All Things in Moderation

Vital Statistics:

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

There isn’t a much in the way of market-moving economic data this week, but we will have a bit of Fed-speak. Despite the weak-ish jobs report on Friday, the Fed Funds futures are handicapping a bigger chance of a hike in December. We are now at at 43% chance of a rate hike versus 38% last week.

Historically, September has been a bad month for stocks. Here are some of the things that could upset the apple cart. Geopolitical risk is probably the biggest, followed by a government shutdown. The Fed is out of the picture. Note that the dividend yield on the S&P 500 is higher than Treasuries.

Factory orders fell 3.3% in July, more or less in line with expectations. The drop was expected due to a big order from Boeing in June.

Fed governor Lael Brainard said the Fed should slow rate hikes if inflation remains below 2%, where it has been for the past 5 years. Brainard is one of the doves on the FOMC, and the one who probably most resembles Janet Yellen’s thinking.

Home prices rose 0.9% MOM and are up 6.7% YOY, according to the CoreLogic Home Price Index. Home prices rose the most in the Pacific Northwest and the mountain states. About a third of the MSAs CoreLogic covers are overvalued. 28% were considered undervalued.

The Trump Administration is backing off threats to shut down the government over funding the border wall. Given the continuing rebuilding efforts in Houston and the potential for Hurricane Irma to hit Florida, a government shutdown over the debt ceiling isn’t going to happen. Trump also said he will rescind the Obama Administration’s executive order on immigration in 6 months, which gives Congress time to handle this legislatively. Funding for the wall in exchange for some protection for the Dreamers is probably the deal that will get done.

Speaking of hurricanes, CoreLogic estimates that about 70% of the flood damage in Houston was uninsured.

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Vital Statistics:

Stocks are higher despite a mediocre jobs report. Bonds and MBS are up.

Jobs report data dump:

• Payrolls up 156,000
• Unemployment rate 4.4%
• Hourly earnings up 0.1% MOM / 2.5% YOY
• Labor force participation rate 62.9%
• 2 month payroll revision down 41,000

Another month where the ADP number was way off of what BLS reported. For the markets, it is a Goldilocks report which is strong enough to keep the recovery going and weak enough to keep the Fed from tightening too aggressively. Construction, professional business services, and manufacturing were the biggest contributors to job growth. Manufacturing job growth was the highest in 5 years, which is encouraging.  2.5% annual wage growth is nothing to write home about, however with inflation around 1.5% or so, it is probably the best we can hope for at the moment. The Fed funds futures moved a touch more towards the Fed standing pat in December and September.

The strong manufacturing job growth was echoed in the latest ISM Manufacturing Survey, which improved in July. New Orders and Production drove the big increase, although employment was close behind. The reading of 58.8 is usually associated with 4.9% GDP growth. Given that strength, wage growth should be accelerating.

Construction spending fell in July by 0.6% and is up only 1.8% YOY. Residential construction improved however, which we need to see to alleviate the tight inventory issue.

Gasoline prices are up 25% in some places after Harvey affected about 10% of the US’s refining capacity. Higher gas prices have invariably tilted towards lower growth and a drop in the consumer confidence indices. Expect to see some hand-wringing over the mindset of the consumer going forward.

Bond strategists are flummoxed to explain the bond market’s rally over the past few months. At the beginning of the year, most were thinking the 10 year would yield closer to 3%, however yields have dropped by about 40 basis points instead. With GDP growth around 3%, you should expect to see investors dump Treasuries, but it hasn’t happened. IMO the Trump reflation trade was always a bit of a stretch, and pre-election yields were closer to reality than post-election yields. Still, there are a lot of bears that are having a tough year right now.

Almost half of all homes in the US have regained their bubble peaks, according to Zillow. The leading MSAs are Denver and Dallas, while the ones who still lag the most include Las Vegas and Riverside.

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Vital Statistics:

Stocks are up this morning on end-of-month window dressing. Bonds and MBS are flat.

Personal incomes rose 0.4% in July, while personal spending rose 0.3%. The PCE index (the Fed’s preferred measure for inflation) rose 0.1% MOM and 1.4% YOY. Good report for stock bulls in that incomes and spending are rising smartly while low inflation keeps the Fed at bay. The December Fed Funds futures are currently predicting a 36% chance of a rate hike at the December meeting and virtually no chance of a hike at the September meeting.

Pending Home sales fell again in July, for the fourth time in five months as tight inventory reduced contract activity. Since bottoming 5 years ago, home prices are up 38% while incomes are only up about a third of that. While that would imply home affordability is getting worse, we are still quite affordable (as far as mortgage payment to income ratios) than we have been historically. It turns out that interest rates matter more than prices when it comes to affordability.

Job cuts rose to 33,825 in August according to the Challenger and Gray Job Cuts report. This is an uptick from July, and a slight uptick on a YOY basis. Retail and construction (surprisingly) were the areas hit. A number in the low 30ks is generally a pretty strong number historically. Don’t forget, these are job cut announcements based on press releases. They may never actually happen.

Initial Jobless Claims were flat at 236,000 last week, which is still an exceptionally strong number.

The Chicago PMI was unchanged at a strong 58.9 last month. New orders and production rose, while employment contracted. Another possible sign of a slowdown in the labor market?

Congress may tie Harvey funding to a debt ceiling increase to make it palatable for all parties to vote for it. If there is going to be a fight over spending increases, the wall, and the debt ceiling, it will happen at the end of the year, not now. Note that Harvey’s costs will also complicate tax reform.

Fannie, Fred, and FHA have announced they will offer forbearance for at least 90 days for homeowners in Houston who were affected by Harvey.

The CFPB has released its planned changes to TRID. These changes go into the Federal Register on October 10, however they are not mandatory until 10/1/18.

The hits keep coming for Wells. An expanded review of fake accounts increased the estimate to 3.5 million. They are also being sued for charging improper lock extension fees. This will certainly be an obstacle for Republicans who want to argue for loosened financial regulation. For the most part, it seems that any regulatory relief will be directed towards the smaller community banks who have been hit the hardest with increased compliance costs. There is still very little sympathy in Washington for the big money center banks.

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Vital Statistics:

Stocks are higher this morning on some strong economic data. Bonds and MBS are down.

The economy added 237,000 jobs in August, according to the ADP jobs report. The Street is looking for 180,000 jobs in this Friday’s jobs report. In a reversal of recent trends, large businesses are starting to add workers.

Second quarter GDP was revised upward to 3% from 2.6% as consumer spending increased 3.3%. The GDP price index was unchanged at 1%, which gives the Fed the leeway to maintain an easy monetary policy.

Mortgage Applications decreased 2.3% last week as purchases fell 3% and refis fell 2%. The 30 year conforming rate fell by a basis point to 4.11%.

Corporate profits fell in Q2 from 11.5% to 8.1%.

The FHFA is changing some of the limits for reverse mortgages, after it found that the program amounts to a 7.7 billion a year loss for the government. The borrowing caps will fall, such that a 62 year old would be able to only access 41% of the equity in their property, down from 52%. An 82 year old would only be able to access 51%, down from 60%. Reverse Mortgages are a way for seniors to tap an illiquid asset (their home equity) and turn it into a liquid asset (cash) while still living in their home. They are a great deal for the senior, however they are a money-loser for the taxpayer.

CoreLogic takes a look at which housing markets are most at risk for a downturn, using its Market Health indicator. This looks at home price appreciation relative to income growth and rental inflation. 8 of the top 10 riskiest markets are in Florida. Note that the highest risk areas are the ones that fell the furthest when the bubble burst. The low risk ones are the areas that didn’t really experience the huge peaks and valleys.

Wells Fargo is being sued over lock extension fees. The suit claims that they charged extension fees when the bank was the reason the lock was blown.

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Stocks are lower on news that North Korea fired a missile over Japan. Bonds and MBS are up.

Pre-open, the 10-year bond is trading at 2.11%, the lowest level of 2017 and we are back at immediate post-election levels. Remember, on the day of the election, the 10 year was trading around 1.83%, so we could still have further to fall in rates. The Great Trump Election Reflation simply isn’t going to happen, though the Administration still intends to pivot to tax reform. The trader in me thinks we test the 1.83 level at some point.

Home prices rose 0.1% MOM and are up 5.7% YOY according to the Case-Shiller Home Price Index. The Case-Shiller index has been lagging the FHFA index, which indicates that there might be some issues at the high end of the market. The FHFA index only looks at homes with a conforming mortgage, so jumbos and all-cash sales are excluded.

Consumer confidence rose again in August to 122.9. The present situation component of the index hit a 16 year high, as we are back to mid 2001 levels.

Tax reform won’t be a slam dunk, but there could be a possibility for a bipartisan deal. Democrats might be willing to trade a carbon tax for an income tax cut, but that might be too tough of a deal for Republicans to stomach. A repatriation holiday for overseas corporate earnings is another possibility, however Democrats will certainly want some sort of strings attached to the repatriation break to ensure the funds don’t simply go to buybacks and dividends, which is what happened last time we did one. Perhaps a deal could be found if there is a stipulation that some percentage of the savings be applied to worker compensation and training.

A drop in the cap for the mortgage interest deduction is also something being considered, however that is such a politically risky issue that I doubt anyone does anything about it. The main beneficiaries are the wealthy and the upper middle class, and the upper middle class is really the third rail of politics. Liberals may hate the distribution of the benefits, but they probably won’t go to the mat for it. Why? It isn’t indexed for inflation, so the cap will hit more and more people simply due to home price appreciation. As a practical matter, the cap is declining 6% a year.

Fannie Mae Chief Economist Doug Duncan looks at the implications of the Fed ending QE. He believes that it will increase MBS spreads, which means that mortgage rates will rise more than you would typically expect when rates rise, and fall less than you would expect when rates fall. FWIW, I think any effect would be minor: it certainly was when QE was actually happening. He also speculates that tapering will affect Fannie Mae and Freddie Mac spreads more than Ginnie spreads due to the differing capital treatment for banks. This means that FHA and VA loans will be relatively more attractive to a borrower than a Fannie or Freddie loan. The GSEs have also been ordered to reduce their balance sheets to a set level, so they won’t automatically absorb that lost demand.

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Vital Statistics:

Stocks are up this morning after Harvey pounded Houston. Bonds and MBS are up.

About 10% of US gasoline refining capacity is offline due to Harvey. We could see higher gasoline and heating oil prices as a result.

We have a big week of economic data with GDP, personal spending and incomes, PCE inflation, and the jobs report. The December Fed Funds Futures are pricing in a 61% chance of no change in the Fed Funds rate at the December meeting.

Janet Yellen and Mario Draghi defended the post-crisis regulatory framework and suggested only “modest” changes to it. Janet Yellen’s term expires early next year, and many are wondering who Trump will nominate to replace her (or whether she will be re-nominated). Gary Cohn is the name most mentioned as a replacement. With regards to Dodd-Frank, most of the regulatory changes will probably concern the regulatory burden for smaller community banks and finding a way to give them some relief. A change in the structure of the CFPB would also be a possibility.

Speaking of the CFPB, there is talk that Director Cordray will be resigning soon in order to run for Governor of Ohio.

The Fed lays out a proposal for a new type of 30 year fixed rate mortgage – the COFI (cost of funds index) mortgage. It is a 30 year fixed rate mortgage, however it has restrictions on refinancing and equity extraction. Essentially, it is an ARM from the banks’ standpoint, and a 30 year fixed from the borrower’s standpoint. The payment never changes, however the amount of the payment that goes to principal and interest varies with interest rates. When rates fall, the interest component of the fixed mortgage payment falls as well, and that extra payment is applied to the principal, which creates a reservoir of home equity. When rates rise, the interest component increases, and the home equity component falls. If the reservoir is empty (i.e. no home equity to draw upon), the bank covers it. Essentially the idea would be to replace something that is difficult to hedge (prepayment risk) with something easy to hedge (basically option-like interest rate risk). The added equity build will also limit risk to the government, which still guarantees the credit risk.  Interesting idea, however the industry will probably not like it, as it reduces refinancing opportunities. I suspect these bonds will also be difficult to securitize as well.

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Stocks are up this morning as we await Janet Yellen and Mario Draghi speeches in Jackson Hole. Bonds and MBS are flat.

Janet Yellen will be speaking at 10:00 am EST at Jackson Hole. The markets aren’t expecting much in the way of new policy guidance, however given the general illiquidity of the markets, and the fact that it is a Friday during summer, anything that spooks the herd could have outsized effects.

Durable goods orders slipped 6.8% in July largely due to a drop in aircraft orders. Ex-transportation they were up 0.5% MOM and 5.6% YOY. Capital Goods orders rose 0.4% and are up 3.5% YOY. Capital Goods orders are a good proxy for business capital expenditures, and indicates manufacturing confidence in the future.

Credit scoring is something we take for granted, however there is competition to the standard Fair Issac model (FICO). VantageScore (created by Fair Issac competitors Transunion, Equifax and Experian) is attempting to become an alternate scoring methodology for Fannie / Fred and FHFA loans. FHFA is worried that allowing new credit scoring methods would create a race to the bottom, where the agencies end up using the one that shines the most favorable light on borrowers. Some feel the FICO methodology, which doesn’t distinguish between types of debt, is outdated. Vantagescore uses things like utility and rent payment history, which is useful for people who don’t borrow much in the first place and don’t have a FICO score.

The post-election sell-off in bonds is unwinding, and mortgage rates have hit the lows of 2017, matching levels seen just after the election, according to Freddie Mac. The 30 year fixed rate mortgage averaged 3.86% for the week ending August 24, which is the lowest level since November 10, 2016.

The homeownership rate may have bottomed, and perhaps we are seeing a turnaround for the younger buyers. Below is a chart of the homeownership rate by age cohort, going back to 1994. The youngest age brackets definitely have the most volatility, and they are the most affected by the dearth of starter homes for sale.

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Vital Statistics:

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

Today starts the Fed conference in Jackson Hole. No major speeches are planned for today, however Janet Yellen speaks tomorrow. There is the possibility of some volatility around then. The big question will be whether Yellen is nominated for another term or will she be replaced when her term expires next year. National Economic Council Chairman Gary Cohn is the name most mentioned as a replacement. Donald Trump criticized the Fed’s low interest rate policy while on the campaign trail, but it will be interesting to see if he nominates a hawk. Most politicians prefer doves when push comes to shove.

Initial Jobless Claims fell to 234k last week. The labor market remains strong as companies hang on to their workers.

Existing home sales fell 1.3% in July, according to NAR. This is up 2.1% YOY, but is the lowest number of 2017. Lawrence Yun, NAR chief economist, says the second half of the year got off on a somewhat sour note as existing sales in July inched backward. “Buyer interest in most of the country has held up strongly this summer and homes are selling fast, but the negative effect of not enough inventory to choose from and its pressure on overall affordability put the brakes on what should’ve been a higher sales pace,” he said. “Contract activity has mostly trended downward since February and ultimately put a large dent on closings last month.” The median house price was $258,300 which is up 6.2% YOY. Unsold inventory is down to 4.2 month’s worth, from 4.8 months a year ago.

What are the most active real estate markets right now? Colorado Springs, Chicago, and Reno. Least active? San Francisco, where the average house price is now over a million. Much of the Northeast is cold as well. What makes a market active? Access to both good jobs and affordable homes.

Big money managers are swapping corporate debt for mortgage backed securities, particularly subprime MBS from before the crisis. Corporate debt simply got too expensive, and MBS got too cheap. The supply of subprime MBS has been shrinking however as loans get paid off, and non-agency MBS outstanding are about 25% of what they used to be. For fixed income managers, MBS have outperformed most everything this year. The appetite for MBS paper is encouraging, as it would open up the origination business to more outside-the-box product and allow credit to be extended to borrowers who have been more or less shut out of the market post-crisis.

A reduction in the mortgage interest deduction is on the table as part of tax reform. The talk is that the cap would drop from $1 million to $600k or so. Toll Brothers CEO Doug Yearley said reducing the MID would be bad policy and would discourage homeownership. Of course Toll is in the McMansion business, so he is talking his book a little. Bob Shiller thinks the effect would be de minimus as it would only affect something like 4% of taxpayers.

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Stocks are lower this morning after Donald Trump threatened to shut down the government over a wall. Bonds and MBS are up small.

Mortgage Applications dipped half a percent last week as purchases fell 2% and refis rose 0.3%. The average rate on a 30 year fixed was unchanged, while jumbos dropped 5 basis points. Mortgage rates are back at the lows of November 2016.

New Home Sales slipped to 571,000 in July, which was lower than expectations.

For all the talk about Millennials wanting to stay in cities, many are beginning to move to the suburbs. I guess it was only a matter of time. That age cohort is now the biggest group in the housing market. They are starting later than previous generations, however and the median age for a first time homebuyer is 33, which has been inching upward for decades. So, for all the handwringing articles about this generation being reluctant to buy houses, it turns out that they are pretty much like every generation before them: preferring to live in urban areas until they get married and have kids. That said, they are largely renters for the moment, as a combination of a dearth of starter homes and high student loan debt keeps them from buying. Eventually builders will realize there is an opportunity in starter homes, but as of now they are remaining lean and are stymied by regulation and a lack of skilled labor.

Several investment banks are warning that we are approaching the tail end of the expansion and are heading for another recession. They note that global correlations (in other words markets all moving together) has broken down and is back at levels we saw back in 2005. They also cite the fact that companies that beat earnings estimates are not seeing the sort of pop we are used to seeing. We also could be seeing a downturn in profits just as equity valuations reach stretched levels. FWIW, the fact that we are not seeing inflation provides some comfort. Most recessions in the past were driven by an overheating economy (low unemployment, high resource utilization) which caused inflation and tightening from the Fed. We aren’t seeing that at all today – in fact the fear is that inflation is too low. The Fed has been increasing rates not to slow the economy, but to eliminate some of the distortions caused by rates sitting at the zero bound. While you can’t rule out some sort of black swan event (some sort of shock that comes out of left field) the imbalances that usually precede Fed-driven recessions simply aren’t there at the moment, aside from a low unemployment number.

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Vital Statistics:

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

House prices rose 1.6% in the second quarter and are up 6.6% YOY, according to the FHFA House Price Index. The fastest growth was out West, with Washington up 12.4%. The weakest areas were in the Northeast and Mid-Atlantic, particularly CT.

Morgan Stanley is warning that stocks and corporate bonds could be vulnerable once the Fed begins to let its portfolio of Treasuries and MBS run off. A committee of investors and banks hypothesized that corporate credit spreads could widen as much as 135 basis points. Will that have the same effect on mortgage backed securities spreads? Quantitative easing itself didn’t move in spreads all that much, so I cannot imagine something that will amount to a tiny fraction of that having much impact either. The Fed’s balance sheet is now about $4.5 trillion. Pre-crisis it was under $1 trillion. Many market observers think the Fed may never be able to get its balance sheet back down to where it was pre-crisis.

Tensions with North Korea and fears of a debt ceiling standoff have pushed down the market’s assessment of future Fed Funds hikes. The December Fed Funds futures are now predicting a 62% chance of no hike versus a coin toss about a week ago.

The government plans to try and get some sort of tax reform done this year, however it will be difficult. We are much more likely to see some sort of “tax reform light” which probably won’t have a massive impact on the economy in the near term. The first order of business is to fund the government and to get an increase in the debt ceiling. Meanwhile, Bridgewater CEO Ray Dalio is taking off risk due to political polarization and buying gold.

The DOJ ended the Obama Administration’s Operation Choke Point, which was sold as an attempt to prevent banks from funding fraudulent actors, but in reality was just an attempt to prevent banks from doing business with payday lenders, which the Administration opposed on ideological grounds. The idea was to hopefully drive payday lenders out of business by making them unable to find banks to service them.

Luxury homebuilder Toll Brothers reported earnings this morning, and the stock is down a touch pre-market. Average selling prices fell due to a change in product mix. ASPs for signed contracts were flat and contracts were up 25%. Could we be seeing exhaustion, pricing-wise- at the high end of the market? Perhaps, but Robert Toll, Chairman of the Board said: “We believe our industry has room to run. Single-family housing starts, at 811,000, are still well below the 50-year industry average of 1.02 million units. The home ownership rate is on the rise but also still below historic norms. Interest rates remain low, unemployment is low, and more and more buyers are entering the upscale market. Based on these trends, we believe Toll Brothers is well positioned for future growth.”

Despite the lousy housing starts numbers, homebuilder stocks have been on a tear, rising 31% this year. Part of this was due to corporate tax reform – since homebuilders generally have little to no international exposure, a drop in the statutory rate would boost their earnings the most, compared to someone like Apple who has international entities all over the world. Builders have been struggling with their own issues however, especially a shortage of skilled labor. Many of the skilled laborers who worked in homebuilding during the boom either retired or went to work in different industries. Second, construction materials (aka sticks and bricks) are rising as well, and any sort of trade war with Canada will affect framing lumber prices. One thing to remember about homebuilding is that it is a very cyclical business, and during booms, multiples compress. The average homebuilder P/E is about 11 right now, and during the go-go years, it got down to 8.5. In other words, you could be right on earnings increasing, but wrong on the stock price as it goes nowhere while earnings grow. The other side of that argument is that there is so much pent-up demand for housing right now that a slowdown is simply not on the horizon.

A new lending firm claims it can cut the closing process down to 8 days, and the borrower never has to speak to a loan officer. The industry average is 43 days.

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