All Things in Moderation

Vital Statistics:

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

Banks reported tightening credit standards and weakening demand in the latest Federal Reserve Senior Loan Officer Survey.

“Regarding loans to businesses, survey respondents reported, on balance, tighter standards and weaker demand for commercial and industrial (C&I) loans to large and middle-market firms as well as small firms over the first quarter.² Meanwhile, banks reported tighter standards and weaker demand for all commercial real estate (CRE) loan categories.”

“For loans to households, banks reported that lending standards tightened across all categories of residential real estate (RRE) loans other than government-sponsored enterprise (GSE)-eligible and government residential mortgages, which remained basically unchanged. Meanwhile, demand weakened for all RRE loan categories. In addition, banks reported tighter standards and weaker demand for home equity lines of credit (HELOCs). Standards tightened for all consumer loan categories; demand weakened for auto and other consumer loans, while it remained basically unchanged for credit cards.”

Small Business Optimism fell again in April, according to the NFIB. The is the sixteenth consecutive reading below the historical average. Quality of labor is the biggest concern, with manufacturing, construction and transportation showing the biggest shortages. Inventories now are too high relative to expected sales. Inflation seems to be waning.

A banking crisis does not appear to be a major risk. The bank failures were not due to bad loans, the usual cause. Defaults will rise as the economy weakens but hopefully not at pandemic levels. The manufacturing sector appears to be in contraction (ISM <50). The service sector is still in growth mode, but much weaker (ISM 51.2, down 3 points). Main street firms have been pessimistic for the last 18 months, with the NFIB Optimism Index at 89 (49 year average = 98). Price raising activity has slowed but remains historically high, and reports of higher labor compensation are sticky at historically high levels. This will make inflation sticky as labor costs are the major operating cost of small firms, especially in the service sector. The economy seems inclined to slow down and this will make raising prices harder and slow inflation. Maybe it’s time for the Fed to pause and let nature (markets) take its course.

Rate lock volume fell 22% in April, according to Black Knight. Part of this is due to more business days in March, however volumes fell 10% even after taking this into account. Overall lock volumes rose 14% over the past 3 months, however they are down about 50% from a year ago.

“Home prices rose a seasonally adjusted 0.45% in March at the national level,” said Walden. “A modest bump in homebuyer demand ran headlong into falling for-sale supply, leading to the third consecutive monthly increase in home prices after they’d been pulling back from recent peaks through the tail end of 2022, essentially nationwide. In fact, just five months ago, prices were declining on a seasonally adjusted month-over-month basis in 92% of all major U.S. markets. Fast forward to March, and the situation has done a literal 180, with prices now rising in 92% of markets from February. Despite the home price strengthening of these past couple of months, the backward-looking annual growth rate continued to cool as the influence of the red-hot spring 2022 market fades in the rearview mirror. Prices are now up just 1.0% year over year, with the annual growth rate on track to fall to roughly 0% by April.  That said, low inventory levels will limit just how far that metric will fall in coming months.”

Filed under: Economy | 19 Comments »

Vital Statistics:

Stocks are higher this morning as the regional banks rally. Bonds and MBS are down.

PacWest cut its dividend to conserve cash, which has caused the stock to rally. Generally dividend cuts are not received well by investors, but PACW is up 21% this morning. Don’t see that too often. Western Alliance is up, along with Comerica and KeyBank.

The week ahead will be generally data-light, with the exception of the consumer price index on Wednesday. The Case-Shiller Home Price Index peaked in June of 2022, so we are pretty close to having the owner’s equivalent rent portion of the CPI fade into the background. The labor market remains super-tight however.

Charlie Munger warned that commercial real estate is going to be a growing problem. ” A lot of real estate isn’t so good any more. We have a lot of troubled office buildings, a lot of troubled shopping centers, a lot of troubled other properties. There’s a lot of agony out there.” Office is clearly a problem, and I don’t see that going away. Apartment supply is elevated as well, especially in urban areas. While nobody is calling this another 2008 problem, valuations are collapsing in the office space.

The pain in the commercial real estate sector, along with the problems with the regional banks will have a further tightening effect on the economy. Credit will become more restricted, which gives the Fed more leeway to stand pat in June. The debt ceiling kabuki theater can also help if the Federal Government manages to actually cut spending. The Federal Government used a lot of fiscal stimulus during the pandemic, and that helped stoke the demand we are seeing now. This is an unappreciated contributing factor to inflation and while the Fed has been taking steps to reduce demand, the Federal government has not.

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Filed under: Economy | 8 Comments »

Vital Statistics:

Stocks are higher after the jobs report. Bonds and MBS are down.

The economy added 253,000 jobs in April, which came in above the 173k estimate. The unemployment rate fell to 3.4%, while average hourly earnings rose 4.4%. The labor force participation rate was unchanged at 62.6% and the employment-population ratio was unchanged at 60.4%.

Overall, this report shows that the Fed’s tightening policy has yet to slow down the labor market much. That said, average hourly earnings and the CPI are trending downward.

Those hoping for the Fed to cut rates in response to the regional banking situation might be disappointed. Former Fed Governor Randy Krozner put it succinctly: The Fed won’t quit until the labor market quits.

The regional banks got slammed again yesterday, with PacWest down another 50% and Western Alliance down 38%. There was a piece in the Financial Times about Western Alliance supposedly exploring strategical alternatives, which the company denied. Given the strong liquidity of some of these banks, the rout in the regional banks seem to be overdone. The regional banks are up pre-market.

The Biden Administration is closely watching the situation in the regional banks looking for evidence of market manipulation by short-sellers. SEC Chairman Gary Gensler put out a statement saying: “As I’ve said, in times of increased volatility and uncertainty, the SEC is particularly focused on identifying and prosecuting any form of misconduct that might threaten investors, capital formation, or the markets more broadly.”

Filed under: Economy | 37 Comments »

Vital Statistics:

Happy Dave Brubeck Day. Stocks are lower this morning as regional bank fears continue to simmer. Bonds and MBS are up.

As expected, the FOMC hiked the Fed Funds rate by 25 basis points and signaled they are ready to pause. It removed language referring to further tightening of policy. During the press conference, Powell pushed back on the idea that the Fed was ready to cut rates. If you look strictly at the dual mandate, that makes sense. On a scale of 1-10, the labor market is at a 9.8, while inflation remains way too high. He acknowledged that it will take a while to get us down to 2% inflation, but emphasized the Fed isn’t willing to relax that target to something like 3%. FWIW, inflation averaged about 3% from 1985 – 2000 and I think most people would regard that time period as pretty comfortable economically.

The bond market was already strong due to the regional bank situation, with PacWest falling 50%, so there wasn’t much reaction to the new language on the long end, although the 2 year did rally on the announcement. The Fed Funds futures are now predicting the Fed will do nothing at the June meeting, and there is a 50-50 chance of a rate cut at the July meeting. The futures are not factoring in any more rate hikes, and they see 75 basis points of easing by the end of the year.

Nonfarm productivity fell 2.7% in the first quarter as output rose 0.2% and hours worked increased 3%. Compared to a year ago, productivity fell 0.9%. Unit labor costs rose 6.3%. Productivity is an inflation-killer, so this is bad news for the Fed.

The regional banks are getting slugged again today, with PacWest down another 40%, and First Horizon down big after its merger with TD bank is terminated. Western Alliance is down despite a press release that updated the markets on its deposit situation. Zions is down as well. If anything will push the Fed to cut rates, this is going to be the catalyst.

Job cuts in April fell 25% month-over-month to 66.995. They are still triple the number they were a year ago. Retail led, along with technology. Separately, initial jobless claims rose to 242k.

Mortgage applications decreased last week as purchases fell 2% and refis fell 1%. “Mortgage applications decreased last week, despite rates declining slightly for the first time in three weeks. The 30-year fixed rate decreased five basis points to 6.5 percent, which is still 114 basis points higher than a year ago,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Elevated rates continue to both impact homebuyer affordability and weaken demand for refinancing. Home purchase activity has been very sensitive to rates and local market trends, including the very low supply of existing-home inventory. However, newly constructed homes account for a growing share of inventory, giving more options for prospective buyers. The jumbo-conforming spread continues to narrow, an indication that there is reduced lender appetite for jumbo loans following the recent turmoil in the banking sector and heightened concerns about liquidity. The spread was 13 basis points last week, after being as wide as 64 basis points in November 2022.”

Filed under: Economy | 26 Comments »

Vital Statistics:

Stocks are higher as we await the FOMC decision. Bonds and MBS are up.

The FOMC decision is due at 2:00 pm today. Investors will be looking for language that suggests a pause in rate hikes. We are seeing more Fed officials call for a pause given the First Republic situation. The Fed Funds futures are overwhelmingly predicting 25 basis points today, but the June futures are now assigning a below 10% chance of another 25. Late last week, that number was about 25%.

Larry Summers was interviewed on Bloomberg TV yesterday, and the interviewer asked about reports that up to half of US banks would have negative equity if everything was marked to market. I personally have not seen such reports, but that is a remarkable statistic if true.

Larry’s answer didn’t push back against that claim, however he called it somewhat alarmist because it didn’t take into account that many banks have deposit rates below the interest rate earned on these Treasuries and MBS assets, so they are earning a spread and that below-market rate deposits could be considered asset-like. Of course the problem with that theory is that the bank isn’t in control of that asset. It doesn’t get to determine whether it stays on the balance sheet – the depositor does.

Ultimately, we are talking about Treasuries and MBS and these assets are money good. Now commercial real estate (especially office) is struggling and that could dent the banks.

The economy added 296,000 jobs in April, according to the ADP Employment Report. This was well above expectations and is higher than the forecast for Friday’s jobs report. Pay gains overall rose 6.7%, although the pace of gains is moderating. Job changers saw an increase of 13.2%, a percentage point lower than the previous month and the lowest level since November 2021.

“The slowdown in pay growth gives the clearest signal of what’s going on in the labor market right now,” said Nela Richardson, chief economist, ADP. Employers are hiring aggressively while holding pay gains in check as workers come off the sidelines. Our data also shows fewer people are switching jobs.”

Manufacturing jobs fell, as did professional and business services. Leisure and hospitality accounted for over half the job gains.

Between the banking situation and the inflation situation, the Fed is in a bind. The surest way to fix the banking system is to lower rates, while the inflation situation is not fixed yet. The easiest path is probably to pause and wait to see how things shake out.

The services economy improved in April, according to the ISM Services Index. Employment decelerated, while new orders increased. Prices advanced as well. “There has been a slight uptick in the rate of growth for the services sector, due mostly to the increase in new orders and ongoing improvements in both capacity and supply logistics. The majority of respondents are mostly positive about business conditions; however, some respondents are wary of potential headwinds associated with inflation and an economic slowdown.”

Filed under: Economy | 15 Comments »

Vital Statistics:

Stocks are lower as we begin the FOMC meeting. Bonds and MBS are down.

Construction spending rose 0.3% MOM in February, according to Census. This was up 3.8% compared to a year ago. Residential construction spending was down 0.2% MOM and 10% on a YOY basis. It is interesting how much single family and multi-family construction spending has diverged.

Lending Tree is down some 22% this morning after reporting a disappointing quarter. Mortgage revenues were down big, but home equity was a bright spot. Given the home affordability problems as well as the lock-in effect (i.e. hate the house, love the mortgage) we are probably going to see more emphasis on reno products, and HELOCs are another good way to do some business while we wait for rates to fall.

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The number of job openings decreased to 9.6 million, according to the latest JOLTS jobs report. This was down 384,000 from February and 1.6 million from December 31. The quits rate, which tends to predict wage inflation, fell to 2.5%. The quits rate was 2.9% a year ago.

The job openings rates were highest in leisure / hospitality, especially arts and entertainment. I guess the world needs more poets.

Filed under: Economy | 16 Comments »

Vital Statistics:

Stocks are flattish this morning after First Republic Bank was seized by regulators over the weekend. Bonds and MBS are down.

The big event this week will be the FOMC meeting on Tuesday and Wednesday. The Fed Funds futures are predicting about a 80% chance of a 25 basis point hike this week. Besides the FOMC meeting, the other big piece of data will be the jobs report on Friday.

First Republic Bank was seized by the FDIC over the weekend. JP Morgan will acquire the bank for $10.6 billion. JP Morgan will also get loss coverage from the FDIC of 80% on all acquired loans. The underlying assumption of the deal was that FRB’s loans were marked at 87.

Separately, the Fed’s review of the Silicon Valley Bank situation is here. It basically lays the blame on deregulation and limiting the regulatory burden on the banking system: “In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory action,” the report says, adding that this may have “in some cases led staff not to take action.”

I still find the fact that the Fed didn’t even consider the scenario of rising interest rates in its stress tests to be the biggest surprise. Especially since their policies made that scenario happen. The assets that got the bank in trouble were Treasuries and MBS, but just because an asset doesn’t have credit risk doesn’t mean it has no risk.

The US manufacturing economy improved in April, according to the ISM Manufacturing survey. That said, it remains in contraction territory.  “The U.S. manufacturing sector contracted again; however, the Manufacturing PMI^® improved compared to the previous month, indicating slower contraction. The April composite index reading reflects companies continuing to manage outputs to better match demand for the first half of 2023 and prepare for growth in the late summer/early fall period. Demand eased again, with the (1) New Orders Index contracting, but at a slower rate, (2) New Export Orders Index slightly below 50 percent but improving, (3) Customers’ Inventories Index entering the low end of ‘too high’ territory, a negative for future production and (4) Backlog of Orders Index continuing in strong contraction. Output/Consumption (measured by the Production and Employment indexes) was positive, with a combined 4.4-percentage point upward impact on the Manufacturing PMI^® calculation. The Employment Index indicated slight expansion after two months of contraction, and the Production Index logged a fifth month in contraction territory, though at a slightly slower rate. Panelists’ comments continue to indicate near equal levels of activity toward expanding and contracting head counts at their companies, amid mixed sentiment about when significant growth will return. Inputs — defined as supplier deliveries, inventories, prices and imports — continue to accommodate future demand growth. The Supplier Deliveries Index indicated faster deliveries, and the Inventories Index dropped further into contraction as panelists’ companies manage inventories exposure. The Prices Index moved back into ‘increasing’ territory, at a moderate level, after one month of marginally decreasing prices.

Filed under: Economy | 46 Comments »

Vital Statistics:

Stocks are lower this morning after disappointing earnings from Amazon. Bonds and MBS are up.

Personal Incomes rose 0.3% in March, while spending was flat. The all-important PCE Price Index rose 0.1% MOM while the core rate rose 0.3%. The headline number rose 4.2% YOY while the core rate was up 4.6%. Inflation continues to move down, although it is well above the Fed’s target range.

This probably won’t change the Fed’s plans to hike 25 basis points next week. The market sees a 90% chance for another 25 basis points next week, and then a 25% chance of another 25 in June. After that, the betting is that rate cuts soon follow.

Employment costs rose 1.2% in the first quarter, according to the BLS. On an annualized basis, employment costs rose 4.5%. Private industry workers saw a 4.8% increase in compensation. Service workers saw increases up to 6%. The rise in service wages is a particular focus for the Fed.

The National Multifamily Housing Council reports that the apartment market is beginning to loosen. “Apartment operators reported an uptick in vacancies and concessions this quarter,” noted NMHC’s Vice President of Research Caitlin Sugrue Walter. “And while some of this softness can be attributed to seasonality, investors remain concerned about the coming wave of supply in some markets and the prospect of slower economic growth in 2023. Only 11% of Quarterly Survey respondents believe that the Fed will be able to achieve a soft landing this year in its effort to rein in inflation. The transaction market, meanwhile, remains at a virtual standstill, with current apartment owners unwilling to offer buyers the lower prices necessary to compensate for both this diminished economic outlook and the elevated cost of debt.”

You can see below how much multifamily units have been coming onto the market. We are at levels last seen since the mid 80s.

Filed under: Economy | 8 Comments »

Vital Statistics:

Stocks are higher this morning after Meta’s numbers surprised to the upside. Bonds and MBS are down.

GDP growth fell to 1.1% in the first quarter, according to the BEA. This was a substantial miss as the Street was looking for a 2% gain. Interestingly, yesterday’s Atlanta Fed GDP Now estimate was spot-on, although the prior week’s estimate was 2.5%.

A slowdown in inventory and homebuilding were drags on GDP growth, while increases in income and spending were positive components. The PCE price index rose 4.2% in the first quarter compared to 3.7% in the fourth quarter. If you strip out food and energy, Q1’s PCE rose 4.9% compared to 4.4% in Q4.

Pending Home sales fell by 5.2% in March, according to the NAR. “The lack of housing inventory is a major constraint to rising sales,” said NAR Chief Economist Lawrence Yun. “Multiple offers are still occurring on about a third of all listings, and 28% of homes are selling above list price. Limited housing supply is simply not meeting demand nationally.”

That said, it isn’t all bad as NAR is more optimistic about the rest of the year: “Sales in the second half of the year should be notably better than the first half as job gains continue and more favorable mortgage rates are expected,” said Yun. “Sales of new homes are already matching 2019 pre-COVID activity and are expected to increase in 2023, largely due to plentiful inventory in this segment of the market.”

Do you think next week will be the last Fed rate increase? Recent comments from Fed officials run the gamut from hawkish to dovish and tightening credit conditions in the wake of recent bank failures contrast with surprisingly resilient economic indicators. What will it mean for the mortgage industry if this is the final rate hike? Register for the first Agile Trader Talk webinar as Tawab Abawi explores these questions with industry veterans Chris Maloney of BOK Financial and Ian Lyngen of BMO Capital Markets. Agile is working to create a better MBS market through digital platforms and industry analysis; register for the End of QT? Mortgage Markets & the Fed Webinar and subscribe to the Agile newsletter to stay in touch with future coverage.  

Sandra Thompson at FHFA put out a statement on the new LLPAs for Fannie and Freddie. These LLPA changes (increasing for high FICO, decreasing for low FICO) have garnered a lot of attention in the media. FHFA says that these LLPA adjustments are being made to better take into account the risk profiles of these loans – in other words low FICO LLPAs were too big in the past. Of course they are basing this on expected performance, and since the COVID-19 pandemic delinquencies have in fact been low. Whether that will continue into the future is an open question given that forbearance might be messing with the numbers.

Things are indeed bad in the office commercial real estate space. The Wall Street Journal has a piece on a building in San Francisco which is for sale and might trade 80% lower than its estimated value in 2019. It is 75% vacant. Nearly 30% of San Francisco’s office space is vacant – about 6x the pre-pandemic level. “We’re all really on the edge of our seats to see the first office trade in San Francisco,” said J.D. Lumpkin, executive managing director at real estate services firm Cushman & Wakefield.

Office REIT Vornado recently suspended its common stock dividend for the rest of the year, and might pay its end-of-2023 dividend with cash or a combination of cash and stock. Interestingly, they authorized a $200 million buyback, as if that will mollify shareholders. Suspend the dividend, but authorize a buyback? Weird.

Office real estate will almost certainly weigh on bank balance sheets, and will probably make banks a little more risk-averse.

Filed under: Economy | 2 Comments »

Vital Statistics:

Stocks are higher this morning after good numbers from Microsoft. Bonds and MBS are up.

Durable Goods orders rose 3.2% in March, which was well above Street expectations. If you strip out transportation, they rose 0.3%. Core Capital Goods, which can be considered a proxy for business capital expenditures fell 0.4%.

Mortgage Applications rose 3.7% last week as purchases rose 4.6% and refis increased 1.7%. “Both conventional and government home purchase applications increased last week. However, activity was still nearly 28 percent below last year’s pace, as high mortgage rates and low supply have slowed the market this year, even as home-price growth has decelerated in many markets across the country,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Refinance applications also increased last week but remained at half of last year’s levels. Although incoming data points to a slowdown in the U.S. economy, markets continue to expect that the Fed will raise short-term rates at its next meeting, which have pushed Treasury yields somewhat higher. As a result of the higher yields, mortgage rates increased for the second straight week to their highest level in over a month, with the 30-year fixed rate now at 6.55 percent.”

Small cities in the Midwest topped the list of the Wall Street Journal’s Emerging Housing Markets Index. These markets include many in Indiana, including Elkhart, Fort Wayne and Lafayette. With remote work becoming more of a permanent fixture in American life, it was probably only a matter of time before people started fleeing the expensive urban areas and moved to the much more affordable South and Midwest. “While it has become more expensive, it is still more affordable than a lot of other areas of the country,” said Brett Lueken, managing broker at Century 21 The Lueken Group in Lafayette.

Fears of an implosion in the commercial real estate space haven’t yet shown up in Blackstone Mortgage Trusts’s numbers. The mortgage REIT which focuses on CMBS reported an increase in book value per share and earnings which comfortably covered the dividend. The stock yields 14%.

Homebuilder Taylor Morrison reported an increase in first quarter earnings as gross margins improved. The cancellation rate fell to 14%, which is still elevated but approaching more normal levels.  “Following a strong early start to the year, positive sales momentum accelerated further into March, consistent with typical seasonal patterns despite the uncertainties facing the market. In total, during the quarter, our gross sales orders improved to a healthy monthly pace of 3.4 per community, the highest level since the third quarter of 2021, while our cancellation rate declined to more normalized levels at 14% of gross orders. This drove our monthly net sales pace to 2.9 per community as compared to 1.9 in the fourth quarter and 3.1 a year ago. This momentum has carried through the first three weeks of April, with our sales running at a pace of approximately 3.1 net orders per community. Meanwhile, leading indicators—including sales traffic, mortgage pre-qualifications and digital home reservations, which remained our top conversion source at a rate of 40% in the first quarter—point to continued strength.”

Luxury apartment landlord Equity Residential reported an increase in earnings per share. Same store rental increase came in at 3.9%, which is interesting given that Equity Residential has a lot of West Coast exposure (especially in expensive California urban MSAs) and real estate prices have been falling there.

Filed under: Economy | 7 Comments »