All Things in Moderation

Vital Statistics:

Stocks are lower this morning as investors fret about China. Bonds and MBS are flat.

Housing starts rose 4% MOM to a seasonally adjusted annual rate of 1.45 million units. This is up 6% on a YOY basis. Single family starts were up about 9.5% on a YOY basis while multi-fam was flat. Building Permits were flat MOM and down 13% on a YOY basis.

The homebuilders have been on a tear this year, outperforming the S&P 500 by 23% year-to-date. Below is a chart of the homebuilder ETF (XHB) versus the S&P:

New Home purchase applications rose 35.5% compared to a year ago, according to the MBA. “Applications for purchase loans on newly constructed homes remained strong in July, up 36 percent annually, as new homes continued to account for a growing share of homes available for sale,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The FHA share of purchase applications was 24.2 percent, the highest share since May 2020, and has increased in four of the last five months. FHA purchase loans are a popular option for many first-time homebuyers and this increasing trend in the FHA share is indicative of more first-time buyers looking to new homes as an option, given the lack of for-sale inventory among existing homes and challenging affordability conditions.”

The spurt in new home purchases is being driven by the lock-in effect where people who might be inclined to sell stay put because they hate the idea of trading their 3.5% mortgage rate for a 7% rate.

Mortgage applications fell 0.8% last week as purchases fell 0.2% and refis fell 1%. “Treasury rates were elevated again last week following mixed data on inflation and more indication of resiliency in the economy, which may pose a challenge to the Federal Reserve’s efforts to lower inflation. The 30-year fixed mortgage rate increased for the third straight week, reaching 7.16 percent, matching October 2022’s rate and the highest rate since 2001,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Overall applications decreased because of these higher rates, as both purchase and refinance applications ended the week at their lowest levels since February 2023. Government purchase applications provided a bright spot, increasing 2.4 percent over the week, driven by increases in both FHA and VA purchase categories. The ARM share of applications rose slightly to 7 percent, the highest since April 2023, as borrowers look for relief from higher fixed rates.”

More news that indicates how bad things are getting in China. The government is asking mutual funds to avoid selling stock in order to support the market. This is similar to Japan’s “price keeping operations” that it followed in the 1990s to support the stock market. The government has already said it will stop reporting the youth unemployment rate because the number is so bad. Here is an eye-opening video about the reality of being young in China.

Industrial production rose 1% MOM, while manufacturing production rose 0.5%. Both numbers were above Street expectations. Capacity Utilization inched up to 79.3%.

Filed under: Economy | 69 Comments »

Vital Statistics:

Stocks are lower this morning on weak Chinese data. Bonds and MBS are down.

China reported weak economic data overnight and cut interest rates. It also suspended reporting on youth unemployment data, which hit a record high of 21.3%. To put that number into perspective, the youth unemployment rate in the US was 7.9% in 2022. Nomura said: “We believe the Chinese economy is faced with an imminent downward spiral with the worst yet to come, and the rate cut this morning will be of limited help,” they said.

The increase in US Treasury rates is somewhat perplexing in the face of this, as weakness in China will send a disinflationary pulse throughout the world as commodity consumption falls and credit issues cause a flight to safety. Treasuries seem bound and determined to re-test the highs of October 2022.

Retail Sales rose 0.7% month-over-month and 3.2% year-over-year, according to the Census Bureau. These changes do not incorporate adjustments for inflation, so on an inflation-adjusted basis sales fell YOY. Food and drinking establishments rose the most at 11.9%.

We are coming up on the back-to-school shopping season which is a good predictor of the holiday shopping season. The resumption of student loan payments will be a drag on consumption going forward.

Homebuilder sentiment fell in August due to rising mortgage rates. “Rising mortgage rates and high construction costs stemming from a dearth of construction workers, a lack of buildable lots and ongoing shortages of distribution transformers put a chill on builder sentiment in August,” said NAHB Chairman Alicia Huey, a custom home builder and developer from Birmingham, Ala. “But while this latest confidence reading is a reminder that housing affordability is an ongoing challenge, demand for new construction continues to be supported by a lack of resale inventory, as many home owners elect to stay put because they are locked in at a low mortgage rate.”

“Declining customer traffic is a reminder of the larger challenge that shelter inflation is up 7.7% from a year ago and accounted for a striking 90% of the July Consumer Price Index reading of 3.2%,” said NAHB Chief Economist Robert Dietz. “The best way to bring housing inflation down and ease the housing affordability crisis is to enact policies at all levels of government that will allow builders to construct more homes to address a nationwide shortfall of approximately 1.5 million housing units.”

I talked about homebuilder affordability in my latest Substack. The ratio of the median home price to median income ratio has eclipsed the bubble years of 2006.

Separately, Warren Buffett initiated positions in the homebuilders, buying stakes in NVR, Lennar, and D.

Filed under: Economy | 5 Comments »

Vital Statistics:

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

Bond yields lurched higher yesterday after a lousy 30-year bond auction. The bad results pushed the 10 year yield up about 10 basis points.

Inflation at the wholesale level increased 0.3% MOM in July. On a year-over-year basis wholesale prices rose 0.8%. If you strip out food and energy, prices rose 0.3% MOM and 2.4% YOY. Overall, it looks like commodity inflation is pretty much over.

Final demand services did increase 0.5% MOM and 2.5% YOY. Final demand services is largely wage growth, and it appears that wage inflation is moderating. This is good news for the Fed.

San Francisco Fed Chair Mary Daly said that it is too early to declare victory on the battle against inflation. “Whether we raise another time, or hold rates steady for a longer period — those things are yet to be determined,” Daly said in an interview with Yahoo Finance. “It would be premature to project what I think would happen because there’s a lot of information coming in between now and our next meeting….We do need to see that come back to prepandemic levels if we’re going to be confident that we can get to 2% on a sustainable basis,” Daly said. “I’m going to need to see some traction in getting there before I feel comfortable that we’ve done enough.”

Mortgage delinquencies fell to 3.37% in the second quarter, according to the MBA. This was down 19 basis points compared to the first quarter and 27 basis points from a year ago. The strong labor market is the big driver of this performance.

We have been in a nirvana market for mortgage servicing rights, with elevated short term rates providing interest on escrow accounts and low delinquencies keeping down servicing costs.

From the United Wholesale earnings conference call: Mat Ishbia is staffed up for a refi boom coming soon: “We know the [refi] (ph) boom, whether it’s a long sustained one or a mini refi boom is going to come soon. The opportunities are usually in the first three, six months, maybe nine months to really make money from a volume and margin perspective and it really grow your business. We are prepared for that now.”

Mortgage banking is the most cyclical business on the planet, and while good times don’t last forever, neither do bad times. This bad time has lasted 18 months, which is an eternity.

Consumer sentiment was flat in July, according to the University of Michigan Consumer Sentiment Index. Inflationary expectations ticked down from 3.4% to 3.3%. Long-term inflationary expectations remained at 2.9%, which is above the pre-pandemic range of 2.2% – 2.6%.

Filed under: Economy | 36 Comments »

Vital Statistics:

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

China has slipped into deflation, which will almost certainly affect developed economies and their fight against inflation. Their consumer price index fell 0.3% year-over-year in July, and their producer price index was down even more.

China has a big issue with its real estate market and another property developer – Country Garden – just missed a payment on its dollar bonds. Country Garden joins Evergrande in the list of troubled property developers. China seems to be following the familiar pattern where a period of supernormal growth triggers a real estate bubble, similar to the US in the early 20th century and Japan in the 70s and 80s. That bubble has burst, and China is grappling with a massive oversupply of property, along with vacant cities built on spec.

The impact on the US will probably be relatively benign. China will probably try and export their way out of the problem, and since their domestic demand is moribund they will run a massive trade surplus. That means China will buy US Treasuries and MBS instead of US goods and services which will help push down rates in the US.

This will take years to play out, but the massive deflationary pulse out of Asia probably isn’t done yet.

Mortgage credit availability slipped in July, according to the MBA. “Mortgage credit availability declined to its lowest level since 2013, as lenders pulled back on underutilized loan programs and as liquidity concerns remain for some jumbo lenders,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Declining origination volumes have led to lower profitability for many lenders, resulting in narrower loan product offerings to reduce operational costs. One key driver of this month’s decline was a drop in cash-out refinance loan programs. The 30-year fixed mortgage rate averaged 6.94 percent in July, more than a percentage point higher than July 2022, and this has significantly discouraged cash-out refinance activity, as borrowers turn to home equity and consumer loans instead. The jumbo index fell for the third straight month, as jumbo lenders further reduce the number of available loan programs.”  

United Wholesale reported second quarter earnings that beat the street, with origination volume climbing to $31.8 billion, which was up 43% compared to the first quarter and up 6.4% compared to a year ago. Gain on sale margin compressed to 88 basis points in Q2 compared to 92 in Q1 and 99 a year ago. Purchase volume was 88% of total volume.

UWM is guiding for third quarter volume to come in between $26 and $33 billion, and gain on sale to range between 75 and 100 basis points. The stock is up about 7% pre-open.

Adjusted earnings per share came in at $0.11, which covers the $0.10 dividend. At current levels, the stock has a dividend yield of 6%.

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Vital Statistics:

Stocks are lower this morning after weak economic numbers out of China. Bonds and MBS are up.

Philly Fed President Patrick Harker said that the Fed could hold rates steady at the September meeting and indicated this tightening cycle could be in the books. “Absent any alarming new data between now and mid-September, I believe we may be at the point where we can be patient and hold rates steady and let the monetary policy actions we have taken do their work,” Harker said in remarks prepared for delivery at an event in Philadelphia.

That said, he did pour cold water on the idea of rate cuts any time soon. Rates might have to hold at this level until inflation hits 2% or we hit a recession. “Allow me to be clear about one thing, however. Should we be at that point we will need to be there for a while. The pandemic taught us to never say never, but I do not foresee any likely circumstance for an immediate easing of the policy rate.”

The September Fed Funds futures agree with Harker’s sentiment, seeing only a 12% chance of a rate hike. The December futures see about a 25% chance of one more rate hike by the end of the year. The March 2024 futures see a 60% chance of a rate cut.

If the Fed does indeed signal that the rate hikes are over, that should go a long way towards decreasing bond market volatility which is a big driver of MBS spreads. Mortgage rates could work their way lower as long-term rates decline and MBS spreads contract. This probably won’t be in time to save 2023 for the originators, but 2024 could be better than 2023.

Small business optimism increased in July, however we remain below the long-term average. While inflation was listed as the biggest problem, fewer businesses reported raising prices. A net 25% reported raising prices, the lowest since January of 2021.

Given the strength of the labor market and consumer demand, it is surprising to see the index at lower levels, but here we are. It seems like small business is waiting for the next shoe to drop – i.e. the recession we have all been waiting for.

Lock volume in July was marginally higher than June, according to MCT. “While July’s mortgage lock volume remained relatively flat, mortgage rates continued to climb through July,” said MCT’s COO, Phil Rasori. “If rates continue to hold or climb from these new levels established in the first week of August, we can expect volume to drop.”

The Black Knight home price index rose in June as tight inventory continues to push up prices. That said, prices rose less than 1% on both a monthly and an annual basis. Home equity rose to $16 trillion. “Overall mortgage-holder equity is now back above $16T, with some $10.5T of that being ‘tappable,’ or available for the homeowner to borrow against while still maintaining a relatively conservative 20% equity stake. The average mortgage holder has some $199K in tappable equity available to them; down somewhat from 2022’s historic highs but still a historically large amount regardless. In terms of negative equity, or ‘underwater borrowers,’ it’s a nearly nonexistent phenomenon in today’s market – just 344K homeowners currently owe more on their homes than the properties are worth. Yes, it’s true that is a 70% jump from this time last year – which may sound ominous – but everything is relative. There are less than half as many underwater homeowners than there were in 2019 before the onset of the pandemic, with only 3.9% having less than 10% equity, down from 6.6% in 2019.”

Filed under: Economy | 4 Comments »

Vital Statistics:

Stocks are higher this morning after a decent jobs report. Bonds and MBS are flat.

The economy added 187,000 jobs in July, which was a tad below Street expectations. The unemployment rate slipped from 3.6% to 3.5%. Average hourly earnings increased 0.4% MOM and 4.4% YOY. Average weekly hours fell to 34.3 from 34.4.

The average hourly earnings were higher than expected, which will probably grab the attention of the business press. Average hourly earnings aren’t the whole story however since average weekly hours fell. This means that average weekly earnings rose only 0.1% month-over-month, and 3.5% year-over-year. Those are not alarming numbers. Average weekly earnings growth is back at 2018 levels, which triggered a Fed tightening response, but the growth rate is rapidly approaching normalcy.

Richmond Fed President Tom Barkin addressed the question about why we haven’t had a recession yet.

So, why haven’t we seen a recession? I think it’s because the pandemic is still with us — not the public health crisis, thankfully, but the economic dislocation it unleashed.

Businesses experienced severe shortages over the last few years. So, they tell me they are holding on to workers and investing in safety stock. More fundamentally, they are still seeing healthy demand from their customers, and working through order backlogs. And manufacturing and construction are seeing a boost from coming government investments in infrastructure and the like. If your business is healthy, why cut back?

At the same time, consumers continue to spend, funded by excess savings accrued during the pandemic, elevated equity and housing wealth, and a robust jobs market. This year, the drop in gasoline prices has freed up additional spending capacity.

Further slowing is almost surely on the horizon. A number of pandemic-era fiscal support programs are ending. Rate increases work with a lag; many models estimate their impact should start to really hit around now. In addition, as banks preserve liquidity and protect earnings by stepping back from marginal lending, credit conditions have tightened, reducing consumer and business spending capacity.

I personally think the reason why the economy has taken so long to respond to higher interest rates is because real (i.e. inflation-adjusted) interest rates were negative for most of 2022. In other words, the Fed took us from ludicrous speed to ridiculous speed, which was still highly stimulative. It is like going from giving the patient a 0.5 ml dose of adrenaline to a 0.3 ml dose of adrenaline. Yes it is lower, but you are still pumping the patient with adrenaline. Interest rates have only recently become restrictive, and that IMO is why the recession keeps getting deferred. The resumption of student loan payments in September will almost certainly be a drag on consumption.

Filed under: Economy | 13 Comments »

Vital Statistics:

Stocks are lower as bond yields continue to rise on the Fitch downgrade. Bond and MBS are down big as the Bank of England raised interest rates again.

Productivity rose 3.7% in the second quarter, which was way higher than expectations. The increase was driven by a 2.4% increase in output and a 1.3% decrease in hours worked. Unit labor costs rose 1.6%, which was driven by a 5.5% increase in compensation and a 3.7% increase in productivity.

Rising productivity is generally good news for battle against inflation, and should give the Fed more ammo to pause in September.

Announced job cuts fell 42% in July, according to outplacement firm Challenger, Gray and Christmas. They were down on a YOY basis for the first time this year. “The job market is remaining resilient in the face of rising interest rates, as consumers continue to spend and inflation falls. Companies, weary of letting go of needed workers, are finding other ways to cut costs. Many have slowed hiring, but wages continue to rise, particularly for the lowest-wage earners, for the moment,” said Andy Challenger, labor expert and Senior Vice President of Challenger, Gray & Christmas, Inc.

Challenger has started to keep track of AI’s impact, which has the potential to do to white collar workers what robotics did to blue collar workers. “AI has the potential to completely disrupt almost every workplace. Those who become familiar with the technology will be incredibly valuable going forward,” said Challenger.

Separately, initial jobless claims remain low, rising to 227k last week.

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The services economy expanded in July albeit at a slower pace than in June. “There has been a slight pullback in the rate of growth for the services sector. This is due mostly to the decrease in the rate of growth for business activity, new orders and employment, as well as ongoing faster delivery times. The majority of respondents are cautiously optimistic about business conditions and the overall economy.” Prices did increase however which is bad news, however this seems to be an outlier in the context of other economic data.

Filed under: Economy | 12 Comments »

Vital Statistics:

Stocks are lower this morning after Fitch downgraded the US’s sovereign credit rating. Bonds and MBS are down.

Credit rating firm Fitch downgraded the US sovereign debt rating from AAA to AA+ yesterday. “The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”

Fitch sees US GDP growth slowing to 1.2% in 2023 and 0.5% in 2024. They expect a mild recession starting in Q4 and lasting into Q1. They also see one more Fed rate hike in September.

Note that S&P downgraded the US 12 years ago, so this is not as big of an event as the press is making it out to be.

Mortgage applications fell 3% last week as purchases and refis fell by the same amount. “Mortgage rates edged higher last week, with the 30-year fixed mortgage rate’s increase to 6.93 percent leading to another decline in overall applications,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The purchase index decreased for the third straight week to its lowest level since the beginning of June and remains 26 percent behind last year’s levels. The decline in purchase activity was driven mainly by weaker conventional purchase application volume, as limited housing inventory and rates still close to 7 percent are crimping affordability for many potential homebuyers. The refinance market continues to feel the impact of these higher rates, and applications trailed last year’s pace by over 30 percent with many homeowners not looking for refinance opportunities.”  

The economy added 324,000 jobs in July, according to the ADP Employment Report. As usual, leisure and hospitality jobs accounted for the bulk of the pickup. Wage growth continues to be decent, with job stayers reporting an increase of 6.2% YOY. Job changers saw an increase of 10.2%. That said, the increase for job stayers was the lowest since November 2021. The Street is looking for an increase of 200,000 jobs in Friday’s Employment Situation Report.

Rithm capital, formerly known as New Residential, announced second quarter earnings that were just about the company’s best ever. “Rithm had one of its best quarters ever,” said Michael Nierenberg, Chairman, Chief Executive Officer and President of Rithm Capital. “We had near record earnings, grew book value, acquired $1.4 billion of consumer loans and grew our SFR business with the acquisition of 371 units. Subsequent to quarter end, we announced the acquisition of Sculptor Capital Management. This acquisition helps accelerate our growth in the alternative asset management space, as Sculptor’s $34 billion of AUM complements Rithm’s $7bn of permanent equity capital and $30+ billion balance sheet. With the introduction of new capital rules being instituted on banks and the highest level of rates seen in 20+ years, the investing environment has not been this good in years.

Filed under: Economy | 22 Comments »

ital Statistics:

Stocks are lower this morning as earnings continue to come in. Bonds and MBS are down.

Job openings were 9.6 million at the end of July, according to the JOLTS report. Hires decreased to 5.9 million, with losses experienced in finance and manufacturing. The quits rate, which tends to forecast wage inflation, decreased to 2.4% from 2.6% in June and 2.7% a year ago. This is evidence that the US labor market is weakening.

The manufacturing economy continues to contract, according to the ISM Manufacturing Report, albeit at a slower rate. The ISM Index ticked up in July compared to June, but is still below 50 which is considered neutral. New Orders improved, and pricing pressures continue to fall. Supply delivery times decreased. Overall, the news on pricing should be good for the Fed, as it looks like the tightening policy is having the desired effect.

Homebuilder LGI Homes reported second quarter numbers, with new orders and backlog improving smartly. The company raised guidance for the year as well. LGI has changed its focus to smaller homes, which has helped the affordability issues. Average selling prices fell 2% which helped propel a 124% increase in new orders. Gross margins improved on a QOQ basis but are still down big YOY.

Some good news for MBS spreads. Mortgage REIT Two Harbors reported earnings and said that the volatility has decreased. “In the second quarter, many of the unknown variables in the market were resolved. Congress passed a resolution on the debt ceiling, inflation expectations and the Fed path of rate hikes appeared well contained, and the market readily absorbed the supply of RMBS being auctioned by the FDIC,” stated Bill Greenberg, Two Harbors’ President and CEO. “This led to lower volatility, which supported positive performance in our portfolio, while spreads remained at historically attractive levels.”

Mortgage REITs like Two Harbors are the buyers of mortgage origination. Lower volatility means that mortgage rates should continue to decrease relative to movements in the 10 year bond. His point about spreads remaining at historically attractive levels means that mortgage rates have the potential to fall further.

One big influence on rates will be the developments in Asia, particularly Japan and China. On one hand, Japan is loosening its iron grip on Japanese Government Bond yields, which will will mean higher rates at the margin in the US. On the other hand, China’s real estate bubble has burst, and this will send a strong deflationary pulse throughout the world. This will work to move rates lower. I talked about this in my weekly substack piece, linked above.

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Vital Statistics:

Stocks are higher as earnings continue to come in. Bonds and MBS are down.

Global bond yields shot higher overnight after the Bank of Japan tweaked the language in its policy statement which hinted at policy normalization. This caused the yield on the Japanese Government Bond to shoot higher by 11 basis points (from 0.44% to 0.55%) which caused global bond yields to spike higher. As a general rule, global government bonds do correlate with each other, so this pushed yields higher.

Personal Incomes rose 0.3% month-over-month in June, according to BEA. Personal consumption rose 0.5%. The PCE Price Index, which is the Fed’s preferred measure of inflation, rose 0.2% month-over-month and 3% year-over-year. Excluding food and energy, it rose 0.2% MOM and 4.1% YOY.

Here is the long-term chart of the annual change in the PCE Price Index excluding food and energy, which is the focus for the Fed:

Lower energy prices (they fell 19% YOY) pushed down the headline number to 3%, but the ex-food and energy number is still elevated. June 2022 was the peak of the housing market, and that will help to push down the monthly numbers going forward. The next Fed meeting in September 19-20, so we will have a lot of data to chew through before that meeting.

The employment cost index rose 1% in the quarter ending June 30, and 4.5% for the past 12 months. It rose at 5.1% for the year ending in June 2022, so we are seeing wage growth decelerate.

Pennymac reported that volumes rose 9% to $24.9 billion in Q2. This was down 7% on a YOY basis. Overall margins improved, but elevated interest rate volatility pushed up hedging costs.

Consumer sentiment improved markedly in July, according to the University of Michigan. “Consumer sentiment rose for the second straight month, soaring 11% above June and reaching its most favorable reading since October 2021. All components of the index improved considerably, led by a 18% surge in long-term business conditions and 14% increase in short-run business conditions. Overall, the sharp rise in sentiment was largely attributable to the continued slowdown in inflation along with stability in labor markets.”

Year-ahead inflationary expectations increased from 3.3% to 3.4%. Long-term inflationary expectations were stuck at 3%.

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