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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A new development project may finally build new housing on on property whose condemnation for purposes of “economic development” was upheld by the Supreme Court in a controversial 2005 decision.
The former site of Susette Kelo’s house, May 2014. Photo by Ilya Somin.
The recent release of Justice John Paul Stevens’ papers have attracted new attention to the Supreme Court’s controversial 2005 ruling in Kelo v. City of New London, the 5-4 decision in which the justices ruled that the condemnation of homes for “private economic development” is permissible under the Takings Clause of the Fifth Amendment, which only allows takings that are for a “public use.” Notoriously, the development project that supposedly justified the condemnations fell through, and nothing was actually built on the property where the dispossessed owners’ homes previously stood. Since the last homeowners were forced out and their houses torn down, the only regular users of the condemned land were a colony of feral cats.
Feral cat on the site of one of the properties condemned in the Kelo case, 2011 (photo by Jackson Kuhl).
That may now be in the process of changing. While I missed the news at the time, in January the Renaissance City Development Association (the private nonprofit development firm formerly known as the New London Development Corporation, which took ownership of the property after it was taken by eminent domain) sold the condemned land to a developer, which may plan to build new housing on it. The New London Day reported some details on January 19:
[A]ll the properties on the Fort Trumbull peninsula are slated for development.
Parcels on the peninsula, which also is home to Fort Trumbull State Park, have been vacant for almost 20 years. The land was cleared for development in a move by the city that led to the landmark 2005 U.S. Supreme Court decision, Kelo v. New London, about the use of eminent domain….
The land is owned and marketed by the city’s development arm, the Renaissance City Development Association.
According to a development agreement between RCDA and RJ Development, parcels labeled 1A and 3C were sold for $500,000 and parcel 4A was sold for $1. The developer agreed to pay a $30,000 deposit to show its commitment.
The agreement states the projects on the property will primarily consist of, but will not be limited to, “the construction of residential units to be offered for market rate sale or rent/lease,” with the associated parking and other improvements.
Parcels 3C (formerly part of a larger unit called Parcel 3) and 4A are the former sites of the residential properties condemned in the Kelo litigation. Susette Kelo’s famous “little pink house,” which became a nationally known symbol of the case, was on 4A.
A later story, published on February 3, provides some additional information, including that the low price of Parcel 4A was because of the “cost of remediating the remaining contamination of soil and groundwater.” That contamination apparently developed during the long period when the parcel lay empty.
I have not been able to find any further information on what exactly RJ Development plans to build and when construction will be completed. The project is not listed on their website, which does however describe in detail another project they are doing in the area. I have contacted RJ Development to see if they are willing to provide any details. If I learn anything of interest, I will post it right here at the Volokh Conspiracy blog!
Since 2005, several efforts to redevelop the condemned land have fallen through. Hopefully, this one will succeed. But even if it does, I don’t think it will somehow vindicate the Kelo condemnations. The new development initiative is obviously different from the badly misconceived plan that led to the use of eminent domain over twenty years ago. Moreover, by the time any construction is completed, the land will have lain unused (except by feral cats!) for nearly twenty years. From the standpoint of promoting development, that’s an enormous waste.
The region would almost certainly have been better off economically if the original owners had been allowed to keep living there, paying property taxes, and contributing to the local economy. And that doesn’t even consider the enormous pain and suffering the original development project inflicted on those who lost their homes (including some who sold them “voluntarily” as a result of harassment and the threat of eminent domain). I describe the history of the condemnation process and the harm it inflicted in much more detail in The Grasping Hand: Kelo v. City of New London and the Limits of Eminent Domain, my book about the Kelo case and its aftermath.
As I have previously emphasized in the book and elsewhere, the flaws in the New London development project don’t necessarily prove that the Court got the Kelo decision wrong. Plenty of unjust and ill-conceived government policies are still legal. But there are in fact compelling reasons to reject the Court’s reasoning, from the standpoint of both originalism and living constitutionalism. At least four current Supreme Court justices have expressed interest in revisiting and possibly overruling Kelo, and I hope it will indeed eventually be overruled. In the meantime, I will do what I can to find out what, if anything, is going to be built on the two parcels.
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.”
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.”
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.”
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.
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.
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.
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.
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.
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