All Things in Moderation

Vital Statistics:

Stocks are lower as we await Jerome Powell’s semiannual Humphrey-Hawkins testimony. Bonds and MBS are down.

Jerome Powell heads to the Hill this morning to testify in front of Congress. Here are his prepared remarks. He discussed the hawkish pause and the Fed’s mindset:

In light of how far we have come in tightening policy, the uncertain lags with which monetary policy affects the economy, and potential headwinds from credit tightening, the FOMC decided last week to maintain the target range for the federal funds rate at 5 to 5-1/4 percent and to continue the process of significantly reducing our securities holdings. Nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year. But at last week’s meeting, considering how far and how fast we have moved, we judged it prudent to hold the target range steady to allow the Committee to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, we will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. We will continue to make our decisions meeting by meeting, based on the totality of incoming data and their implications for the outlook for economic activity and inflation, as well as the balance of risks.

Mortgage applications increased 0.5% last week as purchases rose 2% and refinances decreased 2%. “The 30-year fixed mortgage rate declined for the third consecutive week to 6.73 percent, while other mortgage rates saw mixed results. Purchase applications increased, driven by a 2 percent gain in conventional purchase applications and a 3 percent increase in FHA purchase activity,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “First-time homebuyers account for a large share of FHA purchase loans, and this increase is a sign that while buyer interest is there, activity continues to be constrained by low levels of affordable inventory. Refinance applications continued their decline after the previous week’s increase, with the refinance share of applications just below 27 percent.”

The homebuilders have been on a tear this year, despite all of the pain in the mortgage market. The S&P SPDR Homebuilder ETF (XHB) has outperformed the S&P 500 by 12% YTD:

We had an upside surprise in housing starts yesterday, and new home purchase applications rose 16% in May, according to the MBA.

“Purchase activity for newly built homes was strong in May, with builders continuing to bring homes to the market and buyers keen to act on available units,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Applications for purchase loans were up on a monthly basis and increased annually for the fourth consecutive month. Our estimate of new home sales also jumped in May, up 16 percent to the fastest pace of new home sales in 15 months.”

Added Kan, “The new home sales segment continues to gather momentum, growing at a pace of 5 percent compared to a year ago, while existing-home sales in recent months continue to experience annual declines of more than 20 percent on a non-seasonally adjusted basis. These results were also broadly in line with the Census data showing an uptick in residential housing starts and permitting in recent months.”

Homebuilding is an early-stage cyclical industry, which usually leads the economy out of a recession. Investors are piling into the homebuilding stocks in anticipation of a recession and rate cuts. Note homebuilder KB Home reports after the close today. The Atlanta Fed bumped up its Q2 GDP Now estimate to 1.9% on the strong housing starts number.

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Vital Statistics:

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

The week ahead won’t have much in the way of market-moving data, but we will have plenty of Fed-Speak, with Jerome Powell speaking on Wednesday and Thursday.

Housing starts rose to 1.63 million in May, which was way above expectations. The number was 5.2% above April, but still 12.7% below May of 2022. The Street was looking for 1.4 million, so this was an upside surprise. Both multi (5+ units) and single-family saw big increases. Building Permits rose to 1.49 million.

While this is a big uptick in starts, we still are not back to levels we saw in mid-2022.

Downtown areas are struggling to get back on their feet after COVID. Office vacancy rates are way up, and municipal bonds are beginning to waver as declining revenues make them more risky. The beneficiary of this phenomenon are the suburbs which are seeing renewed interest. Apartments under construction are at record levels, and I wonder how many are in the cities.

The improvement in construction is good news for the mortgage business, and Goldman is out there with a positive call on a couple mortgage companies: AGNC Investment and Rithm Capital. AGNC is a mortgage REIT which invests in spec pools while Rithm is New Rez, Caliber and Shellpoint.

The bull case for AGNC is based on narrowing MBS spreads, which is a function of interest rate volatility. The ICE MOVE Index, which is sort of like a VIX for bonds, is at the bottom of its tightening cycle range. The lower it goes, the more attractive MBS are against Treasuries.

Rithm has agency MBS exposure, servicing and origination. Rithm was one of the only mortgage REITs that reported an increase in book value per share over 2022.

Any decline in interest rate volatility will be driven by more certainty about the Fed. The Fed’s tightening cycle appears to be winding down, but it is interesting to see just how far behind the curve they were in 2022. I discussed this in my Substack piece: Week in Review: Plotting the Fed Funds Forecast over time. For almost all of 2022, the real Fed Funds rate (i.e. the Fed Funds rate minus inflation) was highly negative, which means that monetary policy was still highly expansionary even in the context of a tightening regime.

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Vital Statistics:

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

The Fed’s decision to hold rates steady yet forecast two more rate hikes appears inconsistent, at least to ex-Treasury Secretary Larry Summers.

“This meeting felt like it was driven as much by the internal political dynamics of the Fed, as by any consistent and coherent reading of the economic situation and that was a bit disturbing to me…I found the Fed’s action a little bit confusing. I understand the arguments for not hiking this at this meeting. But those arguments wouldn’t point towards signaling two further rate increases, they wouldn’t point towards significantly revising the forecasts towards a stronger economy and more inflation…I understand the arguments for having gone the other way,” Summers continued. “But I don’t really understand the internal consistency of an approach of pausing at this meeting, but then signaling two further rate hikes down the road and signaling that they no longer expect unemployment to increase nearly as much as they used to expect it.”

I am not sure what “internal political dynamics” refers to in this context given that the vote was unanimous. The minutes from the meeting will make interesting reading when they come out in a few weeks.

Consumer sentiment improved in June, according to the University of Michigan Consumer Sentiment Survey. Sentiment is improving, however it is still low on a historical basis;

Inflationary expectations for the next year improved dramatically, falling from 4.2% in May to 3.3% in June. Longer-term expectations remain persistently in a 2.9%-3.1% range.

Mortgage credit decreased in May, according to the MBA’s Mortgage Credit Availability Index. “Mortgage credit availability decreased for the third consecutive month, as the industry continued to see more consolidation and reduced capacity as a result of the tougher market. With this decline in availability, the MCAI is now at its lowest level since January 2013,” said Joel Kan, Vice President and Deputy Chief Economist. “The Conforming index decreased almost 4 percent to its lowest level in the history of the survey, which dates back to 2011. The Jumbo index fell by 1.5 percent last month, its first contraction in three months, as some depositories assess the impact of recent deposit outflows and reduce their appetite for jumbo loans…Additionally, lenders pulled back on loan offerings for higher LTV and lower credit score loans, even as loan applications continued to run well behind last year’s pace. Both Conventional and Government indices saw declines last month, and the Government index fell by 3.8 percent to the lowest level since January 2013. In a market where a significant share of demand is expected to come from first-time homebuyers, the depressed supply of government credit is particularly significant.”

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Vital Statistics:

Stocks are lower after the Fed produced a hawkish pause yesterday. Bonds and MBS are flat.

The Fed delivered a hawkish pause, skipping a rate hike in June but signaling there is still more to come. They increased the estimate for 2023 GDP growth to 1% from 0.4%, lowered their unemployment estimate from 4.5% to 4.1% and increased their forecast for 2023 core PCE growth from 3.6% to 3.9%.

They predicted another two rate hikes this year in the dot plot. The March / June comparison is below:

They see a Fed funds rate of 5.5% at the end of 2023 versus 5% in March. The outer years were pushed up as well. At the press conference, Jerome Powell telegraphed that the Fed is going to hike in July, by referring to the June meeting as “the skip.” and characterizing the July meeting as “live.”

The Fed Funds futures see a 65% chance for another hike in July, but are assigning a low probability for anything further. At some point we probably are going to have a recession. Historically, tightening cycles have triggered recessions and this one has been the most aggressive since Paul Volcker’s dramatic moves in the early 1980s which caused the deepest recession since the Great Depression. While it is always tempting to think this time is different, it probably isn’t.

Separately, the ECB hiked rates by 25 basis points this morning.

In other economic data, retail sales rose 0.3%, which was better than expected. Consumption remains strong, but the resumption of student loan payments looms at the end of the summer. Initial Jobless claims were steady at 262k, and industrial production fell 0.2%.

Homebuilder Lennar reported better-than-expected earnings however they were down on a year-over-year basis. Stuart Miller, Executive Chairman of Lennar, said, “During the quarter, we continued to see the housing market
normalize and recover from the Fed’s 2022 aggressive interest rate hikes in response to elevated inflation. As consumers have come to accept a “new normal” range for interest rates, demand has accelerated, leaving the market
to reconcile the chronic supply shortage derived from over a decade of production deficits. Simply put, America needs more housing, particularly affordable workforce housing, and demand is strong when price and interest rates are affordable.”

The press release didn’t mention cancellation rates, but it will probably come up on the conference call. Another interesting tidbit from the press release: “Our cycle time during the quarter was down slightly sequentially, and we believe it will decline further in the back half of the year as the improving supply chain and labor market will positively impact our production times.

Homebuilders in general have been gun-shy to build single-family residences in the aftermath of the bubble, and then supply chain and labor issues have been the impediment. It seems that perhaps this might be easing. Skilled labor is in high demand and plumbers / electricians can make a boatload – certainly more than most college graduates their age.

The homebuilders have been on a tear this year, with the S&P SPDR homebuilder ETF outperforming the S&P 500 by a large amount.

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Vital Statistics:

Stocks are flattish as we await the Fed decision. Bonds and MBS are down.

The Fed decision is due at 2:00 pm today, and Jerome Powell will hold a press conference afterward. The Fed Funds futures overwhelmingly see the Fed maintaining the current Fed Funds range of 5% – 5.25%. The consensus seems to be the Fed will do a hawkish pause, meaning they will skip hiking this meeting and leave the door open for another hike in July. We probably aren’t going to get an all-clear signal out of them.

The dot plot will be the focus for the markets. The March dot plot showed the majority of members saw the end-of-2023 Fed Funds rate in the current range. There were a few members who thought rates could go higher. I wouldn’t be surprised to see the economic projections revised as well, especially GDP which was forecast to rise 0.5% this year. With Q1 coming in at 1.1% and the Atlanta Fed GDP Now Index seeing a 2.2% increase in Q2, the economy would have to fall off a cliff to make that 0.5% forecast. The unemployment forecast of 4.5% is probably too high as well.

We got another benign inflation report with the Producer Price Index declining 0.3% in May. On a YOY basis, the index rose 1.1%, which is below the Fed’s target rate for inflation. If you strip out food, energy and trade services, the index was flat in May and up 2.8% on an annual basis. About 60% of the decline in the headline number was due to lower gasoline prices.

Mortgage applications rose 7.2% last week as purchases rose 17% and refis increased 6%. “Mortgage rates declined for the second straight week, with the 30-year fixed rate decreasing to 6.77 percent. Mortgage applications were up over the week, but remained well below levels from a year ago,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Rates that are still more than a percentage point higher than a year ago, and low for-sale inventory continue to constrain homebuying activity in many markets. The average loan size on a purchase loan decreased for the third straight week, as we continue to see more first-time homebuyer activity in the purchase market. Refinance applications accounted for less than a third of all applications and remained more than 40 percent behind last year’s pace. Elevated rates have reduced the benefit of a rate/term refinance for many borrowers and continue to discourage cash-out refinances as borrowers are unwilling to give up their lower rates.”

Comerica is exiting the mortgage banker finance business. This should primarily affect the warehouse lending business.

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Vital Statistics:

Stocks are higher after May inflation came in lower than expected. Bonds and MBS are flat.

Consumer prices rose 0.1% MOM and 4% YOY. Shelter and used cars / trucks were the big contributing factors. Shelter increased 0.8%, however home prices peaked in June of last year so the inflationary push of this component is expected to fade in the coming months.

Jerome Powell has mentioned 3 basic components for inflation – goods, housing, and services ex-housing. The goods issue was driven by supply chain issues in the early days of COVID. That component of inflation is largely finished, and if you look at the ISM reports they pretty much confirm that inventory issues are no longer a problem. The real estate component is likely to fade as the year-over-year comparisons on home prices become much easier.

Finally services ex-real estate are working lower as well. Below is a chart of the CPI with services ex-real estate.

We are still elevated, but the index is falling rapidly. Services ex-real estate is really a proxy for wage inflation. We have seen layoffs in the tech sector, and job openings are working their way lower. Consumer expectations for inflation are decreasing as well.

The Fed Funds futures have moved decisively to a pause forecast for the June FOMC meeting. Certainly the CPI print gives them the leeway to do that. The July futures still see a 60%+ chance for another hike. Before the July meeting, we will get the May PCE inflation reading, and the June CPI / PPI.

Commercial real estate continues to struggle, especially in the office sector. The office sector is reeling from rising interest rates and work-from-home. Manhattan’s official vacancy rate is 17%, and should remain above 20% for the next several years. The unofficial vacancy rate is closer to 50%. Goldman sees continued pain the CRE sector. “There’s no question that the real estate market, and in particular commercial real estate, has come under pressure,” he said in an interview on CNBC’s “Squawk on the Street.” “You’ll see some impairments in the lending that would flow through our wholesale provision” this quarter.

Small Business Optimism increased in May, according to the NFIB. Inflation remains the single biggest problem, although it has eased from its peaks last summer. Job openings are still hard to fill, and average selling prices are increasing overall. Overall optimism still remains historically low:

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Vital Statistics:

Stocks are higher as we begin Fed Week. Bonds and MBS are up.

The week ahead will be dominated by the Fed decision, although we do have some important economic data. The Consumer Price Index will be released tomorrow, and that could impact the Fed’s decision. While the Fed Funds futures have a 74% chance of no increase, the markets are interpreting that as a “skip” not a “stop.” The July Fed Funds futures are assigning a 65% chance for a rate hike if nothing happens in June. Tightening credit may also be driving the narrative for a skip.

The Fed is caught between a credit crunch and inflation. “If inflation is going to fall quickly…we might be in a position to be able to cut rates, if not this year, then soon in the new year,” said Minneapolis Fed President Neel Kashkari in an interview last month. “But if, on the other hand, inflation is much more persistent and much more entrenched…then I think the stresses in the banking sector probably become more serious.” 

The dot plot will be critical. At the March meeting, the FOMC largely forecasted that the Fed Funds rate would be at the current level, with a few forecasts for higher rates. I go into way more detail on this in my weekly Substack piece.

UBS sent a note to its clients expecting a hard landing, with GDP set to contract 1% in the coming quarters. Their model sees a 80% recession risk:

Aside from the Fed decision and the CPI, we will also get retail sales and consumer sentiment. Homebuilder Lennar reports earnings on Wednesday. The homebuilders have been on fire this year, with the S&P Homebuilder ETF (XHB) up 22% year-to-date.

Homebuilders report that there is still a shortage of lots, although it is better than it was in 2021. While you would think that work-from-home would make the exurbs more marketable, the issue is credit. Credit for developers is expensive and scarce. In addition, overall costs are higher and it is hard for builders to construct new homes that are affordable. Government regulation adds $94k to the price of a home alone.

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Vital Statistics:

Stocks are flattish this morning after we round out a week with limited economic data and no Fed-speak. Bonds and MBS are flat as well.

Another slow news day.

Housing affordability improved in the first quarter of 2023, however affordability issues remain, according to the NAHB. This was driven by wage growth, with flattish home price growth and a decline in mortgage rates. Given the shortage of skilled labor and cost of building materials, new construction will have a limited effect on affordability, which means that wage growth will have to do the heavy lifting here.

Household net worth increased to $148.835 in the first quarter of 2023, according to the Federal Reserve. Meanwhile, assets held by the Federal Reserve banks fell to just under $8.4 trillion. The Fed has reduced its balance sheet by some $500 billion since it started QT in March of 2022. It had tried QT before in 2018, and reduced its balance sheet by $700 billion before problems in the repo market caused it to halt the process.

The Atlanta Fed’s GDP Now Index sees 2.2% growth in Q2. This is surprising given that the ISM data has been pretty weak for manufacturing and the services economy seems to be decelerating as well. Global growth has been downgraded by the IMF, and China is struggling with deflation.

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Vital Statistics:

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

The Bank of Canada unexpectedly hiked rates 25 basis points yesterday, triggering a sell-off in global sovereign debt. Fears about the impending sale of $1 trillion in T-bills isn’t helping things either. The yield curve inversion has increased over the past couple of weeks:

Rate lock volume fell 16% in May compared to April according to MCT’s Rate Lock Index. Purchase volume was down 15% while refi volume fell 22%. Overall lock volumes are down 29% compared to last year. MCT’s lock index is more reliable than the MBA’s mortgage application index in that it eliminates the multiple application problem for a single loan. Regardless, times are tough out there in the mortgage space.

Initial Jobless claims increased to 261k last week. This is the highest level since October of 2021. While claims are still low on a historical basis, it looks like the Fed’s tightening policy is getting some traction in the labor market.

Overall, the groundwork is being laid for lower rates going forward. The Fed Funds futures still see a 70% chance for a pause in June. Student loan repayments will resume in August, which will crimp consumption. The Eurozone economy is officially in a technical recession, and the ISM data shows US manufacturing is contracting and the services economy is slowing. Increased capital requirements for banks will push long-term rates down, at least at the margin. Notwithstanding the jobs report last week, the evidence is pointing towards a cooling labor market. The volatility in the bond market (measured by the MOVE Index) is falling again, which should help MBS spreads. While it is hard to be optimistic in the mortgage space right now, the second half of 2023 should be better than the first.

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Vital Statistics:

Stocks are flattish this morning on no real news. Bonds and MBS are flat as well.

Mortgage applications decreased 1.4% last week as purchases fell 2% and refis fell 1%. The number contains an adjustment for the Memorial Day holiday. “Mortgage rates declined last week from a recent high, but total application activity slipped for the fourth straight week. The 30-year fixed rate dipped to 6.81 percent, 10 basis points lower than last week but still the second highest rate of 2023,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Overall applications were more than 30 percent lower than a year ago, as borrowers continue to grapple with the higher rate environment. Purchase activity is constrained by reduced purchasing power from higher rates and the ongoing lack of for-sale inventory in the market, while there continues to be very little rate incentive for refinance borrowers. There was less of a decline in government purchase applications last week, which was consistent with a growing share of first-time home buyers in the market.”

With the debt ceiling deal in place, Treasury is poised to issue more than $1 trillion in short-term debt to keep the lights on. This will push up short term rates at least in the near-term, which won’t be supportive for mortgage rates. MBS spreads continue to hang out at the highest levels since the Reagan Administration.

Another headache for the mortgage industry: All-cash buyers are the highest since 2014, coming in at 33%. With higher rates and home prices more borrowers are opting for FHA loans. FHA loans are back to pre-pandemic levels, while jumbo loans are declining.

“A homebuyer who can afford to pay in all cash is weighing two potential paths,” said Redfin Senior Economist Sheharyar Bokhari. “They can use cash to pay for the home and avoid high monthly interest payments, or take out a loan and pay a high mortgage rate. In that case, they could use the money that would have gone toward an all-cash purchase to invest in other assets that offer bigger returns, which could partly cancel out their high mortgage rate.”

“Buyers who can’t afford to pay in all cash also have two potential—but different—paths,” Bokhari continued. “They can avoid a high mortgage rate by dropping out of the housing market altogether, or they can take on a high rate. That discrepancy is the reason the all-cash share is near a decade high even though all-cash purchases have dropped: Affluent buyers have the choice to pay cash instead of dropping out of the market.” 

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