All Things in Moderation

Vital Statistics:

Stocks are up as we enter Fed Week. Bonds and MBS are up as well.

The upcoming week will be dominated by the FOMC meeting on Tuesday and Wednesday, however we will have a lot of data as well. We will get house price data on Tuesday, the FOMC decision on Wednesday, GDP on Thursday, and the PCE inflation index on Friday.

The Chicago Fed National Activity Index remained in negative territory last month, with most indicators suggesting a national slowdown. The CFNAI is sort of a meta-index that tracks some 85 economic indicators.

It is pretty remarkable to think that after 500 basis points of tightening, the economy is still as strong as it is. I talked about it my latest substack piece: Where is the recession we were promised? The answer is that we are somewhere between ludicrous speed and ridiculous speed.

Rithm Capital (aka New Rez) agreed to buy Sculptor, an asset manager with $34 billion in assets under management. It looks like a bolt-on acquisition for Rithm, as Sculptor’s current management will run the company. Sculptor gets access to more permanent capital, and I guess Rithm gets to diversify into non-mortgage related businesses which will help smooth the insane cyclicality of the mortgage business. Note that AGNC Investment and Rithm Capital are the only mortgage REITs that haven’t cut their dividends in response to the Fed’s tightening policy.

The economy expanded modestly in July, according to the Flash Composite PMI.

“July is seeing an unwelcome combination of slower economic growth, weaker job creation, gloomier business confidence and sticky inflation. The overall rate of output growth, measured across manufacturing and services, is consistent with GDP expanding at an annualized quarterly rate of approximately 1.5% at the start of the third quarter. That’s down from a 2% pace signaled by the survey in the second quarter. However, growth is being entirely driven by the service sector, and in particular rising spend from international clients, which is helping offset a becalmed manufacturing sector and increasingly subdued demand from US households and businesses. Furthermore, business optimism about the year-ahead outlook has deteriorated sharply to the lowest seen so far this year. The darkening picture adds downside risks to output growth in the coming months which, alongside the slowing in the pace of expansion in July, will keep alive fear that the US economy may yet succumb to another downturn before the year is out. The stickiness of price pressures meanwhile remains a major concern. As the survey index of selling prices has acted as a reliable leading indicator of consumer price inflation, anticipating the easing to 3% in June, it sends a worrying signal that further falls in the rate of inflation below 3% may prove elusive in the near term.”

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Vital Statistics

Stocks are lower this morning after disappointing numbers out of Netflix and Tesla. Bonds and MBS are down.

Bank earnings continue to come in. Truist reported numbers this morning. Mortgage banking origination rose 38% QOQ to $5.6B. They were down 53% on a year-over-year basis. Fifth Third reported originations rose 21% to $1.7B, but still fell 60% on a YOY basis. On the plus side, gain on sale increased to 1.71% compared to 1.21% in Q1 and 0.85% a year ago.

Existing Home Sales fell 3.3% in June, according to NAR. “The first half of the year was a downer for sure with sales lower by 23%,” said NAR Chief Economist Lawrence Yun. “Fewer Americans were on the move despite the usual life-changing circumstances. The pent-up demand will surely be realized soon, especially if mortgage rates and inventory move favorably. There are simply not enough homes for sale….The market can easily absorb a doubling of inventory….Home sales fell but home prices have held firm in most parts of the country,” Yun said. “The national median home price in June was slightly less than the record high of nearly $414,000 in June of last year. Limited supply is still leading to multiple-offer situations, with one-third of homes getting sold above the list price in the latest month.”

Days on market rose to 18 from 14 a year ago, while all-cash buyers accounted for 26% of sales. Investor activity increased to 18%. The first time homebuyer was 27%.

The Index of Leading Economic Indicators fell again in June, according to the Conference Board. “The US LEI fell again in June, fueled by gloomier consumer expectations, weaker new orders, an increased number of initial claims for unemployment, and a reduction in housing construction,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “The Leading Index has been in decline for fifteen months—the longest streak of consecutive decreases since 2007-08, during the runup to the Great Recession. Taken together, June’s data suggests economic activity will continue to decelerate in the months ahead. We forecast that the US economy is likely to be in recession from Q3 2023 to Q1 2024. Elevated prices, tighter monetary policy, harder-to-get credit, and reduced government spending are poised to dampen economic growth further.”

The components pulling down the LEI include the ISM New Orders Index, the inverted yield curve, and consumer sentiment. Consumer sentiment is a squishy indicator, which is often driven heavily by gasoline prices. The ISM New Orders Index maybe has more rigor but it is still one of these diffusion indices without a lot of quantitative meat on the bones. Ever since QE began the shape of the yield curve has been driven by central bank policy, so IMO the information contained in that has been limited at best. Maybe we get a recession, but with the strength of the labor market, I can’t imagine a deep one, if we get one at all.

Bernstein sees equities providing bond-like returns over the next decade. They plot the rolling 10 year return of equities going back almost 150 years. We “take a step back by 100 years or so to get some perspective on the prospect of likely future equity and bond returns over the next decade,” strategists Sarah McCarthy and Mark Diver wrote in a note. “US Equities have delivered 12% annualized total return over the last decade Not bad, but not that unusual,” they said. “While the 2000s were a largely lost decade for equities, the period from the mid-80s to late 90s had a consistent higher 10-year rolling return, in the region of 15%. The 50s and early 60s were similar.”

My gut feeling looking at that chart is that aside from special cases like the tech bubble, long-term interest rate trends are the driver. Long periods of low interest rates are a positive catalyst for stock returns, while rising rates are a negative.

It is easy to forget how long interest rate cycles are. Bonds were in a long term bull market starting during the Great Depression and lasting into the 1960s. Bonds began a secular bear market starting in the 1960s and ending in the early 1980s. The long secular bull market in bonds began in the early 80s and ended last year. Are we in for a 20 or 30 year bear market in bonds? If inflation is a permanent part of the landscape maybe we are.

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Vital Statistics:

Stocks are flattish this morning as earnings season begins in earnest. Bonds and MBS are up.

Retail Sales rose 0.2% MOM in June, which was well below the Street consensus. On a year-over-year basis, they rose 1.5%. This number is not adjusted for inflation, and gasoline was a big driver of the decline. Consumers are spending money on health care products and restaurants. Consumption will probably begin to struggle as we approach the resumption of student loan payments in October.

Manufacturing took a step back in June, according to the Fed. Industrial production fell 0.5%, while manufacturing production fell 0.3%. May’s numbers were revised lower. Capacity Utilization fell to 78.9% which is more or less at the historical average.

Bank of America reported better-than-expected earnings this morning. Mortgage origination volume rose to $5.9 billion compared to $3.9 in Q1. This was still well below last year’s volume of $14.5 billion in Q222. Home Equity originations were flat YOY at $2.5 billion.

Delinquencies in the consumer book increased, however they are still below pre-pandemic levels. Commercial Real Estate provisions increased as well.

Homebuilder confidence improved one point in July, according to the NAHB Housing Market Index.

“Although builders continue to remain cautiously optimistic about market conditions, the quarter-point rise in mortgage rates over the past month is a stark reminder of the stop and start process the market will experience as the Federal Reserve nears the end of the ongoing tightening cycle,” said NAHB Chief Economist Robert Dietz.

Given that shelter inflation accounts for roughly 40% of the Consumer Price Index, Dietz added the best way to ease this largest source of inflationary pressure is to build additional for-rent and for-sale housing. “There’s been some commentary linking gains for housing construction with increased concerns for additional inflation, but this has the economics backwards,” he said. “More housing supply is good news for future shelter inflation readings in the market. Furthermore, higher interest rates increase the cost of financing for building homes and developing lots.” 

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Vital Statistics:

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

The upcoming week won’t have much in the way of market-moving data, however we will get a lot of housing data, with the NAHB Housing Market Index, housing starts, and existing home sales. We won’t have any Fed-speak as we are in the quiet period ahead of next week’s FOMC meeting. Earnings season begins in earnest with most of the banks reporting.

ICE and Black Knight have agreed to sell Optimal Blue to Constellation Software in an effort to get regulatory approval for their merger. Constellation Software is already buying Empower, and will purchase OB for $700 million paid for in $200 MM cash and a $500MM promissory note

Morgan Stanley is out with a call saying they expect yields to work their way lower. “We maintain a bullish stance on government bond duration and expect yields to trend lower. Stubbornly hawkish central bank rhetoric remains the biggest impediment to a larger bond market rally, but could provide dip-buying opportunities in preparation for a rhetorical policy pivot,” Morgan Stanley stated. PIMCO is out with a similar call, saying the bond market offers “equity-like” potential with bond market volatility.

Speaking of bond market volatility, we are seeing bond market volatility fall to the bottom of the range associated with the current Fed tightening policy. Falling bond market volatility will go a long way towards reducing MBS spreads which will help push down mortgage rates.

The Empire State Manufacturing Index expanded last month, although optimism remains subdued. Price pressures continue to abate, which is good news for the Fed.

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Vital Statistics:

Stocks are higher this morning after a benign producer price index report. Bonds and MBS are up.

The Producer Price Index (a measure of inflation at the wholesale level) came in lower than expected; another sign that inflation continues to moderate. Final demand prices rose 0.1% month-over-month and 0.1% on a year-over-year basis. If you strip out food, energy and trade services the index rose 2.6% on a year-over-year basis. The flat YOY growth is due to commodity prices.

The index for final demand services rose 0.2% MOM and 2.3% YOY. Final demand services has a lot to do with wage inflation and that is what the Fed is most concerned about.

This report probably doesn’t move the needle for the Fed’s decision for the July meeting, but it is an indication that they have largely achieved their goal of reining in inflation.

The Fed released its Beige Book yesterday, which is a survey of all the regional Fed districts. Overall economic growth is increasing modestly, however consumer spending was mixed, with more being spent on travel and less on discretionary goods. Demand for real estate remains strong, albeit constrained with limited inventory. The Fed noted that the labor market is coming more in balance:

Employment increased modestly this period, with most Districts experiencing some job growth. Labor demand remained healthy, though some contacts reported that hiring was getting more targeted and selective. Employers continued to have difficulty finding workers, particularly in health care, transportation, and hospitality, and for high-skilled positions in general. However, many Districts reported that labor availability had improved and that some employers were having an easier time hiring than they were having previously. Employers also reported that the unusually high turnover rates in recent years appear to be returning to pre-pandemic norms. Wages continued to rise, but more moderately. Contacts in multiple Districts reported that wage increases were returning to or nearing pre-pandemic levels.

This is another good sign for the Fed. Separately, initial jobless claims remain low at 237,000.

Since the beginning of the week, we have seen a particularly robust rally in bonds, with the 10 year shedding 26 basis points in yield, while the 2 year has lost 30 basis points. Shares in mortgage banks have improved as well, with United Wholesale and Rocket up 16% since last Friday. The XHB homebuilder ETF is up 6.5% as well, while the S&P is up about 2% over the same period. The Fed Funds futures still see a 25 basis point hike at the June meeting, but are taking down the chance for any more hikes this year.

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ital Statistics:

Stocks are higher this morning after the Consumer Price Index came in weaker than expected. Bonds and MBS are up on the benign CPI print and the fact that China cut interest rates overnight.

The consumer price index rose 0.2% MOM in June, according to the BLS. On an annual basis, prices rose 3%. If you strip out food and energy, prices rose 0.2% MOM and 4.8% YOY. Shelter was the biggest contributor to the index, accounting for 70% of the increase, while energy was the biggest drag. Shelter rose 7.8% year-over-year. Home prices peaked in June of 2022, so the YOY increases will go flat starting with next month’s report.

The report didn’t have much of an impact on the July Fed Funds futures, which still see a 92% chance of another 25 basis points. All of the Fed-speak seems to indicate that the central bank will hike rates next week.

We are still elevated compared to the past 10 years, but are returning to normal

Mortgage Applications increased 0.9% last week as purchases increased 2% and refis fell 1%. “Incoming economic data continue to send mixed signals about the economy, with the overall impact leaving Treasury yields higher last week as markets expect that the Federal Reserve will need to hold rates higher for longer to slow inflation. All mortgage rates in our survey followed suit, with the 30-year fixed rate increasing to 7.07 percent, the highest level since November 2022,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The jumbo rate also increased to 7.04 percent, a record high for the jumbo series, which dates back to 2011. Purchase applications increased, but remained at a very low level and are 26 percent lower than the same week last year. The rise in purchase activity was driven by increases in both FHA and VA purchase applications. The refinance index dropped to its lowest level since early June, as demand for rate/term and cash-out refinances remains extremely low with mortgage rates over 7 percent.”

Mortgage credit availability increased in June, according to the MBA. “Mortgage credit availability was essentially unchanged in June, remaining close to the lowest level since early 2013, as the industry continues to operate at reduced capacity,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Lenders are streamlining their operations by offering fewer loan programs, with some exiting certain channels. Data from our Weekly Applications Survey indicated that June mortgage applications were more than 30 percent lower than a year ago and at the slowest pace since December 2022.”

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Vital Statistics:

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

The upcoming week will have some important inflation data with the consumer price index and the producer price index. We will also kick off earnings season with the big banks reporting on Friday. Investors will be particularly interested in whether the banks take provisions on their commercial real estate portfolios. Interestingly, we don’t have much Fed-speak despite the fact the the quiet period for the July meeting starts next week.

The Fed Funds futures are pricing in a 92% chance of a 25 basis point hike at the July meeting. The December futures are pricing in a roughly 1-in-3 chance for another 25 basis point hike by the end of the year.

Chicago Fed President Austan Goolsbee thinks the US can avoid a recession while still defeating inflation: “What the Fed’s overriding goal right now is to get inflation down. We’re going to succeed at it and to do that without a recession would be a triumph,” Goolsbee told CNBC’s Steve Liesman during a “Squawk on the Street” interview. “That’s the golden path, and I feel like we’re on that golden path. So I hope we keep putting off the recession to forever. Let’s never have a recession again.”

This sort of thinking: that that Fed can “fine tune” the economy and override the business cycle goes back to the 1960s. Goolsbee’s professors at the University of Chicago probably taught him that this is impossible since the Fed has an information lag. Regardless, economic central planning – i.e. industrial policy – seems to be back in vogue, and with it comes the idea that the Fed can engineer away the business cycle. Color me skeptical.

Housing affordability is a big problem right now, with affordability back at the levels we saw during the ’04-’06 housing bubble. Affordability is a function of three things: house prices, mortgage rates and incomes. The most effective lever is mortgage rates, but we need the Fed out of the way. “The Fed has engineered a massive increase in interest rates in order to combat high inflation. We expect it to cut the federal-funds rate aggressively in the coming years, driving the [Federal funds] rate down from 5% currently to below 2% by 2025,” wrote economists at Morningstar. “Once the Fed wins the battle against inflation, its priority will shift to jump-starting economic growth, which will require much lower interest rates, in our view.” Morningstar predicts that interest rates will stay low long-term due to demographic trends such as an aging population and depressed fertility rates.

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Vital Statistics:

Stocks are flattish after a the jobs report. Bonds and MBS are up small.

The economy added 209,000 jobs in June, according to the Employment Situation Report. This was more or less in line with expectations and much lower than the ADP report yesterday. The unemployment rate slipped to 3.6%, while average hourly earnings increased 0.4% MOM and 4.4% YOY. Job openings fell 500k to 9.8 million. After declining for two months, the quits rate increased to 2.6%, which is leading indicator for wage growth.

Wage inflation is the Fed’s biggest concern now, and it seems to have plateaued around this level for the past several months after declining in the second half of 2022. Pre-pandemic, average hourly earnings were increasing at around 3.5%, so we still have some ways to go in order to get back to a level the Fed is comfortable with.

The 10 year bond yield is off slightly from yesterday’s highs, but we are still solidly above 4%. The two year is up as well, trading at 4.97%.

If you look closely at the chart above, despite the increases in rates, the yield curve remains highly inverted. The distance between the two lines indicates yield curve inversion. The bigger the distance, the more inversion. The labor data is indicative of a roaring economy, but the yield curve is blaring recessionary signs.

Lock volume increased 31% in June according to the MCT Rate Lock Index. “We saw originations towards the end of May slow down, so this is likely a summertime pickup in originations”, said Andrew Rhodes, Senior Director and Head of Trading at MCT. “Rates, housing supply, and affordability will continue to be the forces behind the lack of new originations.”

The ISM Services Index increased in June, which was the sixth consecutive expansion. New orders and business activity increased, while prices moderated. “There has been an uptick in the rate of growth for the services sector. This is due mostly to the increase in business activity, new orders and employment. Increased capacity, backlog reduction and continued improvements in logistics have impacted delivery times (resulting in a decrease in the Supplier Deliveries Index). The majority of respondents indicate that business conditions remain stable; however, they are cautious relative to inflation and the future economic outlook.”

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Vital Statistics:

Stocks are lower this morning after the FOMC minutes from June indicated that some members wanted to hike rates. Bonds are down, and the 10 year has a 4-handle on it again.

The FOMC minutes were released yesterday, and the market reacted to the revelation that the unanimous decision to pause was not without some opposition:

Some participants indicated that they favored raising the target range for the federal funds rate 25 basis points at this meeting or that they could have supported such a proposal. The participants favoring a 25 basis point increase noted that the labor market remained very tight, momentum in economic activity had been stronger than earlier anticipated, and there were few clear signs that inflation was on a path to return to the Committee’s 2 percent objective over time.

Separately, Dallas Fed President Laurie Logan said it would’ve been “entirely appropriate” to raise the benchmark lending rate at the Fed’s June meeting. However, she said “in a challenging and uncertain environment, it can make sense to skip a meeting and move more gradually.”

The July Fed Funds futures are close to a lock for another 25 basis point hike at the July meeting in 3 weeks.

The private economy added almost half a million jobs in June, according to the ADP Employment Report. This is well above the 213k the Street is looking for in tomorrow’s jobs report. “Consumer-facing service industries had a strong June, aligning to push job creation higher than expected,” said Nela Richardson, chief economist, ADP. “But wage growth continues to ebb in these
same industries, and hiring likely is cresting after a late-cycle surge.” As usual, leisure / hospitality was the biggest contributor to job growth, adding 232k jobs, while construction added 90k. White collar and manufacturing jobs fell. Wage growth fell to 6.4% from 6.6% for job stayers, and fell to 11.2% for job changers. Job changers received the lowest annual increase since October 2021.

In other labor-related indicators, announced job cuts fell 49% to 40,709 according to Challenger and Gray. Tech, retail and finance have seen the most job cuts this year. Initial Jobless Claims remain low at 248k.

Mortgage Applications fell 4.4% as purchases fell 5% and refis fell 4%. “Mortgage applications fell to their lowest level in a month last week as rates for most loan types increased. As mortgage-Treasury spreads remained wide, the 30-year fixed rate increased to 6.85 percent, the highest rate since the end of May,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications decreased for the first time in a month, as homebuyers remained sensitive to rate changes. Rates are still over a percentage point higher than a year ago, and housing affordability is still a challenge in many parts of the country. However, the average loan size for a purchase application declined to $423,500 – its lowest level since January 2023. This was likely driven by reduced purchase activity in some high-price markets and more activity in some of the lower price tiers as buyers searched for more affordable options.” The composite index is at the lowest levels since 1997.

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Vital Statistics:

Stocks are lower this morning on the escalating chip war between the US and China. Bonds and MBS are up small.

There isn’t much in the way of economic data this morning, but we will get the June FOMC minutes at 2:00 pm today. It will be interesting to see the Fed’s thoughts on commercial real estate and any potential impacts on the banking sector. Office is definitely a problem, and we have seen some pain in retail as well.

Manufacturing contracted in June for the 8th consecutive month, according to the ISM Manufacturing Report. The weakness was across the board, with new orders, production, prices and employment all in contraction. “Demand remains weak, production is slowing due to lack of work, and suppliers have capacity. There are signs of more employment reduction actions in the near term. Seventy-one percent of manufacturing gross domestic product (GDP) contracted in June, down from 76 percent in May. More industries contracted strongly, however, as the share of manufacturing GDP registering a composite PMI^® calculation at or below 45 percent — a good barometer of overall manufacturing weakness — was 44 percent in June, compared to 31 percent in May,” says Fiore.

PeerStreet has filed for bankruptcy. The company built a marketplace for individual loans however rising rates killed the company. It went from 281 employees to 28 over the past year.

Construction spending rose 0.9% MOM and 2.4% YOY to a seasonally adjusted annual rate of $1.93 trillion. Interestingly, residential construction was down over 11% on a year-over-year basis. Single family construction was down 11.6% while multi-family was up 20%.

I talked about whether we are finally seeing the turn in homebuilding in my latest Substack posting.

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