All Things in Moderation

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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Vital Statistics:

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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Vital Statistics:

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

The big event of the day will be the release of the FOMC minutes at 2:00 pm EST. The Street will be looking for more info on how the Fed plans to wind down its QE portfolio. Investors will also be parsing the statement for clues regarding the Fed’s stance on the current status of low inflation. While inflation remains low if measured against the Fed’s inflation target, we are starting to see wage inflation. The hawks on the Committee will push to get ahead of that, while the doves (like Yellen) will prefer to let the labor market “run hot” for a while. The minutes will probably not be market-moving, but just be aware if you are locking around that time.

The minutes will be interesting given the recent GDP forecasts out of the Atlanta Fed, which have Q3 growth coming in at 3.7%, and are predicting a much stronger second half to the year. You could really start to see a battle between the hawks and the doves. The Fed Funds futures contracts are still predicting no move in September and a 50-50 chance of a hike in December.

Mortgage Applications fell 0.1% last week as purchases fell 2% and refis increased 2%. Mortgage rates continue to tick lower, with the 30 year fixed rate mortgage down to 4.14%, the lowest since November.

Housing starts disappointed last month, coming in at 1.15 million, down 4.8% MOM and 5.8% YOY. The notoriously volatile multi-family segment drove the decrease, as single family starts were more or less unchanged. The Street was looking for 1.22 million units. Building permits came in at 1.22 million, lower than estimates as well. They were down 4% on a MOM  basis but were up 4% on a YOY basis.

Where is the growth in housing construction? Texas. Of course Texas didn’t really experience the bubble type behavior the way states like California, Arizona, and Florida did. This may be because Texas has more restrictions on cash-out refinances than other states. Here is a chart of where the action is (and is not)

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Vital Statistics:

Stocks are higher this morning as tensions between the US and North Korea seemed to ease a bit over the weekend. Bonds and MBS are down.

Not a lot of data this week (nor is there any Fed-Speak). The highlight should be housing starts on Wednesday.

The St. Louis Fed is forecasting 3.7% GDP growth for Q3, while the Atlanta Fed is forecasting 4% growth. Seems surprisingly high, but we will get an idea of how realistic that is when retailers report same store sales for August, which covers the back-to-school shopping season.

These GDP forecasts (if they end up playing out) should boost rates higher over the near term. This will be offset by international tensions (and a general sense of uncertainty in DC) which will pull rates lower. There is no real way to forecast how things will shake out, but just be aware that this push-pull effect should make for increased rate volatility over the near term.

With the Fed on hold until December, the markets are turning to the debt ceiling, which should hit in late September / early October. You are starting to see a tick up in the yields of 3 month T-bills maturing in late September. The debt ceiling has always been a bit of an annual kabuki dance, this time around the unpredictability of things in DC is making traders a little more worried.

Average credit scores have eclipsed their October 2006 peak, hitting 700 this year. It is interesting to see that US consumer debt levels are at all-time highs, however debt service is at a low. Debt service is one’s mortgage, car, installment, and credit card debt as a percentage of income. Check out the charts below:

Consumer credit:

Debt service:

These two charts demonstrate just how much interest rates matter (and why owning a home isn’t quite as unaffordable as the home price indices suggest). If you want to see what determines how Fair Issac (of FICO fame) determines your score, here is a handy chart. The single best thing one can do is make timely payments, followed by reducing the amount they owe.

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Vital Statistics:

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

Job openings increased by 461,000 to hit 6.2 million in June, according to the JOLTS job openings report. The quits rate was steady at 2.1% (or about 3.1 million people). The quits rate is an important number to the Fed and often signals impending wage growth. The quits rate was the lowest in the Northeast, at 1.7% while the highest in the South at 2.5%.

Small business optimism increased in July, according to the NFIB. Small business continues to hire, adding .21 workers on average over the past several months. Finding qualified workers remains a problem, and 87% of those trying to hire found few or no qualified applicants. Apparently drug use remains a big issue – getting workers who can pass a drug test can be difficult. Regarding the political environment in DC, while there has been no movement on anything legislatively, there have also been no new regulations put in place, and we are seeing some regulations from the Obama administration reversed, which is having a positive effect on sentiment.

Minneapolis Fed Head Neel Kashkari spoke yesterday of the tight labor market and dismissed the idea that there is a labor shortage. “Are you really struggling to find workers? If so, the proof for me is you are raising wages. If you are not raising wages, then it just sounds like whining,” he said. While Kashkari is definitely the dove on the committee, if that sentiment is any indication of the rest of the FOMC, they will be content to nudge up the Fed Funds rate at their current cautious pace until they see wage growth.

China is trying to take away the punch bowl and reduce overseas investment, in an effort to prevent them from experiencing a bust similar to Japan’s in the late 80s. I guess they see parallels between Mitsubishi paying $2 billion for the Rockefeller Center, which ended up going bankrupt a few years later. While I think they are barking up the wrong tree here (industrial policy and a residential real estate bubble are the real issues) it will have some knock-on effects perhaps in our markets. The Chinese withdrawal is probably going to hit the Canadian residential real estate market hard, and you are already seeing transactions dry up in Toronto. Chinese money will be most felt in the ultra-expensive urban areas like Seattle, New York City, and San Francisco. If China does in fact go through a Depression, they will probably try and export their way out of it, which means less inflation in the US, and lower interest rates, at the margin.

The Fannie Mae Home Purchase Sentiment Index ticked off of record highs last month as high prices and tight inventory led to a record low of people saying now is a good time to buy. Granted, the index only goes back to 2012, but it does show how high prices are scaring buyers away. Those that say it is a good time to sell also saw a big decrease, which was the main driver of the reading. That is surprising since you would think that tight inventory + demand would equal a great seller’s market. Not sure what would be causing that.

Delinquency rates are improving for the industry according to the latest CoreLogic Loan Performance Insight Report. 30 day + DQs fell to 4.5% in May, which is down 0.8% from last year. The number in foreclosure fell 0.3% to 0.7%. About the only place you are seeing increases in delinquency are the fracking areas (South Dakota, Louisiana, some parts of Texas) which have been affected by falling oil prices.

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