All Things in Moderation

Vital Statistics:

Stocks are higher this morning as earnings continue to come in. Bonds and MBS are flat.

Homebuilder sentiment collapsed in July according to the NAHB / Wells Fargo Housing Market Index. “Production bottlenecks, rising home building costs, and high inflation are causing many builders to halt construction because the cost of land, construction, and financing exceeds the market value of the home,” says NAHB chairman Jerry Konter. “In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”

The issues surrounding inflation and supply chain bottlenecks are well-known, however it looks like demand is softening, which is new. Fears of a recession, along with high prices and rates are causing potential buyers to put plans on hold for the moment. It will be interesting to see the cancellation rates when the builders start reporting.

Housing starts disappointed again, falling 6.3% YOY to a seasonally adjusted annual rate of 1.55 million. Building Permits were flat at 1.66 million. It looks like activity is primarily slowing in the West, where prices have been soaring. Single family starts are still holding up.

The stock market has noticed the issues surrounding homebuilding, with the S&P SPDR Homebuilder ETF (XHB) down 31% YTD.

The Mortgage Bankers Association reported that applications for new home purchases fell 12% YOY in June. “Higher mortgage rates and heightened economic uncertainty cooled borrower demand in June, leading to new-home purchase applications declining to the lowest level since April 2020,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Additionally, new residential construction and permitting activity weakened from March through May, reducing the number of homes available for home buyers. MBA’s estimate of new home sales for June fell to a pace of 620,000 homes, a 15 percent drop of over 100,000 units compared to May.”

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Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

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Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

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Vital Statistics:

Stocks are higher this morning after a positive retail sales number. Bonds and MBS are flat.

The yield curve continues to invert, with the 2s / 10s spread at -20 basis points and the 2s / 30s spread at -5 basis points. The yield curve’s shape isn’t dispositive – there is an old joke that an inverted yield curve has predicted 12 of the last 5 recessions, but it flashing warning signs and we are getting confirmation elsewhere.

Retail Sales rose 1% MOM and 8.4% YOY. Note this number is not adjusted for inflation, which is running right about the same level. Ex-vehicles and gasoline sales rose 0.7%, which was much better that -0.2% Street expectation.

Wells Fargo reported earnings this morning. Earnings per share declined 47% on a YOY basis. Revenues were down 16% YOY, and earnings were mainly affected by provisions for credit losses. The credit losses should really have an asterisk nest to it. Most of the banks over-reserved for losses in the early days of COVID and when the losses never materialized, they reversed them in 2021. Now that we are back to normalcy, they are reserving for credit losses again. So you get a strange YOY comparison, which will be pretty common for all the banks, IMO.

The mortgage banking numbers were pretty lousy, as expected. Home lending earnings were down about 50% (as they telegraphed a month ago), as falling origination income was offset somewhat by increased servicing income. Originations fell 11% QOQ and 36% YOY to $34.1 billion.

Consumer sentiment improved in the preliminary July reading of the University of Michigan Consumer Sentiment Index. More importantly, the inflationary expectations of consumers began to moderate. As we learned from the FOMC minutes from the June meeting, the Fed pays close attention to this number.

Consumer sentiment indices are often nothing more than gasoline price indices – in other words high gas prices depress sentiment. Gas prices are off the highs from a month ago, so I guess it makes sense that inflationary expectations would fall. Regardless, this number is welcome news for everyone.

This highlights one of the big risks at the fed: by adjusting policy to inflationary expectations, the Fed risks chasing oil prices which is the wrong metric to use.

That said, consumers’ financial situation isn’t in the best of places. One of the metrics for this survey asks consumers about their current financial situation. You can see from the chart below, they are in a bad place:

A recent article in the New York Post shows the difficulty in measuring inflation. BMW is now requiring subscriptions to use heated seats or automatically adjusted high-beams. Access to CarPlay requires an up-front fee. It is the Spirit Airlines model – advertise a low price and then charge for the oxygen the passenger breathes.

Now, according to the government, the only relevant number is the price of the car, however if automakers are lowering prices by introducing a slew of add-on charges, then the price growth is understated. It is a different play on shrinkflation, which is evident again to anyone who eats a bagged salad for lunch.

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Vital Statistics:

Stocks are lower this morning as the banks kick off earning season. Bonds and MBS are flat.

JP Morgan reported earnings that missed Street expectations. Earnings per share fell 27% YOY as provisions for loan losses and noninterest expense increased. Mortgage banking revenue fell 14% QOQ and 27% YOY as lower production revenue was offset somewhat by higher servicing income. Origination volumes fell 11% QOQ and 45% YOY to $21.9 billion. The stock is down about 3% pre-open.

The producer price index came in hotter than expected, rising 1.1% on a MOM basis and 11.3% on a YOY basis. The PPI focuses on inflation at the wholesale level, which will translate into higher prices at the consumer level down the road. About half of the increase was attributable to gasoline prices, which thankfully are beginning to fall. Final demand when you strip out food and energy rose 0.4% MOM and 8.2% YOY.

The strength of the dollar is beginning to help in the fight against inflation as commodities generally trade in US dollars. Note that the US dollar just went below parity versus the Euro. The downside will be lower corporate earnings for companies with overseas operations.

The Fed’s Beige Book reported that economic activity expanded at a “modest” pace (“modest” is Fed-speak for “meh”), but several districts reported that they are seeing a decrease in demand and many noted an increased risk for a recession.

The increase in the CPI and PPI has changed the outlook for the July FOMC meeting. The markets are now predicting a 83% chance for a 100 basis point hike in the Fed Funds rate. For the end of the year, the central tendency is a rate of 3.75% – 4%, which would indicate another 125 basis points of increases in September, October and December.

The fact that we are talking about recessionary conditions now, with this much tightening ahead of us and a 9 – 12 month lag for the economic effects to matter bodes ill for the economy by the end of the year and into 2023.

The spread between the 2 year and the 10 year bond has become even more negative, falling to -23 basis points. This recessionary indicator is flashing red.

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Vital Statistics:

Stocks are lower this morning after the consumer price index came in hotter than expected. Bonds and MBS are down.

The consumer price index rose 1.3% month-over-month and 9.1% year-over-year. This is the highest rate in over 4 decades. Energy prices (particularly gasoline) was a big driver of rising prices. Ex-food and energy the index rose 0.7% MOM and 5.9% YOY. On both indices, the monthly rates are rising, which means that inflation is accelerating, not decelerating. This will almost certainly raise alarm bells at the Fed and keep them on a path for increasing rates.

And just like that, the Fed Funds futures for July have a coin flip between a 75 basis point hike and a 100 basis point hike:

On the bright side, we are seeing some commodity prices fall. Oil and natural gas prices are falling, and we are seeing recent weakness in food such as corn, wheat and cattle. Finally, retailers are reporting that they are stuck with inventory they need to liquidate. This means falling prices for lots of finished goods. This has largely been a June phenomenon, so you won’t see it reflected in the the June CPI. It will filter through to the producer price index first, and then will be reflected in final goods.

The shoe that has yet to drop is the price of shelter. Rising home prices affect the CPI with a 12-18 month lag. So the torrid home price appreciation of the past two years is only beginning to impact the numbers. Shelter rose 5.6% YOY, and the monthly numbers are increasing. Given that all the home price indices show high teens increases, more inflationary pressure is coming there. Rents are only beginning to reset to higher levels.

The rapid increase in the Fed Funds rate is almost certainly going to cause a recession, and if the Atlanta Fed’s GDP Now index is correct, you could argue that we are in one already, though that determination is subjective and made by the NBER. The spread between the 2-year and the 10 year Treasury is now negative by 14 basis points, and this indicator is flashing red.

If we hit a recession, you know what is going to take a hit? Servicing values. The first shoe to drop will be rising delinquency rates, and then the second will be falling long-term rates as markets anticipate the Fed taking its foot off the brakes. I suspect this was the issue with First Guarantee and its backer PIMCO. While FGMC dabbled in the jumbo and NQM space, it was known primarily for being the home for low quality FHA loans. Since there are no LLPAs in GNMA securitization, the gain on sale margins for a low FICO FHA can be huge. But, there is a catch.

GNMA servicing rules are exceptionally harsh regarding advances and modifications. I suspect PIMCO pulled the plug on FG because they could see what was coming for that servicing book if the economy rolls over. For them, it was an unbounded liability given that lenders never fully recover servicing advances on GNMA loans. Also, I am hearing rumblings that loan mods are going to be problematic this time around due to the various CFPB rules that never anticipated a rapid increase in rates.

Mortgage Applications fell 1.7% last week as purchases fell 4% and refis fell 2%. The index includes an adjustment for the 4th of July holiday. “Mortgage rates were mostly unchanged, but applications declined for the second straight week,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Purchase applications for both conventional and government loans continue to be weaker due to the combination of much higher mortgage rates and the worsening economic outlook. After reaching a record $460,000 in March 2022, the average purchase loan size was $415,000 last week, pulled lower by the potential moderation of home-price growth and weaker purchase activity at the upper end of the market.”

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Vital Statistics:

Stocks are up this morning as oil prices fall. Bonds and MBS are up.

Small Business Optimism declined again, according to the National Federation of Independent Businesses. “As inflation continues to dominate business decisions, small business owners’ expectations for better business conditions have reached a new low,” said NFIB Chief Economist Bill Dunkelberg. “On top of the immediate challenges facing small business owners including inflation and worker shortages, the outlook for economic policy is not encouraging either as policy talks have shifted to tax increases and more regulations.”

The report is interesting in that it captures the divergence in the economy right now. If you look at things like sales, profits and economic sentiment, the situation is pretty negative. If you look at the employment picture, it is the exact opposite.

That said, the chart for economic optimism is getting pretty dire and approaching Great Recession levels.

The Atlanta Fed GDP Now Index has improved somewhat, but we are looking at negative growth still with the index showing a -1.2% estimate. This would make two consecutive quarters of negative GDP growth, however the media / government is pushing back against calling this a recession. Ultimately, the official recession call is ultimately subjective and the administration / media will be working the refs pretty hard.

Loan Depot is doing a massive restructuring to get its costs in line. Headcount is going to decline 43% between the end of 2021 and 2022. Their outlook is quite dire. We are executing our Vision 2025 plan on a foundation of a strong balance sheet and ample liquidity, with a current cash position of approximately $1 billion. We anticipate continued challenging market conditions, with mortgage originations projected to decline by roughly half in 2022 from 2021, including an accelerated decline in the second half of 2022, followed by a further decline in 2023. We continued to reduce our costs significantly in the second quarter. Over the next two quarters, we expect to accelerate these efforts and aggressively drive down our costs in line with our previously stated goal of exiting this year with a profitable operating run rate. After two years of substantial headcount and expense growth that was necessary to support unprecedented origination volumes we are returning to previous levels of staffing and expense.”

Loan Depot stock has been a disaster this year, falling 70% year-to-date. The current dividend of $0.08 a share clearly ain’t happening – that 19% yield is not real. Surprised they didn’t just rip the band aid off and cut the dividend to $0.02 a quarter.

Mortgage credit availability fell in June, according to the MBA. “Mortgage credit availability decreased slightly in June, as significantly higher mortgage rates compared to a year ago slowed refinance activity and impacted the overall mortgage credit landscape,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “While there was reduced supply of lower credit score, high LTV rate-term refinance programs, the decline was offset by increased offerings for conventional ARM and high balance loans. With higher rates and elevated home prices, more prospective buyers are applying for ARMs, but activity remains below historical averages.”

I am guessing this doesn’t take into account the NQM market, which will be affected by the exit of Sprout and FGMC. Mortgage credit is getting close to the levels seen in the aftermath of the Great Recession.

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Vital Statistics:

Stocks are lower this morning as we begin an important week for data. Bonds and MBS are up.

Ordinarily, the week after the jobs report is data-light. This week that is not the case. This week kicks off earnings season, with a lot of the big banks reporting. Second, we will get the Consumer Price Index on Wednesday, which is now one of the most important economic reports out there. Finally, we will have the University of Michigan Consumer Sentiment Survey. Historically, these consumer sentiment surveys have generally been non-events as far as markets go, but the Fed is focusing on the inflationary expectations embedded in the report. In fact, that report loomed large in the Fed’s decision to move from 50 basis points to 75.

The stock market is down pretty big from its heights of earlier this year. Do we bottom here? IMO the stock market’s behavior is the classic bear market before a recession playbook. Going forward, earnings season will matter a lot. While I don’t generally talk too much about currencies (they generally aren’t relevant to mortgage banking) the US dollar has been quite strong this year.

This is factoring into earnings for companies with big overseas operations. As a general rule, as the dollar rises, corporate earnings fall. So this increase in USD will be a big factor this earnings season. Microsoft has already warned that the US dollar will take a bite out of profits. Chip shortages and currencies will definitely affect the automakers. The fear in stock market investors is that earnings estimates are still too high and need to drop further.

The profit outlook for banks will be dented by mortgage banking. Wells indicated at a conference that Q2 mortgage banking profits will be down about 50% from Q1. Companies are aggressively cutting staff, and it looks like there probably will be more to come: “Over the next month or two we’ll see the bulk of layoffs,” said Doug Duncan, chief economist at Fannie Mae, which, along with Freddie Mac, backs many U.S. mortgages. “There is usually about a six-month lag between a turn in the market and layoffs.” While Wells and JPM are struggling in mortgage banking, apparently Bank of America has not cut staff. They saw mortgage banking revenue increase in Q1, unlike most of their compatriots.

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Vital Statistics:

Stocks are lower this morning after the employment report came in stronger than expected. Bonds and MBS are down.

The economy added 372,000 jobs in June, which was well above the Street estimate of 270k. The unemployment rate remained at 3.6%, and average hourly earnings rose 0.3% MOM and 5.3% YOY. There are 5.7 million long-term unemployed who want a job but were unable to find one, which is still higher than the 5 million pre-pandemic.

Leisure and hospitality, health care and professional / business services added the most jobs. Overall, this report will give the Fed the leeway to raise interest rates 75 basis points at the end of the month as expected.

The demise of First Guaranty and Sprout has people asking if this is the harbinger for another 2008. Given that real estate prices have risen so dramatically over the past two years it is hard to deny the similarities are there. That said, there are big differences. The most important difference is that the products that don’t fit the Fannie / Freddie credit box are still high quality loans. We don’t have the negative amortization (i.e. pick-a-pay) loans that were given to anyone who could fog a mirror. The non-QM loans are often based on rental income, which has been rising at a rapid clip.

Second, the home supply situation is much different today than it was in 2006. In 2006 we were coming off years of overbuilding. For the 10 years prior to the 2006 peak, the US built about 16.8 million units. Over the past 10 years, we have built about 10.5 million. The supply overhang doesn’t exist this time around, homeowners have much more equity and the mortgages that were done since the crisis have been much higher quality than during the bubble years.

Others have pointed out that perhaps the non-QM issue is something more reminiscent of the Russian debt crisis of the late 90s, which blew up hedge fund Long-Term Capital Management. FWIW, I don’t see it – the non-QM market simply isn’t that big. Non-QM issuance is around $20 billion per year, give or take. To put that number in perspective, $20 billion is about half the average daily traded volume of US corporate debt. Year-to-date, corporate bond issuance is about $836 billion. A blow up in the non-QM market won’t even register outside of the mortgage banking space.

My guess is that these firms got stuck with inventory that was depreciating in value as rates rose so rapidly over the past few months. Most of these places hold loans on a sort of warehouse line, and they were being hit with curtailments they couldn’t pay. Don’t forget, there are no products which can hedge the interest rates risk on non-QM. Selling TBAs against non-QM paper is subject to basis risk, which means TBAs and non-QM don’t really correlate all that well. In other words, non-QM paper is basically unhedgeable. This is probably not an issue for lenders who simply buy non-QM for their portfolio, but it is an issue for those who rely on securitization as an exit. Note that this issue doesn’t affect the underlying credit quality at all – NQM securities were falling price due to interest rates, not defaults. This is a huge difference from 2006.

The punch line here is that the non-QM issue is something that isn’t big enough to cause any sort of crisis in the overall economy.

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Vital Statistics:

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

The FOMC minutes were released yesterday at noon. The takeaway is that the Fed is worried most about inflationary expectations becoming entrenched in the economy and is willing to cause a recession to defeat inflation. The time period between the May and June meeting had two big data points: the consumer price index which showed headline inflation at 8.7% and the University of Michigan Consumer Sentiment Index which showed inflationary expectations rising.

Inflationary expectations are critical because they have a self-fulfilling aspect to them. Vendors begin to build them into contracts, employees (especially those that are represented by collective bargaining) negotiate raises into contracts, and consumers / businesses begin to hoard materials in anticipation of future price increases.

The Fed has two vehicles to measure inflationary expectations. The first is consumer sentiment surveys like the University of Michigan and the second is the differential between Treasury Inflation Protected Securities (TIPS) and Treasuries. These market-based measures of inflation so far are still behaving, which gives the Fed some comfort. That said, the University of Michigan report along with the super-tight labor market gives the Fed the leeway to act aggressively. The self-reinforcing aspect of inflationary expectations means that the cost of bringing down inflation now (in terms of growth) are much lower than it will be when these expectations become entrenched. Don’t forget the 1981-1982 recession was the worst since the Great Depression and the Fed took up the Fed Funds rate into the mid-teens to defeat inflation. This is what the Fed is trying to avoid.

In terms of rate hikes, the view that 75 basis points was necessary was almost unanimous, with one participant wanting to hike 50 at this meeting and then 75 in July.

Sprout Mortgage is shutting down, the latest casualty in the mortgage business. So far, the company hasn’t publicly commented, but this was apparently announced on a conference call. There is no word on what Sprout will do with loans in the pipeline and the company isn’t responding to media requests for comment. Separately, Wells announced more layoffs. It will be interesting to hear from the banks next week when they announce earnings. Wells had telegraphed that origination income will be down 50% compared to Q1.

In other economic data, initial jobless claims rose to 235k last week. Meanwhile, outplacement firm Challenger Gray and Christmas reported that announced job cuts rose to 32,517 from 20,712 during the same month last year. The automotive sector bore the brunt of most of the changes, as shortages and high prices are depressing business. Health care / products is also laying off workers as the COVID-19 pandemic hiring spree reverses.

So far the labor market remains tight, but cracks are beginning to show in the foundation. I keep saying this, but it bears repeating: the rate hikes from earlier this year won’t begin to impact the economy until late this year.

Finally, there is no ADP report this month as they are retooling their methodology. There has been too much of a difference between the ADP report and the BLS’s Employment Situation Report so they are reworking their models.

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