If you wanted to eliminate the MID at a point where it will cause the least amount of pain, now would be the time to do it, simply because low interest rates are making the interest portion of the typical mortgage payment small by historical standards. Back when interest rates were super high in the early 80s, almost 100% of your first year’s mortgage payment went to interest. Today, about 70% is interest.

The National Association of Realtors weighed in on the mortgage interest deduction as well, and they are against changes to it, as you would expect. They commissioned a study earlier this year that predicted a 10% drop in home prices and that homeowners with incomes between $50,000 and $200,000 would see an average increase in taxes of $815.

One wrinkle to the change in the MID is that it applies to newly-purchased homes. So, if you haven’t moved, your existing MID would not change. That will make depress existing home sales at the margin, but I can’t see people staying put simply because of tax treatment of mortgage interest. People move for various reasons, but tax treatment usually isn’t one of them. Regardless, if this provision stays, the death of the MID will have a much less dramatic effect than people are forecasting.

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Vital Statistics:

Stocks are flat after the Fed maintained rates and the Bank of England hiked them. Bonds and MBS are flat as well.

As expected, the Fed maintained the current level of the Fed Funds rate and said its plan of tapering QE remained on track. Since there was no press conference or updated projections, there really wasn’t much for the bond market to work with. The part that caught my eye was that the Fed saw risks to the economy as evenly balanced. Given the growth and the low unemployment rate the risks to the economy are probably to the high side. What is more likely? An uptick in inflation to 2 – 3% or a recession?

Separately, the Atlanta Fed bumped up their estimate for Q4 GDP to 4.5%. That would work out to 3.1% growth for 2017. That said, hurricane effects didn’t drag down Q3 all that much so we may not see that big of a rebound in Q4. This estimate is going to hinge on the holiday shopping season.

Job cuts fell to 29,831 in October, the lowest in 20 years, according to outplacement firm Challenger, Gray, and Christmas. The health care sector had the biggest number of cuts. Separately, initial jobless claims fell to 229,000 last week.

Perhaps an explanation of why we are starting to see wage growth: productivity rose to 3% in the third quarter. Lousy start / stop productivity growth has bedeviled the economy since 2008. Increases in productivity drive increases in real (non-inflationary) wages. Unit labor costs rose 0.5%.

Donald Trump is expected to nominate Jerome Powell to run the Fed today. There are many that are disappointed that Yellen didn’t get a second term, however Trump wants someone with private sector experience to run the Fed, after a string of academics. We probably won’t see much difference between Powell and Yellen in terms of monetary policy (any differences would be so minor no one will notice) but there will be differences in regulatory approach. Janet Yellen was very much in the Obama mold of aggressive regulation. Powell is expected to be more balanced in his approach to the banks.

The GOP is slated to release their tax reform bill today. There have been trial balloons galore floated, so nobody really knows what it will entail. The most likely change is a drop in the corporate tax rate (which may or may not be phased in and / or temporary), an increase in the standard deduction, and limitations on deductions for those that itemize. Some sacred cows are going to take a hit in this bill, and with zero expected Democratic votes, it will have a narrow path to approval. Here is what the latest handicapping has..

Donald Trump signed the Congressional Review Act override to the CFPB’s arbitration rule. Eliminating the mandatory arbitration rule was always more about benefiting lawyers than consumers, and even the CFPB’s own research showed that consumers get better compensation from arbitration than they do from class action suits (ever get an unexpected check in the mail for $1.37 after a class action suit you never heard of? The rest went to the legal fees). Small and medium sized financial firms will be the biggest beneficiaries of this rule.

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Vital Statistics:

Green on the screen this morning as markets rally worldwide. Bonds and MBS are down.

The Fed decision is due at 2:00 pm EST today. No changes in interest rates are expected, but there is always the risk that something in the statement could move rates. Be careful locking around then. Separately, Donald Trump is scheduled to announce Yellen’s replacement tomorrow.

Mortgage applications continue to fall (six times in the last seven weeks), according to the MBA. Applications decreased by 2.6% as purchases fell 1% and refis fell 5%. Mortgage rates hit a low for 2017 in September, but have risen about 20 basis points since then. The average contract interest rate was 4.22%, an increase of 4 basis points from last week.

ADP saw an uptick in payrolls for October, increasing to 235k. September was revised downward to 110k due to the hurricanes. Many were expecting to see a bigger rebound for October, but it hasn’t happened, at least according to ADP. The BLS is announcing payrolls on Friday, with the Street looking for 325k.

Construction spending rose 0.3% in September, according to the Census Bureau. On a YOY basis, it is up 2%. Residential construction was flat on a month-over-month basis but is up 9.6% YOY.

Manufacturing is still strong, according to the ISM index. It slipped slightly in October to 58.7 from 59.5. Hurricane effects are probably having some effect here.

House Republicans moved back their tax reform reveal by a day, which shows there is some disagreement in whether this can pass. With uniform opposition from Democrats, it will only take a few Republicans to kill it. The state and local tax deduction will probably prove to be the deal killer, and while many Republicans have big philosophical objections to the estate tax, it probably isn’t a hill worth dying on. While people have historically considered senior citizens to be the third rail of politics, in all reality, it is the upper middle class (especially the HENRY’s, which stands for high earnings, not rich yet). They are the ones most affected by changes in 401k contributions, state and local tax deductions, and the mortgage interest deduction. The top 20% pays 95% of the income taxes in this country, according to OMB.

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Vital Statistics:

Stocks are up this morning as we start the November FOMC meeting. Bonds and MBS are down small.

No changes to FOMC policy are expected at this week’s meeting, however the Fed Funds market is predicting a 96% chance they raise rates in December.

Aside from the FOMC meeting, Congress is expected to unveil tax reform tomorrow, and Trump is slated to nominate the new Federal Reserve Chairman on Thursday. And on Friday, we get the all-important jobs report, so a lot going on this week.

Despite what the business press is saying, the markets are treating the Mueller / Manafort thing as a sideshow. As of now, nothing going on there is going to affect Washington enough to rile up markets. Earnings are the focus at the moment for stocks, and economic data (along with foreign central bank policy) is driving the bond market.

The Washington DC goat rodeo isn’t affecting consumer confidence either, which just hit a 17 year high. Most notably, the job market got positive marks for strength for the first time since 2001.

Are we starting to see stirrings of wage inflation? Perhaps. The Employment Cost Index rose 0.7% in the third quarter, faster than the 0.5% rate we saw in the second. Wages and salaries (which account for 70% of the ECI) rose 0.7%, while benefits rose 0.8%. On a year-over-year basis, they rose 2.5%. So far, bonds aren’t reacting to the number. An increase in wage inflation will force the Fed to move more aggressively. For those who worry about income inequality, the biggest growth was in blue collar jobs, where wages rose 0.8% and benefits rose 1.7%.

Home prices rose 0.5% in August and are up 5.9% for the year, according to Case-Shiller. Seattle has been on a tear, rising over 13% for the past year, followed by Las Vegas and San Diego. A strong economy along with low inventory and rates have been a support for home prices. The interest rate environment will be changing, however inventory doesn’t appear to be a temporary phenomenon, and the US economy seems to be accelerating, not declining. While the usual affordability questions are mentioned, the median mortgage payment for the median house as a percent of income is still very low by historical standards.

Note that the lack of building is simply creating pent-up demand for housing which will get satisfied eventually. That will push up growth for the next few years when it finally happens.

Manufacturing continues to hum along, with the Chicago PMI coming in well above expectations.

Bitcoin futures are coming… The contracts will be cash settled, not by delivery of the underlying.

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Vital Statistics:

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

This week will have a lot of market-moving potential, between the FOMC meeting and the jobs report. We will also get productivity and employment costs, two numbers the Fed monitors closely.

Personal incomes rose 0.4%, while spending rose 1%. Wages and salaries increased 0.4%. Inflation remains under the Fed’s target, but it did pick up in September to 1.6% on higher food and energy prices. The core rate increased 1.3%. A bump up in motor vehicle spending was behind the strong spending number, however that could be replacement activity for areas affected by the hurricanes in September. Regardless, it was the strongest jump in vehicle sales since “Cash for Clunkers” in early 2009.

Donald Trump is leaning towards Jerome Powell to run the Fed after Janet Yellen’s term expires in February. Jerome Powell is the economists’ choice and will probably continue on the same path that has already been established: gradual rate increases and a gradual tapering of QE. “People are anxiously awaiting my decision as to who the next head of the Fed will be,” Trump said an Instagram video Friday. Historically, nobody pays too much attention to who runs the Fed aside from bankers and financial economists. Reagan jammed Paul Volcker’s re-appointment in an unrelated radio address from Camp David. He even joked before the big announcement that “I have a story that will crack this town wide open”

Home price appreciation continues, as the Black Knight Home Price Index rose .2% in August and is up 6.2% YOY. New York (!) was one of the fast growing states, rising 1.6%. Georgia, Maryland and Virginia saw slight declines. Seattle continues to astound, with prices up 12% YTD and up 14% YOY.

We should get more details on tax reform this week, and we have been getting a lot of mixed signals and trial balloons. After talk about limiting 401k contributions, now the talk is of increasing the deduction to $20k. On the state and local tax deduction, it looks like property taxes may still be deductible, but state taxes will not be. Stay tuned.

There is a big merger in the homebuilder space this morning: Lennar and CalAtlantic will merge which will create the US’s biggest homebuilder by revenue.

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Vital Statistics:

Stocks are higher this morning on strong earnings and a good GDP report. Bonds and MBS are down.

Very slow news day.

Third quarter GDP came in at 3%, much higher than the 2.5% the Street was looking for. This is the strongest back-to-back performance since 2014. It looks like the hurricanes had a negligible effect on growth, and the Commerce Department cannot measure the effect at any rate. Consumption increased 2.4%. Housing remained a weak spot, falling 6%, as builders struggle with labor shortages and a lack of buildable land. This is the worst stretch for housing since 2010. The core inflation rate rose at 1.3%, an increase from the 0.9% from Q2, but well below the Fed’s 2% target.

Paul Ryan is confident he can sweeten tax reform to bring some of the last GOP holdouts in line. The biggest hurdle will be Republican house members in blue states, who will be affected by any changes to the state and local tax deduction. Tax reform is scheduled to be unveiled November 1.

The luxury end of the market is beginning to bifurcate, as the super high end ($5 MM plus) languishes while homes in the $1.5 million range are moving quickly. Demand for high-end homes is being driven by foreign demand as well as the stock market rally. That said, in the Northeast, particularly the pricey NYC suburbs, sellers are pulling their listings given weak demand.

Janet Yellen is reportedly out of the running now for Fed Chairman. It will come down to John Taylor (the conservative choice) versus Jerome Powell (the Professional Economist’s choice). Her term ends February 1.

Ben Carson says that HUD will work with DOJ to pull back on fines for mortgage lending errors. Aggressive prosecution during the Obama Administration pushed J.P. Morgan to get out of the FHA business altogether. “Innocent errors should not create chaos and fear and make people less likely to get involved in the first place,” he said.

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Vital Statistics:

Stocks are up this morning after yesterday’s sell-off. Bonds and MBS are up on the ECB’s decision to start tapering QE.

Initial Jobless Claims rose 10k to hit 233k last week. We are still at historically low levels.

Pending home sales were flat in September, according to NAR. The hurricanes in Florida and Texas did depress the number somewhat, but the same old story of low inventory is the real culprit. The Pending Home Sale Index is the lowest since early 2015.

The House will vote on a budget for next year, which will set the stage for tax reform scheduled to be announced on November 1. As expected, the state and local tax deduction is the biggest bone of contention, with Northeast Republicans dead set against ending it. They are hoping to use the budget vote as leverage to keep the deduction in the tax plan, but they may end up having to wait to see what comes out of the Committee.

Rising rents are becoming a burden for one in five renters, as the number of people looking to rent exceeds the supply of rentals out there. For people earning under 30,000, 28% were unable to make a full rental payment in the last 3 months. Affordable housing advocates will undoubtedly seize upon this number in order to push HUD to do more.

The MBA is forecasting about a 5% drop in origination volume from 2017 to 2018 based on higher interest rates depressing refinancing opportunities. Refis will probably be driven by two effects going forward: home price appreciation and the flattening yield curve. As home prices appreciate, those that have FHA loans with MI may now have enough equity in their homes to refinance into a conventional loan with no MI, thus saving a lot of money. Second, 30 year fixed rate mortgages will become more attractive relative to ARMS as the yield curve flattens. These two effects will create refinance opportunities in a rising interest rate environment. That said, purchase activity will be driving things going forward.

The financial services industry had a small victory yesterday as the Senate overturned a rule from the CFPB allowing class-action suits for banks. The argument in favor of class action lawsuits say it is necessary to prevent bad behavior from the banks, while those against class action suits say that wronged customers make more in arbitration, since they save on legal fees. While the big banks are probably able to absorb the massive penalties from a class-action suit, the smaller ones probably cannot. This is a highly divisive issue, pitting two giant funding sources for both parties: the trial lawyer bar for Democrats, and the financial services industry for Republicans. The vote was 50-50 and Mike Pence had to cast the tiebreaking vote.

The BLS released its projection of the job market for the next 10 years. Suffice it to say, the trends we have been seeing over the past decades (decreased emphasis on manufacturing, increased emphasis on services, higher education requirements) will continue. Heath care employment is the growth area, while many manufacturing jobs are becoming obsolete.

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Vital Statistics:

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

Stocks are in the middle of earnings season. Companies that beat their numbers are seeing a slight bump, while companies that miss are being taken to the woodshed. AMD is down 8% this morning, and Chipotle is down 14%. This has been a historical warning sign for stocks, along with declining breadth.

New Home Sales shocked to the upside, rising 19% MOM and 17% YOY to an annualized pace of 667,000. FWIW, the margin of error on these estimates out of Census is gargantuan, and building permits / housing starts have not really confirmed this data. Regardless, it is great news, if it holds up. The biggest growth was in the South, although we saw increases everywhere.

Mortgage Applications fell 4.6% last week as purchases fell 6% and refis fell 3%. Rising rates affected the numbers as well as the comparison to the holiday-shortened week previously. Overall, mortgage rates increased about 4 basis points to 4.18%. The purchase index is up 10% YOY.

Durable goods orders came in better than expected, increasing 2.2%, a touch better than expectations. Ex-transportation, they rose 0.7%. Core capital goods expenditures rose 1.3%.

Home prices rose 0.7% MOM and 6.6% YOY, according to the FHFA House Price Index.

The 10 year bond yield is trading above 2.4% – a key technical level over the past year. If it holds, it means the bond bears might have their day at last. Much of this will depend on whether we get tax reform, and what shape it takes. Republicans are supposedly releasing their tax bill on November 1.

Machinations in DC are not the only thing influencing bonds, though. Overseas strength is also playing a role here: the UK economy grew faster than expected, and German business confidence is at a high. Despite the differences between economies, sovereign debt does trade as an asset class and therefore strength and weakness overseas will flow through to our bond market.

One thing to keep in mind is that mortgage rates generally lag Treasuries. In other words, if the 10 year bond yield spikes, mortgage rates will generally take a few days to adjust. So, if you are floating and wondering whether to lock, mortgage rates will probably move up over the course of the next few days if this level holds in the 10 year. It pays to check the movements in the 10 year and the mortgage market to get an idea of where mortgage rates are headed over a day or two.

Arizona Senator Jeff Flake announced yesterday that he will not run for re-election. Republicans have a huge advantage in the Senate midterms as they are defending only a few seats while Democrats are defending a lot. There was always a rift in the Republican Party between Trump and Establishment Republicans, who were never comfortable with each other. Establishment Republicans like Corker and Flake were going to be primaried, and it appears that their constituents are further to the right than they are. Despite all the media spin, Jeff Flake was going to have a tough re-election anyway. This is nothing new: In 2010, Republicans hoped to re-take the Senate, however they ran some Tea Party types who ended up losing. The entire US electorate is becoming more polarized, which makes legislation all that more difficult, and shows the importance of controlling the regulatory agencies.

Fannie Mae is collaborating with fintech companies to launch Single Source Validation, part of its Day 1 Certainty program. Single Source Validation will augment a borrower’s credit report with data from other sources. The program is being piloted right now with Quicken. They are also working with companies to improve security and to allow lenders to get info directly from the borrower’s bank without having to scan and email statements.

What jobs are most likely to not be replaced by robots and AI? Many in healthcare.

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