All Things in Moderation

Vital Statistics:

Stocks are lower as third quarter earnings season begins with results from the banks. Bonds and MBS are flat.

JP Morgan reported better than expected earnings this morning, posting a 7% increase in net income. Higher lending revenues offset lower trading revenues. Mortgage origination was flat YOY, but revenue dropped 17%, which means margins are falling. The stock is flat pre-open.

Initial Jobless Claims came in at 243k last week, historically a very low number. For those wondering about places like Puerto Rico, their number is estimated.

Wholesale inflation remains close to the Fed’s target rate of 2%, according to the Producer Price Index. The PPI rose 0.4% MOM and 2.6% YOY, however if you strip out food, energy, and trade services, it rose 0.2% MOM and 2.1% YOY.

The FOMC minutes really didn’t provide much in the way of additional information. There was some discussion that low inflation might not just be a temporary phenomenon, which was interpreted as dovish by some observers. The 10 year didn’t react to the minutes, but the dollar sold off a tad. The December Fed Funds futures decreased the implied probability of a rate hike by a couple points.

Kevin Warsh is now the favorite of economists to run the Fed after Janet Yellen’s term. He is a Wall Street type who worked for Morgan Stanley during the crisis and has been critical of monetary policy since then. He is generally regarded as more hawkish than Yellen, and will definitely be less of a regulatory hawk than she is. Paul Krugman (Dr. Cowbell) threw a little shade Warsh’s way.

Donald Trump is re-thinking the state and local tax deduction after it turns out that about 30% of people making between 50k and 150k a year could be hit with a tax increase under the new plan. The state and local tax deduction (along with the mortgage interest deduction) are two immensely popular deductions which have managed to survive numerous assaults over the years. House Republicans in blue states, like Peter King of NY, will not support tax reform if it means giving many of their constituents a tax hike. If the state and local tax deduction remains, something else has to give, which will probably mean the estate tax (something loathed by the right) remains.

Congress is preparing legislation to subject the credit bureaus to Federal cybersecurity inspections, and to end the use of social security numbers in credit reporting by 2020. The bill will also require the credit agencies to provide free credit freezes.

How tight is the housing market? So tight that people will put up with living in haunted houses.

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Stocks are lower this morning as we await the FOMC minutes. Bonds and MBS are flat.

There were 6.1 million job openings at the end of August, little changed from the prior month. The quits rate (which is a number the Fed watches closely) was unchanged at 2.1%. The quits rate is a leading indicator for wage growth.

Chicago Fed President Charles Evans said yesterday that a December hike is not a sure thing, and that he hoped for an “honest discussion” on whether it was time to hike rates again. He said the Fed should not treat the 2% inflation target as a ceiling, and should be comfortable with higher than 2% inflation given that it has undershot the target for so long. He was also bullish on the economy in general: “Global growth has really solidified,” which has helped the U.S. economy, he said. “I suspect the wage story is improving.”

The FOMC minutes will be released at 2:00 PM EST today. They probably won’t be market-moving, although we could see some adjustment in the December rate hike probabilities, which currently stands at a 93% chance of a rate hike.

Mortgage applications fell 2.1% last week as purchases fell .1% and refis fell 4%. Mortgage rates increased 4 basis points to 4.16%.

Donald Trump plans to adjust his tax reform plan over the next few weeks. With Democrats uniformly in opposition, Republicans have a narrow path to get this across the line. The issue with the tax plan is that it could raise taxes for people in the $50k-$150k range who live in high tax states. There are enough Blue State Republicans in the House to kill it. In the Senate, Trump has a strained relationship with Bob Corker and John McCain, which means he has no margin for error. Rand Paul has also said that any tax hikes on middle and upper middle class incomes is unacceptable. Tax reform is looking like a long shot, especially since 2018 will be all about posturing for midterms.

Blackrock’s Larry Fink said that his biggest fear is an over-aggressive Fed. He considers this to be a low-probability event, however. His fear is that we could see an inversion of the yield curve, which happens when longer-term interest rates are lower than shorter term interest rates. Historically, that has been a recessionary signal. It is more than a theoretical possibility: the yield curve almost always flattens during a tightening cycle, and the technical mechanics of unwinding QE also would encourage the curve to flatten. What does that mean for mortgage rates? Probably nothing, but at the margin it would favor 30 year fixed rate mortgages over ARMs.

CoreLogic estimates that 172,000 homes could be at risk from the wildfires in Napa and Santa Rosa. Mother Nature has made life miserable for servicers this fall, however the effects probably won’t begin to be felt until the end of the year.

Canada is trying to figure out what to do with their housing bubble. The median house price in Vancouver is currently at 1.6 million (or about 20x income). To put that number into perspective, the US bubble peaked at 4.8x. Vancouver’s market is probably tied most closely to China’s and will burst once that one does.

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Stocks are higher this morning after Walmart announced a $20 billion buyback. Bonds and MBS are flat.

Neel Kashkari speaks at 10:00 am.

Small Business Optimism fell in September as the hurricanes hurt retail spending in Texas and Florida. We did see a weakening in the labor market, not just in Florida and Texas, but in 2/3 of all Census regions. The hurricanes will probably boost the economy into Q4 and Q1 next year, but at the moment they are depressing things. 57% of firms are trying to hire, but the vast majority of those are finding few or no qualified applicants.

The US foreclosure and seriously delinquent rate remain very low, according to CoreLogic. The national Foreclosure rate was 0.7%, down from 0.9% last year. The Seriously Delinquent ratio was just under 2%. This is all July data, so pre-hurricane. We are starting to see the effects of the drop in oil prices in some of the energy intensive states like Alaska and Louisiana.

Home Prices continue to rise, jumping 0.9% MOM and 6.9% YOY in August, according to CoreLogic. Their models hold that half of the largest 50 MSAs are now overvalued, which has been driven by low inventory.

Fannie Mae is offering assistance to borrowers affected by the recent spate of hurricanes. Borrowers will be able to temporarily stop making monthly payments for 3 months (up to 12 months) without late fees, negative comments on their credit reports, or a requirement to get back current in one fell swoop.

The IMF took up their forecast for global growth to 3.6% this year and 3.7% next year. At the margin, this means reduced demand for safe haven assets like Treasuries, which would mean higher interest rates going forward. That said, we have several real estate bubbles overseas at the moment, and when they bust, it should be bond bullish (i.e. encourage lower rates).

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Stocks are lower after the jobs report. Bonds and MBS are down as well.

Jobs report data dump:

• Nonfarm payrolls -33,000 (100k-150k expected)
• Unemployment rate 4.2% (4.4% expected)
• Labor force participation rate 63.1% (62.8% expected)
• Average hourly earnings up .5% MOM / 2.9% YOY (expectation .3% / 2.6%)

Hurricanes Harvey and Irma are responsible for the weak payroll number, which is the only depressed number in an otherwise strong report. Much of the drop in payrolls was due to a drop in restaurant / bar jobs. If a restaurant was closed due to power outages or evacuation the employees are generally not paid, and therefore won’t show up on the list of jobs.

The critical numbers from the jobs report (which is causing rates to rise) is due to higher-than-expected wage growth and the increase in the labor force participation rate. These point to a tightening in the labor market and an increased likelihood of a rate hike in December. The Fed Funds futures are now predicting a 92% chance of a December hike, up from 80% yesterday.

Take a look at the chart of average hourly earnings below. You can see the change in inflection (sharp slowdown in growth) starting in early 2009, however you can also see the change in inflection (that appears to be accelerating) that started in early 2015. We could finally be seeing some wage inflation at long last. Note that there is a possibility that the jump in wages could be driven by the drop in restaurant jobs, which are generally low-paying. That would bump up the average a tad.

The NAHB and NAR are parting ways on the issue of the mortgage interest deduction. The MID is slated to become less important as tax reform takes shape. The standard deduction will be doubled, but many popular deductions will go away. For most people, taking the increased standard deduction will make more sense than itemizing. The NAHB is willing to allow the mortgage interest deduction to go away, as long as the low-income housing tax credit remains. The LIHTC is the big driver that makes building affordable housing make sense. NAR, on the other hand is suggesting that losing the MID would cause a 10% drop in house prices. Since Democrats will be uniformly opposed to any changes to the tax code, it will only take a few Republicans in blue states to put the kibosh on this. The MID has survived many attempts to kill it, and it is simply so popular that it may live to fight another day. Note that there are two things to make the MID less and less important: First, with interest rates so low, the actual interest paid is much less than it was, say, 30 years ago. Second, the MID cap is not indexed to inflation, so as house prices rise, the cap will kick in at progressively lower relative levels.

The Fed weighed in on tax reform, saying that it could cause a short term bump in the economy, but will raise the deficit and inflation.  Of course how much it increases the deficit will depend on the economic forecast used. Republicans want to argue that cutting taxes will increase growth, which will increase the taxes received by Treasury (called dynamic scoring). Democrats want to exclude that growth, arguing that it is invariably too rosy. All sorts of think tanks will weigh in on it and you will have to know their political predilections before reading their take. Many think tanks sell themselves as “non-partisan” when they really are not.

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Vital Statistics:

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

I was at the IMN conference earlier this week, which was very informative. Haven’t heard this much about convexity in a long, long time.

We have a lot of Fed-speak today, with 4 speakers. Powell, Williams, and Harker speak this morning and Esther George speaks after the close. Bonds should be quiet as we await the jobs report tomorrow.

Announced job cuts continue to be low, according to outplacement firm Challenger, Gray and Christmas. Job cuts fell 4.4% in September to 32,346. This number is down 26% from last year. The most movement (in terms of cuts and hiring) remains the retail sector. For the quarter, companies announced job cuts of just over 94,000. Sub-100k quarters are rare: the last one was Q4 last year and then you would have to go back to 2000 to find another. Remember, this stat includes announced job cuts (it counts all the press releases companies do) so these job cuts won’t necessarily materialize.

While online shopping has led to job cuts in bricks-and-mortar stores, those losses are being offset by new jobs in e-commerce. Of course the jobs are very different and require different skill sets, but it kind of looks like a wash

Initial Jobless Claims fell to 260k last week as hurricane-related effects continue to mess with the numbers. Note the ADP Survey (which foreshadows the BLS numbers tomorrow) was weak at 135,000 however hurricane-related effects are probably included in that number as well.

Janet Yellen’s term expires early next year. Here are the most likely candidates to run the Fed going forward. Trump could re-nominate Janet Yellen, however she is a liberal and supports stronger banking regulation. Gary Cohn is another possibility, as Trump prefers business people over academics. Jerome Powell is another possibility, and he would be somewhat more hawkish than Yellen. He is supposedly the choice of Treasury Secretary Steve Mnuchin. Kevin Warsh is more hawksh than either Yellen or Powell and supports financial deregulation. Warsh would probably get some opposition from the left. Finally, John Taylor would be the most hawkish. While politicians might rail against too easy money out of the Fed while on the campaign trail, most prefer dovish types once they are in office. Nobody wants a Fed-induced recession on their watch. The last one we had was 81-82, when Paul Volcker tightened to break the back of 1970s inflation. President Ronald Reagan supported his move, which caused the worst recession (at the time) since the Great Depression.

Online betting site Predict It shows the market’s assessment. Kevin Warsh is in the lead at a 40% chance, while Jerome Powell is at 31% and Yellen is at 10%. Gary Cohn is at 9%.

Philly Fed President Patrick Harker says that the US economy will continue to grow at a subdued 2% rate until we get some sort of pro-growth tax reform out of Washington. He still supports hiking rates in December. The Fed Funds futures have more or less doubled their probability of a rate hike over the past month from around 40% to over 80%.

Donald Trump roiled distressed hedge funds yesterday when he suggested that Puerto Rico might need some debt relief to recover. The Commonwealth’s general obligation bonds fell into the low 30s. At least Trump was nice enough to wait until everyone marked their books for Q3.

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