All Things in Moderation

Vital Statistics:

Stocks are higher this morning after a strong jobs report. Bonds and MBS are up small.

Jobs report data dump:

• Payrolls up 235k vs 200k expected
• unemployment rate 4.7%
• labor force participation rate 63%
• average hourly earnings up 0.2% MOM, up 2.8% YOY

Overall a decent report. Didn’t match the ADP number on payrolls, but ADP generally correlates with the revised BLS report, not the first one. Looks like the Fed is going to hike next week. Note another big increase in construction employment, to 58k, which is the highest since 2007. Bonds had already sold off on the strong ADP number, so they are recouping some of those losses today.

Donald Trump met with community bankers yesterday and promised to ease the regulatory burden the state has imposed on them. There has generally been bipartisan agreement that the regulatory burden on small banks has been too heavy, and that it is inhibiting credit to small business.

Goldman is out with a call this morning forecasting that the Fed will hike 3x this year: March, June, and September. They expect the Fed to end their reinvestment of maturing assets in the fourth quarter this year. The end of reinvestment shouldn’t have a major effect on mortgage rates, since spreads were largely insensitive to QE in the first place.

The Fed funds futures are now forecasting a 50% chance of a June rate hike, up from about 20% a couple weeks ago.

Household net worth increased to record levels in the fourth quarter, according to the Federal Reserve. The ratio of net worth to disposable income hit 6.5x, which matches bubble-era highs.

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Vital Statistics:

Stocks are lower this morning as oil continues to fall. Bonds and MBS are down small.

Initial Jobless Claims ticked up to 243k last week. The 4 week moving average is 237k. Consumer Comfort improved.

There were 37,000 announced job cuts in February, according to outplacement firm Challenger, Gray and Christmas. This is a decline of 19% from January and a decrease of 40% from February last year. The job cuts are dominated by the retail sector as department stores had a lousy holiday season. In fact, the job cuts in retail are almost 6x the next biggest sector (energy). Of course some of this is seasonal, but there continue to be problems with the shopping mall sector or retail. The financial sector also reported about 3,300 job cuts as higher interest rates hurt some in the mortgage space and automation / falling fees reduce headcount in banking and asset management. On the other side of the coin, companies announced they were hiring over 162k – and 100k of them were by Amazon.com. It seems strange to think that for every job lost in bricks and mortar retail, 3 were created for online shopping, but there you go.

Import prices rose 0.2% in February and are up 4.6% YOY, however when you strip out petroleum, they fell 0.1% and are up 0.5% YOY. While the Fed is concerned about potential inflation, we have yet to see any hard evidence of it yet.

Rising home prices helped reduce negative equity by over $2 billion in the fourth quarter, according to CoreLogic. About 3.2 million homes (or 6.2%) have negative equity. A total of 7.7 million have under 20% equity. These loans become refi candidates as home price rise. Cashout refis driven by increasing home prices will undoubtedly become a larger component of the refi universe as rates continue to rise.

Under Donald Trump’s proposed budget HUD will get about 14% less than last year. It looks like most of the cuts will fall on community devlopment block grants and public housing maintenance. It doesn’t appear (at least initially) that the mortgage side of things is affected at all.

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Vital Statistics:

Stocks are higher after a strong ADP jobs report. Bonds and MBS are down.

The private sector added 298,000 jobs in February, according to the ADP jobs report. This reading was the highest in 3 years and beat the consensus number by 115,000 jobs. January was revised upward as well. Construction employment increased by 60,000, which bodes well for home construction, although a mild winter probably affected that number.  Friday’s payroll number is forecast to be 195,000. The report sent the 10 year and the 2 year bond yield up 3 basis points.

Mortgage applications rose 3.3% last week as purchases rose 2% and refis rose 5%. Refis as a percent of total production increase marginally after hitting a 9 year low last week at 45.4%. The average mortgage rate increased by 6  basis points last week.

Productivity increased at a 1.3% annual pace in the fourth quarter as output rose 2.4% and hours worked increases 1%. Unit Labor costs increased 1.7%. Productivity was marginally below expectations, while unit labor costs were above. Productivity (or lack thereof) has been a consistent issue over the past 10 years. Productivity ultimately is what drives increases in standards of living.

Given the strong economic data, the Fed has been jawboning the markets, sending Fed Funds forecasts higher. The move over the past 3 weeks in the Fed Funds futures contracts was the result of a number of speeches designed to wake up the markets. “We didn’t clearly see how the balance of risks was shifting, so they have to slap our faces, and say, ‘Look, you are missing the point’,” said Tim Duy, an economics professor at the University of Oregon. You can see the huge change in sentiment in the chart below, which calculates the implied probability of a March hike:

Despite the chance of 2-3 hikes this year, the Fed isn’t really moving to a contractionary monetary policy regime. On a scale of 1 to 10, we are going from 9 to maybe 8.5. We aren’t even remotely near a normal level in the Fed Funds rate, which is still negative by about 100 basis points (the effective FF rate is trading at 67 basis points and the inflation rate is around 1.7% or so, so the real rate is about -1%).

Janet Yellen’s Fed is almost the mirror image of Alan Greenspan’s Fed in that Yellen communicates to the markets what the Fed is thinking, while Greenspan stayed as opaque as possible. Note that the last 3 times the Fed went into a tightening cycle, they blew up the mortgage backed securities markets (1994) the stock market bubble (1999) and the residential real estate bubble (2006). You could argue that we currently have a bubble in global sovereign debt in that bond prices are assuming that inflation has been vanquished and is never, ever, ever coming back.

Republicans released their repeal and replace of Obamacare, and for the most part it is pretty similar to Obamacare. There are some small changes, but it more or less keeps the same structure. Direct subsidies are being replaced by refundable tax credits, while the Medicaid expansion gets block granted to the states. The Cadillac Tax gets pushed out to 2025, and pricing becomes more of a function of age than income. Conservative Republicans are against it, as well as pretty much every Democrat.

When dealing with corporations, there is a public Trump (the tweeter) and the private Trump. Since taking office, he has hit pharma companies on drug prices, automakers on outsourcing, and even retailers. Behind closed doors he is more accommodating. This explains why business confidence has been increasing despite these public statements.

Despite the strong data, the Atlanta Fed revised its forecast for Q1 GDP to an increase of only 1.3%.

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Vital Statistics:

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

Home prices rose 0.7% MOM and are up 6.9% YOY, according to CoreLogic. Including distressed sales, home prices are about 4% below their April 2006 peak. Other indices like the FHFA House Price Index have already surpassed their old bubble peaks. Of course they haven’t really surpassed the bubble peaks on an inflation-adjusted basis – over the past 11 years, inflation has increased prices 20%. Currently, we have pockets of overvaluation in Florida, the Pacific NW, Texas, and parts of the Northeast.

Rising prices are helping homebuyer sentiment. The latest Fannie Mae Home Purchase sentiment index rose 5.6 percentage points to 88.3, a new record. Note that the index only started in 2010, so it has a limited history. The employment-related questions showed big improvements. People are not worried about losing their jobs, and a net 19% of respondents reported increased income over the past year.

Redfin has some advice for Ben Carson regarding affordable housing policy. Punch line: increase subsidies, and try and coax local governments to change their zoning laws using carrots of infrastructure investment.

Meanwhile, construction executives are the most optimistic they have been in years. Of course some of that optimism is predicated on a big infrastructure plan out of DC, which may or may not happen.

The Republican replacement for Obamacare is out. The major changes include an elimination of the individual mandate, and block-granting Medicaid to the states. The Cadillac tax gets deferred until 2025 as well. The popular parts of Obamacare (allowing kids to stay on their parents’ plan until their mid twenties and the the pre-existing condition coverage mandate) remain in place.

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Vital Statistics:

Stocks are lower this morning on overseas weakness. Bonds and MBS are flat.

Fed Funds futures are now fully pricing in a 25 basis point hike at next week’s FOMC meeting. Now that we are in the quiet period, the only market-moving data should be late this week when we get productivity and the jobs report.

Consumer spending has almost fully recovered from the Great Recession, with the February number coming in at $101, the strongest February since 2008.

Factory orders increased 1.2% in January. Consensus was for a 1.1% increase.

Over the weekend, the war between Democrats and Trump intensified, with Democrats calling for Attorney General Jeff Sessions to resign and Trump accusing the Obama administration of tapping the phones of Trump Tower. So far, markets are basically ignoring all of this as a sideshow. IMO, markets are sanguine about this simply because the deepening partisanship makes gridlock even more likely, and therefore a lot of the uncertainty is taken off the table. When and if that ever changes, the canary in the coal mine should be the dollar.

Prepay speeds dropped by 30% in January, according to the Black Knight Financial Services Mortgage Monitor. Delinquencies declined by 4% versus December and are down 17% YOY. That said, foreclosure starts increased largely due to seasonal effects. Note the decline in prepayments was not uniform across the credit spectrum: 720+ FICO prepays declined by 32%, while sub 620 FICO prepays fell by 10%. Even with rates up here, it still makes sense for some borrowers to do cash-out refis in order to consolidate higher interest rate debt like credit cards.

What should you do if you are upside down on your home? Zillow has you covered.

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Vital Statistics:

Stocks are still taking a breather after a nice run. Bonds and MBS are down.

The focus today will be all of the Fed-speak, with Janet Yellen and Stanley Fischer speaking around lunchtime. The Fed enters their quiet period ahead of the March FOMC meeting tomorrow. The markets have gone from pricing a March hike as a 30% chance to an almost certainty over the past several weeks.

The ISM Non-Manufacturing index improved in January, as business activity and new orders (especially exports) led the charge. Employment ticked up slightly. The reading of 57.6 was the highest since October 2015.

Ben Carson was confirmed as the new HUD Secretary yesterday on a 58-41 vote. HUD probably won’t have a lot to do with GSE reform, as that is largely a Treasury function. Ben Carson is a neurosurgeon by trade, and his public record on housing was limited to an editorial criticizing Obama’s enforcement of the Fair Housing Act. During his hearing, however he praised the Fair Housing Act as an important piece of legislation. The safety of public housing is a priority for him, and he plans to increase HUD’s efforts to eliminate lead paint, mold, etc from public housing. He wants to continue to advance HUD’s mission of financing low income / credit / first time homebuyers while introducing private capital and protecting taxpayers.

Snap priced its IPO yesterday, where it had a 44% gain on the first day of trading. Many IPOs lately have not seen a big pop on day 1, so this is a bit of an anomaly. The lack of big gains from IPOs represents the drop in commission revenue and the balance of power between issuers and the buy side (a big jump in price on the first day means that the IPO was underpriced and the issuer is leaving money on the table). In the past, the banks were more worried about keeping the big mutual funds happy since they were a steady source of commission revenue, while issuers would typically do a deal and then go away for a while. Nowadays, commissions are basically nothing, so banks are more concerned with keeping issuers happy than they are with keeping, say Fidelity happy. When I started in the business, commissions were 5 cents a share, and bid-ask spreads were an eighth. Today, commissions are less than half a penny a share and bid-ask spreads are 1/10 of a cent on big liquid stocks.

As a general rule, when the stock price is telling you one thing and the bonds are telling you another, go with what the bonds are telling you. We are seeing a bit of that right now with stocks and bonds – as stocks are off to the races on the reflation trade, bonds have been in a range post-election. Bonds are saying either (a) fiscal stimulus is not going to happen or (b) fiscal stimulus isn’t going to work. That is certainly a fair take, and I do think rates have gotten a bit ahead of themselves. On the other hand, interest rates have been so heavily manipulated by central banks over the past decade, that the signal-to-noise ratio is lower than normal. Ultimately this is a criticism of monetary policy has gotten short shrift in the public debate: that interest rates are an important signal that the economy uses to allocate capital. When central banks manipulate rates to help goose the economy, those signals are distorted, and the typical effect is a bubble. Keynes and Hayek explain it to you here.

One of Donald Trump’s plans is to increase defense spending. The proposed increase is anywhere from $20 billion to $54 billion, from the current $582 billion level (or 3.1% of GDP). Here is a chart of defense spending over the past century as a percent of GDP in order to put current levels into perspective:

Solid tips for doing your taxes this year.

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Vital Statistics:

Stocks are flat this morning on no real news. Bonds and MBS are down small after Fed dove Lael Brainard suggested rates should rise soon.

The Fed funds futures are now assigning a 90% probability of a rate hike at the next FOMC meeting. It was only 30% or so just a few weeks ago.

Fed watcher Tim Duy has a good piece on the Fed’s balancing act and how it relates to November. He was in the “two hikes with an option for a third” camp and thinks the Fed will stand pat in March. He raises a good point on the December dot plot that freaked out bond investors: the most hawkish members that contributed to that plot are non-voters.

Initial Jobless Claims fell to 223k last week, which was the lowest level in 44 years. When you correct for population growth, we are in uncharted territory.

Snapchat priced their IPO at $17 a share yesterday. The company sports a modest 21.4x sales multiple.

Consumer Comfort improved last week, and is at the highest since early 2007.

Donald Trump seems to be settling in on picking Kevin Hassett from the American Enterprise Institute to lead his Council of Economic Advisors. Hassett is known for supporting a “New Deal” style program where the government provides jobs to the long term unemployed. His rationale is that the government gets some value in return, it makes the LT unemployed more attractive to private sector companies, and it probably reduces crime.

While robotics have been displacing manual labor jobs for quite some time, artificial intelligence is replacing white collar jobs as well. In fact, the two professions that have been most insulated from the globalization wrecking ball (law and medicine) are ripe for machine learning and AI. Much of what I used to do as a trader 15 years ago is now completely done by algorithms. This is probably the single biggest reason why wage growth is so hard to find – the competitor to human labor only gets cheaper and better.

As we approach tax season, it pays to look at some of the tax benefits of buying. In 2016, however several tax benefits expired, including the deduction for mortgage insurance, the tax free treatment for forgiven mortgage debt, and the tax break for “green” energy home improvements. The new administration and Congress are looking to simplify the tax code, which means ending some of the social engineering pieces like the green energy home improvements mentioned above. The gist is that tax rates will be lowered, however deductions will be eliminated, and the standard deduction will increase. The mortgage interest deduction, and the deduction for state and local taxes will have the biggest effects.

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Vital Statistics:

We have green on the screen this morning as markets liked Donald Trump’s speech to Congress last night. Bonds and MBS are down.

Donald Trump addressed Congress last night (it wasn’t a full-on State of the Union address), and laid out broad brush strokes about his priorities going forward, including tax reform and healthcare. Generally speaking, the speech was well-received, although those looking for policy depth were disappointed. Here is a transcript. Regardless, equity markets liked what they heard and we are off to the races this morning.

On the bond side of things, yields continue to increase, particularly on shorter-term paper as markets handicap a March hike. The 2 year bond now yields 1.31%, which is a post-crisis record.

Mortgage Applications rose 5.8% last week as purchases rose 7% and refis rose 5%. Refis accounted for just over 45% of all applications last week, the lowest since 2008.

Personal incomes rose 0.4% in January, a little better than expected, while personal spending rose 0.2%, which was a little lower than expected. The Personal Consumption Expenditure index, which the Fed prefers to use, rose 1.9% YOY. The core PCE index which excludes food and energy rose 1.7% YOY. Note that the PCE index is generally about 30 basis points behind the Consumer Price Index, simply because of the difference in weightings. Note that the second revision of GDP from yesterday had PCE inflation at 2.2% at the end of December, so we are seeing a deceleration in January.

Manufacturing improved in February, according to the ISM Manufacturing Survey. New Orders rose, while employment fell. The reading for February of 57.7 would typically correspond to a GDP growth rate of 4.5%. While manufacturing isn’t the driver of the economy that it used to be, this is still good news for growth going forward, especially after a pretty weak 2016.

Construction spending fell 1% in January and is up 3.1% on a YOY basis. Residential construction rose 0.3% and is up 5.5% YOY. Donald Trump plans to add $1 trillion in construction spending, although he does not say over what period. As we learned from the Obama stimulus of 2009, infrastructure spending has a long lead time. That said, take a look at the chart below, which is of public construction spending. We have averaged about $300 billion a year in public construction spending over the past 10 years or so, which means an additional trillion over something like 4 years amounts to almost doubling public construction spending. This would mean public construction spending as a percent of GDP would be at a 50 year high.

Delinquency rates continue to fall according to Freddie Mac. The seriously delinquent rate fell below 1% in January, which is down from 1.33% a year ago. The rate peaked in 2010 at 4.2%. Pre-bubble, seriously delinquent rates were in the 60-80 basis point range.

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Vital Statistics:

Stocks are flattish on no real news. Bonds and MBS are down small.

There were no changes to the headline estimate for fourth quarter GDP in the second revision. It came in at 1.9%, while the price index was revised down to 1.9% from 2.2%.

Despite the subdued growth and inflation, the Fed Funds futures are bumping up their probability of a March hike to about 50% now. There is the perception that Yellen’s Fed is worried most about surprising the markets, so in some ways, this becomes a self-fulfilling prophecy. The more the Fed Funds futures price in a hike, the more likely the Fed is to vote for one.

Home prices rose 5.8% in December, according to the Case-Shiller Home Price index. This is the fastest pace of acceleration in the past 2.5 years. Interestingly, we are starting to see correlations between the top tier and bottom tiers break down as the luxury market slows while the demand for starter homes increases. Much of that is inventory-driven, where starter homes are snapped up within a month of listing, while McMansions languish. Certainly in the Western MSAs, Chinese demand is a big factor, and that has been slowed by capital controls.

Housing demand increased 6.5% in January, according to Redfin. “Soaring stock markets, still low mortgage rates and a steady economy bolstered homebuyers at the start of 2017,” said Redfin chief economist Nela Richardson. “Homebuyers were not just window shopping, they were serious about making offers and getting to the closing table. However, this uptick in homebuyer enthusiasm won’t guarantee strong sales in the coming months. With pending home sales down across the country in January despite strong demand, the lack of supply is a formidable foe for buyers this year.”

The trade deficit widened to $69.2 billion in January from $64.4 billion in December. Exports fell 0.2% while imports rose 2.3%. The US dollar is playing a big part here, but I suspect this number will begin to take on more importance going forward, especially with respect to threats of protectionism, which will flow through to growth and ultimately interest rates.

In other economic news, business activity strengthened in February, according to the Chicago PMI Index. Consumer confidence rose in February and stands at a 15 year high, according to the Conference Board. Finally, the Richmond Fed Manufacturing Index improved.

Donald Trump will address Congress tonight, and lay out his vision for his administration going forward. Expect to see a call for increased defense spending, while cuts in discretionary spending to offset it, along with stepped up growth assumptions. Administration officials are signaling that the speech will be a Reaganesque “Morning in America” speech of optimism and economic growth. Those looking for details on his plans should probably not expect much in the way of clarity. The speech will probably not be market-moving unless it goes really badly, in which case you should expect a flight to safety, with lower stock prices and lower interest rates. Here are the sectors to watch: financials, retailers, healthcare.

Freddie Mac has put out its Outlook for the housing market and origination. They forecast a 27% drop in originations as the refi business goes away, with the 30 year fixed rate mortgage to average 4.4%. Their baseline prediction anticipates some fiscal stimulus out of DC, which should send inflationary expectations somewhat higher, but not cause a major increase. The second most likely scenario would be heavier fiscal stimulus, which would cause higher inflation, with higher interest rates, higher home price inflation, and lower origination numbers. The least likely scenario is a retrenchment of inflation (basically the Japan scenario).

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Vital Statistics:

Stocks are lower this morning on overseas weakness. Bonds and MBS are up small.

We have a slew of economic data this week with the second revision to Q4 GDP, Personal Income and Spending, Construction Spending, and the ISM data. Even though this Friday is the first of March, the jobs report will be released on the 10th. Finally, we get some Fed-speak this week, culminating with Janet Yellen on Friday, which will begin the quiet period ahead of the March FOMC meeting.

Durable Goods orders rose 1.8% MOM but are down 0.6% YOY. Capital Goods expenditures fell 0.4% MOM and are up 0.5% YOY. Capital Goods orders are a proxy for business investment (and therefore the animal spirits), so for all the talk about improved sentiment businesses are still in maintenance mode, not growth mode.

Pending Home Sales fell 2.8% in January as tight inventory reduced sales. Lawrence Yun, NAR chief economist, says home shoppers in January faced numerous obstacles in their quest to buy a home. “The significant shortage of listings last month along with deteriorating affordability as the result of higher home prices and mortgage rates kept many would-be buyers at bay,” he said. “Buyer traffic is easily outpacing seller traffic in several metro areas and is why homes are selling at a much faster rate than a year ago 1. Most notably in the West, it’s not uncommon to see a home come off the market within a month.”

Donald Trump’s proposed budget includes increased defense spending, a cut to agency budgets, and no changes to Social Security and Medicare. This is just an opening bid, and Congress will ultimately determine who gets what. Separately, Trump signed an executive order taking aim at excessive regulations.

Jeffrey Gundlach, CEO of Double Line Capital sees the 10 year heading to a range of 2% – 2.25% as there is a “stealth flight to safety” happening globally and the most crowded trade on the planet (short bonds) goes the wrong way. He is supportive of Treasury’s plan to issue longer-dated bonds (30 years up to 100 years). At these rates, why not? Warren Buffet won’t touch them with a barge pole, however.

For those that follow Buffet, here is his annual letter to shareholders, which is usually a fun read.

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