All Things in Moderation

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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Vital Statistics:

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

Mortgage applications fell 5% as purchases and refis fell by the same amount. “Mortgage applications declined to the lowest level since December 1996, despite a drop in mortgage rates. Both purchase and refinance applications fell, with the purchase index hitting a 28-year low, as prospective buyers remain on the sidelines due to low housing inventory and elevated mortgage rates,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The 30-year fixed mortgage rate decreased to 7.21 percent last week, but rates remained more than a full percentage point higher than a year ago, despite mixed data on the health of the economy and signs of a cooling job market. The refinance index dropped to its lowest level since January 2023, driven by a 6 percent decline in conventional refinances.”

Widening MBS spreads aren’t helping things, as the difference between the 30 year fixed rate and the 10 year (which is a decent enough proxy for MBS spreads) is sitting at close to record levels. The chart below goes back to 1990. Know what sticks out to me? The era of QE. Did QE make that big of a difference in MBS spreads? It is debatable. So if QE didn’t affect things all that much than why would people fret so much about QT?

It looks like there is a mean reversion element to MBS spreads, which means this too shall pass.

The services economy slowed sharply in August according to the S&P Services PMI. The index fell from 52.5 to 50.5, which means the services economy is more or less static. Note the manufacturing economy has been in contraction for almost a year.

“The survey data send a hint of rising stagflation risks, as stubborn price pressures are accompanied by a near-stalling of business activity. The PMI numbers for the third quarter so far point to a faltering of economic growth after a robust second quarter, as a renewed manufacturing downturn is accompanied by a deteriorating picture in the service sector.”

The ISM Services PMI paints a brighter picture, showing the services economy expanded in August. New orders, employment, and activity all increased. That said, we saw a big jump in inventories and a big decrease in backlog, which suggests slower growth ahead. Pricing pressures increased again based on higher energy and transportation costs.

Student loan repayments are about to resume, and that should have a negative impact on services.

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ital Statistics:

Stocks are higher this morning after a weaker-than-expected jobs report. Bonds and MBS are up.

The economy added 187,000 jobs in August, which was a touch above Street expectations. The unemployment rate rose from 3.5% to 3.8%, which was the surprise of the report. The number of unemployed people also increased by 514,000 while the number of people employed rose by 222,000.

The size of the labor force also increased, rising by 736,000 which will help bring supply and demand more into balance. This pushed up the labor force participation rate to 62.8%. Average hourly earnings rose less than expected, increasing 0.2% on a month-over-month basis and 4.2% on a year-over-year basis.

This is obviously good news for the bond market, as it shows the Fed’s tightening is gaining traction in the labor market. This should hopefully take some of the pressure off the Fed to keep hiking rates and give them the confidence to let the hikes that have already happened do the job.

Unfortunately, Loretta Mester interrupted the party in the bond market by acknowledging the increase in unemployment, but stressing that inflation is still too high. “In the labor market, some progress is being made in bringing demand and supply into better balance, but the job market is still strong,” Mester said in a speech text, adding “job growth has slowed and job openings are down, but the unemployment rate is low, at 3.8%.” So these comments mean she already knew the numbers in the report.

Apartment asking rents turned negative for the first time since the pandemic began, according to Apartment List. Rents fell 1.2% on a year-over-year basis. A massive shortage of apartment units drove rent increases in 2021 and 2022 and this has spurred a lot of apartment construction, which is coming on line now. Note we have a record number of units in 5+ buildings under construction at the moment. The vacancy rate for apartment units sits at 6.4%, which is slightly above pre-pandemic levels.

The manufacturing economy improved in August, but remains in contraction territory. “The U.S. manufacturing sector shrank again, but the uptick in the PMI^® indicates a slower rate of contraction. The August composite index reading reflects companies managing outputs appropriately as order softness continues, but the month-over-month increase is a sign of improvement. Demand remains soft, but production execution is consistent with new, reduced output levels based on panelists’ companies order books. Suppliers continue to have capacity. Prices are generally stable.”

Construction spending rose 0.7% MOM, while private residential construction rose 1.4%. We are starting to see a divergence in single family versus multi. Single family rose 2.8% MOM but is down 15.2% on a YOY basis. Meanwhile multi-fam rose only 0.2% but is up 24.6% YOY. With a potential glut of new apartments coming onto the market, the focus is turning to single-family construction.

Note that Warren Buffett bought stakes in three homebuilders recently.

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Vital Statistics:

Stocks are higher after key inflation data came in as expected. Bonds and MBS are flat.

Personal Incomes rose 0.2% in July, while spending rose 0.8%. The PCE Price Index (the Fed’s preferred measure of inflation) rose 0.2% month-over-month and 3.3% year-over-year. Excluding food an energy, the index rose 0.2% MOM and 4.2% YOY. The YOY numbers are an uptick from June, however that month was unusually low. Bonds are positive despite the increase.

Country Garden, China’s biggest property developer, reported a loss of $7 billion for the first half of the year and warned of an imminent default. Country Garden has already missed payments on several bond issues and is in the grace period.

Like the subprime crisis in 2008, the conventional wisdom is that this will be contained and there won’t be any systemic risk to the financial system. Country Garden’s losses are comparable to Lehman’s in 2008, so this isn’t a small event. Granted, China’s economy is more closed than most, however it is naive to me to think that there won’t be any pain in the West when the world’s second largest economy experiences a burst real estate bubble.

Real Estate is about 30% of China’s GDP. In the US, it is about 16%. Japan in about 12%. If China’s real estate percentage falls to normal worldwide levels, it will cause a mid-teens contraction in GDP. To put that into perspective, US GDP dropped by 15% between 1929 and 1932.

Announced job cuts soared 267% year-over-year, according to outplacement firm Challenger, Gray and Christmas. A big portion of this was due to the bankruptcy of Yellow, the trucking company.

“Job openings are falling, and American workers are more reluctant to leave their positions right now. The job market is resetting after the pandemic and post-pandemic hiring frenzy,” said Andrew Challenger, labor expert and Senior Vice President of Challenger, Gray & Christmas, Inc. “The increase in job cuts is not surprising as technological disruption and companies taking a cost savings approach on the economy claim positions,” he added.

Hiring plans are the lowest since 2016. Year-to-date, companies have announced plans to hire 135,980 workers, which is a 83% drop compared to 2022.

Home prices set a new high, according to the Black Knight Home Price Index. Prices rose 2.3% on an annual basis, according to the index. Some of this is due to seasonal factors, and prices should start showing bigger YOY increases. That said, affordability issues will probably cap growth rates.

Atlanta Fed Chairman Ralph Bostic said that the Fed should probably hold tight and not continue rate hikes in a speech overnight in South Africa: “You no doubt saw that the Committee voted last month to raise the federal funds rate another 25 basis points, to a level of 5 1/4 to 5 1/2 percent. Based on current dynamics in the macroeconomy, I feel policy is appropriately restrictive. I think we should be cautious and patient and let the restrictive policy continue to influence the economy, lest we risk tightening too much and inflicting unnecessary economic pain.”

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