All Things in Moderation

ital Statistics:

The stock market is closed today, and the bond market closes early. Bonds and MBS are down on the jobs report.

The economy added 236,000 jobs in March, according to BLS. The unemployment rate ticked down 0.1% to 3.5%. Average hourly earnings rose 0.3% MOM and 4.2% YOY. Overall, the report was more or less in line with expectations. The labor force participation rate and the employment-population ratio rose, which shows that more workers are re-entering the labor market.

Bonds are selling off on the report given that unemployment ticked down again. That said, I think on balance the report should be good news for the Fed / bond market given that the employment-population ratio rose from 60.2% to 60.4%. Pre-pandemic the employment-population ratio was 61.1%, so we are still not back to normalcy, but we are getting closer. To put these numbers into perspective, the EP ratio was 57.4% at the end of 2020 and 59.5% at the end of 2021.

The Fed would like to see labor supply and demand more in balance. By raising interest rates, the Fed is trying to reduce demand for labor. If supply increases, that would accomplish the same thing, and that is much less painful than a recession-induced spike in unemployment.

As we saw in Wednesday’s ADP report, wages are rising smartly (and some of the lowest-paid jobs like leisure / hospitality) are seeing high single-digit annual gains. Wage increases are drawing workers back into the labor force, and that will go a long way towards balancing the market. Workers are not only coming back into the market, but job openings are falling as well. Ultimately the labor supply-demand situation is working itself out in the least painful way. This gives the Fed ammo to halt the tightening cycle.

The Atlanta Fed’s GDP Now Index has declined sharply over the past few weeks, with the index now seeing 1.5% growth in Q1. The index was at 3.5% just a few weeks ago. It looks like the ISM reports, along with weaker consumption numbers pulled down the index, not the banking issues.

The jobs report did put some starch in the May Fed Funds futures, which are now handicapping a 2/3 chance of another 25 basis point hike. A day ago, they saw a 50% chance.

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Vital Statistics:

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

The services economy expanded in March, albeit at a much slower rate than in February, according to the ISM Services Index. We saw pretty dramatic declines in new orders and a deceleration in prices. The employment index fell as well, which means the Fed should be pretty happy with these numbers. “There has been a pullback in the rate of growth for the services sector, attributed mainly to (1) a cooling off in the new orders growth rate, (2) an employment environment that varies by industry and (3) continued improvements in capacity and logistics, a positive impact on supplier performance. The majority of respondents report a positive outlook on business conditions.”

Lock volume rose 24% in March, according to the MCTLive Lock Index. Locks increased throughout all categories, with purchases up 23%, rate / term up 39% and cash-out refis up 28%. Part of this is of course seasonal, however lower interest rates are helping matters as well.

Western Alliance announced its earnings date and gave an update on its business. The company’s liquidity covers the number of uninsured deposits by 1.4x, and insured deposits increased to 68% of total deposits. Western Alliance is getting lumped in with Silicon Valley Bank, which is somewhat unfair given that SVB was kind of a one-trick pony and Western Alliance is more diversified with its mortgage ops. The Street expects WA to earn $9.11 this year, which puts the stock on a P/E of 3.2x with a 37% discount to book.

US employers announced 89,703 job cuts in March, according to outplacement firm Challenger, Gray and Christmas. This is up 15% from February and more than triple the number a year ago. “We know companies are approaching 2023 with caution, though the economy is still creating jobs. With rate hikes continuing and companies’ reigning in costs, the large-scale layoffs we are seeing will likely continue,” said Andrew Challenger, Senior Vice President of Challenger, Gray & Christmas, Inc. 38% of the cuts were in tech. Separately, initial jobless claims rose to 228k, which is further confirmation the labor economy is slowing down.

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Vital Statistics:

Stocks are lower this morning on renewed recession fears. Bonds and MBS are up.

Private employers added 145,000 jobs in March, according to the ADP Employment Report. This was lower than the 200,000 expectation, and is well below the 240,000 forecast for Friday’s payroll number. Annual pay increased for job stayers by 6.9%, while people who switched jobs saw a 14.2% increase. “Our March payroll data is one of several signals that the economy is slowing,” said Nela Richardson, chief economist, ADP. “Employers are pulling back from a year of strong hiring and pay growth, after a three-month plateau, is inching down.”

Leisure / hospitality was the biggest gainer, with 98,000 jobs, while we saw declines in finance and professional / business services. Manufacturing also fell. That said, the softening of the labor market looks to be occurring in the white collar sectors, not the blue collar sectors.

Still the pay increases, especially in services ex-housing will be a thorn in the Fed’s side. Look at the pay increases for leisure / hospitality – pushing 10%.

Mortgage applications fell 4.1% last week as purchases fell 4% and refis fell 5%. “Spring has arrived, but the housing market is missing the customary burst in listings and purchase activity that typically mark the season. After four weeks of increasing purchase application activity, volume declined a bit this week even with another small drop in mortgage rates,” said Mike Fratantoni, MBA’s SVP and Chief Economist. “Additionally, refinance application volume continues to be quite low. Although the mortgage rate for conforming balance loans declined by five basis points over the week to 6.40 percent, the mortgage rate for jumbo loans increased by nine basis points to 6.36 percent.  While we have seen relative weakness at the high end of the housing market in recent months, the divergence in rates suggests that banks may be tightening credit in response to recent challenges, preserving balance sheet capacity as deposit balances have declined. In recent years, most jumbo loans have been kept on depository balance sheets.”

Conforming versus jumbo rates YTD:

Jamie Dimon put out his annual shareholder letter yesterday, and discussed the banking crisis, which he says is not over.

Regarding the current disruption in the U.S. banking system, most of the risks were hiding in plain sight. Interest rate exposure, the fair value of held-to-maturity (HTM) portfolios and the amount of SVB’s uninsured deposits were always known – both to regulators and the marketplace. The unknown risk was that SVB’s over 35,000 corporate clients – and activity within them – were controlled by a small number of venture capital companies and moved their deposits in lockstep. It is unlikely that any recent change in regulatory requirements would have made a difference in what followed. Instead, the recent rapid rise of interest rates placed heightened focus on the potential for rapid deterioration of the fair value of HTM portfolios and, in this case, the lack of stickiness of certain uninsured deposits. Ironically, banks were incented to own very safe government securities because they were considered highly liquid by regulators and carried very low capital requirements. Even worse, the stress testing based on the scenario devised by the Federal Reserve Board (the Fed) never incorporated interest rates at higher levels. This is not to absolve bank management – it’s just to make clear that this wasn’t the finest hour for many players. All of these colliding factors became critically important when the marketplace, rating agencies and depositors focused on them.

It is fascinating that the Fed’s stress tests didn’t envision that an environment of rising interest rates could cause trouble given that this was precisely the situation in the 1970s that was the impetus for banking deregulation and the S&L crisis in the 1970s.

As he points out, this is not going to be a replay of 2008 – we are talking about Treasuries and MBS, which are money good. The ultimate recovery on these bonds is par, not something like 50 or 60. Silicon Valley Bank made an interest rate bet and was wrong,or more charitably, early.

Jamie Dimon goes on to talk about the necessity of the regional banks, and it is clear that JP Morgan isn’t interested in taking over a bunch of deposits fleeing the regional and smaller banks.

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Vital Statistics:

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

Job openings decreased from 10.6 million in January to 9.9 million in February. It looks like openings fell across most business sectors. This is evidence the Fed’s tightening is finally getting some traction on the labor market. The quits rate inched up, however it still lower than late last year. Quits are often a leading indicator for wage increases.

The bond market rallied on the number, with the 10 year yield falling 7 basis points immediately after the report.

Home prices rose marginally in February, according to Black Knight. This was the first increase in 8 months. Black Knight attributes this to the decline in rates in the beginning of February bringing buyers back into the market. That said, inventory remains extremely tight and isn’t improving. Some of the usual suspects – places like Miami – saw increases.

Overall prices rose 0.16% MOM and rose 1.94% YOY. “The unfortunate reality is that the scarce supply of inventory that’s the source of so much market gridlock isn’t getting any better. In fact, seasonally adjusted inventory levels continued to deteriorate in February, marking not only the fifth straight month of such declines, but also the largest inventory deficit we’ve seen since May of last year, with more than 90% of markets seeing such deficits grow in February. New listings – already trending well below pre-pandemic levels for months – ran 27% below those levels in February as potential home sellers continued to shy away from the market. All in, total active for-sale inventory is back to 47% below pre-pandemic levels after having recovered to within 38% of normal levels late last year. Without a significant shift in interest rates, home prices or household income, this is a self-fulfilling dynamic that is quite likely to continue for some time.”

You would think with such low inventory that the homebuilders would step into the breach, but their cancellation rates were pretty elevated in their fourth quarter numbers, and many are in the process of just burning off their backlog.

Private residential construction fell 0.6% month-over-month / 5.7% year-over-year in February. Single family construction was down big: 1.8% MOM and 21.4% YOY. On the other hand multifamily was up big: 1.4% MOM and 22.% YOY

You can see the divergence below. Single family remains the dominant component of housing starts, but it has been in decline while multi has kind of stayed in a range. The construction spending numbers suggest that multi-fam is accelerating.

CoreLogic reported that home prices rose 0.8% MOM and 4.4% YOY in February.

“The divergence in home price changes across the U.S. reflects a tale of two housing markets,” said Selma Hepp, chief economist at CoreLogic. “Declines in the West are due to the tech industry slowdown and a severe lack of affordability after decades of undersupply. The consistent gains in the Southeast and South reflect strong job markets, in-migration patterns and relative affordability due to new home construction.”

“But while housing market challenges remain, particularly in light of mortgage rate volatility and the ongoing banking turmoil,” Hepp continued, “pent-up homebuyer demand is responding favorably to lower rates in many markets. This trend holds true even in the West, leading to a solid monthly gain in home prices in February. U.S. home prices rose by 0.8% in February, double the month-over-month increase historically seen and indicating that prices in most markets have already bottomed out.”

Home price appreciation does exhibit a seasonal variation, and it looks like home prices started rising at the beginning of the Spring Selling Season.

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Vital Statistics:

Stocks are lower this morning after OPEC voted to restrict production over the weekend. Bonds and MBS are down.

The jobs report on Friday will be the big event for the week, along with the ISM data. The bond market will close early on Friday.

FHFA is making the COVID-era six month deferral permanent, allowing borrowers to skip up to six monthly payments and then tack them on to the end of the mortgage. “The Enterprises completed more than one million COVID-19 payment deferrals during the pandemic, helping borrowers nationwide to stay in their homes,” said FHFA Director Sandra L. Thompson. “Based on the success of the COVID-19 payment deferral, we are making this solution a key part of our standard loss mitigation toolkit that is available to all borrowers with eligible hardships.”

More evidence that the bank deposit run of a few weeks ago is abating. Raymond James points out that smaller banks are gaining deposits. Overall, deposits did fall, but they came out of the larger banks and the foreign-domiciled ones. “Essentially, the liquidity crisis, if it even was one outside a handful of banks, appears to be easing, which should be good news for banks and financials, which were the worst performing sector in Q1,” the strategist wrote. “It makes very little sense we would have a broad liquidity crisis in the banking system when there is so much excess liquidity (cash) sloshing around,” he said.

The manufacturing economy contracted in March, according to the ISM Manufacturing Survey.  “The U.S. manufacturing sector contracted again, with the Manufacturing PMI^® declining compared to the previous month. With Business Survey Committee panelists reporting softening new order rates over the previous 10 months, the March composite index reading reflects companies continuing to slow outputs to better match demand for the first half of 2023 and prepare for growth in the late summer/early fall period. New order rates remain sluggish as panelists become more concerned about when manufacturing growth will resume. Supply chains are now ready for growth, as panelists’ comments support reduced lead times for their more important purchases. Price instability remains, but future demand is uncertain as companies continue to work down overdue deliveries and backlogs. Seventy percent of manufacturing gross domestic product (GDP) is contracting, down from 82 percent in February.”

My weekly Substack piece focuses on the Greenspan Put and if it will make a re-appearance with the banking instability. Check it out and please consider subscribing.

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Vital Statistics:

Stocks are higher this morning as we put Q1 into the books. Bonds and MBS are flat.

Personal incomes rose 0.3% in February, according to the BEA. Personal consumption expenditures rose 0.2%.

The Personal Consumption Expenditures Price Index – the Fed’s preferred measure of inflation rose 0.3% month-over-month and 5% year-over-year. Excluding food and energy, the core rate 0.3% MOM and 4.6% YOY.

It looks like the spike in the PCE index in January may have been a one-off, or perhaps a some sort of statistical anomaly. It looks like the January numbers on just about every stat were out of step with the previous and subsequent readings. Q1 seasonal adjustments have always been imperfect (there has been a persistent bias in lower Q1 GDP) and that may have played a part in the January readings.

Regardless, the increase in the month-over-month rate seems to be limited to January and we are back in a period of declining month-over-month inflation. The year-over-year numbers are declining as well and will continue to fall especially as we approach the high water mark for 2022 real estate prices in the summer. This is good news as it takes some of the pressure of the Fed to keep raising rates.

The Spring Selling Season is looking like a bust, at least according to data from NAR. Part of the reason is that homes are taking a longer time to sell. Days on market rose to 54 this year compared to 36 a year ago. Higher rates are impacting demand, and if a home is priced right it will move. “Amid fewer new choices on the market and still rising home prices, home shoppers have shown that they are very rate sensitive, only jumping back in the market when rates dip, and so what happens with rates this spring will likely play a strong role in determining whether the housing market bumps along or picks up speed this year,” said Danielle Hale, chief economist at Realtor.com.

Overall, the competition is lower these days, however this is a function of affordability problems, not due to a balanced market. Median listing prices are still up on a year-over-year basis.

The FDIC is looking to sell Silicon Valley Bank and Signature’s portfolio of underwater MBS are Treasuries. The banks who took parts of these banks had no interest in these bonds as they would have to realize losses on the portfolios. The bond portfolios total about $116 billion.

Consumer sentiment fell in March, according to the University of Michigan Consumer Sentiment Survey. Both the current situation and expectations numbers fell.

Most notably, the year-ahead inflationary expectations index fell from 4.1% to 3.6%, while the long-term expectations were flat at 2.9%.

“Consumer sentiment fell for the first time in four months, dropping about 8% below February but remaining 4% above a year ago. This month’s turmoil in the banking sector had limited impact on consumer sentiment, which was already exhibiting downward momentum prior to the collapse of Silicon Valley Bank. Overall, our data revealed multiple signs that consumers increasingly expect a recession ahead. While sentiment fell across all demographic groups, the declines were sharpest for lower-income, less-educated, and younger consumers, as well as consumers with the top tercile of stock holdings. All five index components declined this month, led by a notably sharp weakening in one-year business conditions.”

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Vital Statistics:

Stocks are higher this morning as investors sense the banking problems of the past few weeks are in the rear view mirror. Bonds and MBS are flat.

The Fed Funds futures now see a coin flip for another 25 basis points hike in either May or June to get to a Fed funds rate of 5%, and then they see the Fed beginning to cut rates. Even if the banking crisis is over, the banks will probably be a bit more conservative in their lending which will act as a brake on the economy. Of course that is the whole point of tight monetary policy, but this adds an additional component.

The economy expanded 2.6% in the fourth quarter, according to the third estimate for GDP. Consumption was revised downward, while the core rate of inflation was revised upward. Corporate profits fell.

The Fed’s tightening policy still has had little to no effect on the labor market. Initial Jobless Claims came in again below 200k, which is extraordinarily low. I plotted the Fed Funds rate versus initial jobless claims. Jobless claims and the Fed Funds rate should correlate, but over the past year they have not.

Pending Home sales rose 0.8% in February, marking the third consecutive increase. “After nearly a year, the housing sector’s contraction is coming to an end,” said NAR Chief Economist Lawrence Yun. “Existing-home sales, pending contracts and new-home construction pending contracts have turned the corner and climbed for the past three months.” Note that activity is still way down from a year ago.

The most affordable regions – the Midwest and South – are leading the activity. As work-from-home becomes more cemented in American culture, we should see more of an evening out between the expensive coastal MSAs and the cheaper Midwest and Southern ones.

The cuts keep coming in the finance industry – Lending Tree announced it is cutting about 13% of its workforce in order to lower operating expenses.

The Fed is considering adding a special assessment to the biggest banks in order to replenish the FDIC insurance fund after covering deposits for Silicon Valley Bank and Signature. Regulators see this as a way to ease pressure on the regional banks.

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Vital Statistics:

Stocks are higher this morning as banking fears recede. Bonds and MBS are down.

Mortgage applications rose 2.9% last week as purchases rose 2% and refis rose 5%. “Application activity increased as mortgage rates declined for the third straight week. The 30-year fixed rate declined to 6.45 percent, the lowest level in over a month,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “While the 30-year fixed rate remained 1.65 percentage points higher than a year ago, homebuyers responded, leading to a fourth straight increase in purchase applications. Home-price growth has slowed markedly in many parts of the country, which has helped to improve buyers’ purchasing power. Purchase applications remain over 30 percent behind last year’s pace, but recent increases, along with data from other sources showing an uptick in home sales, is a welcome development.”

Consumer confidence improved slightly in March, according to the Conference Board. Surprisingly, the bank failures didn’t have much of an impact and the survey was conducted about 10 days after the failure of Silicon Valley Bank. “While consumers feel a bit more confident about what’s ahead, they are slightly less optimistic about the current landscape. The share of consumers saying jobs are ‘plentiful’ fell, while the share of those saying jobs are ‘not so plentiful’ rose. The latest results also reveal that their expectations of inflation over the next 12 months remains elevated—at 6.3 percent. Overall purchasing plans for appliances continued to soften while automobile purchases saw a slight increase.”

That inflationary expectations number for the next 12 months is not good. We know the Fed pays close attention to inflationary expectations in these consumer confidence surveys because this gets baked into the cake with wage negotiations. The 6.3% number does seem pretty far from the 3.8% number we saw in the University of Michigan survey earlier this month.

The New York Fed puts out its own survey of consumer expectations regarding the real estate market. Needless to say, consumers see mortgage rates rising further, although they see rental inflation falling back. Expectations for rental inflation are still elevated compared to historical numbers, but they are better than last year. As Jerome Powell has said numerous times, one of the legs in our 3-legged inflationary stool is real estate and that component of inflation will return to normal by the summer. For a more granular look at rents by MSA, check this study out by Rent.com.

Rising rates have pushed down people’s plans to move to a series low (which started in 2014). This is case of “hate the house, love the mortgage.” This might be driven by pessimism over mortgage rates. The respondents see mortgage rates pushing 9% in the next 3 years and hitting 8.4% this year.

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Vital Statistics:

Stocks are flat this morning as bank fears recede. Bonds and MBS are down.

House prices rose 0.2% month-over-month in January and 5.3% year-over-year, according to the FHFA House Price Index. “U.S. house prices changed slightly in January, continuing the trend of the last few months,” said Dr. Nataliya Polkovnichenko, Supervisory Economist, in FHFA’s Division of Research and Statistics. “Many of the January closings, on which this month’s HPI is constructed, reflect rate locks after mortgage rates declined from their peak in early November. Inventories of available homes for sale remained low.”

The West Coast and Mountain states saw the biggest declines, while the East Coast held up better.

Separately, the Case-Shiller Home Price Index rose 3.8% year-over-year in January. Declines were reported in many West Coast markets including San Diego, San Francisco, Portland, and Seattle. The hottest markets were in Florida and Atlanta. “January’s market weakness was broadly based. Before seasonal adjustment, 19 cities registered a decline; the seasonally adjusted picture is a bit brighter, with only 15 cities declining. With or without seasonal adjustment, most cities’ January declines were less severe than their December counterparts. Financial news this month has been dominated by ructions in the commercial banking industry, as some institutions’ risk management functions proved unequal to the rising level of interest rates. Despite this, the Federal Reserve remains focused on its inflation-reduction targets, which suggest that rates may remain elevated in the near-term. Mortgage financing and the prospect of economic weakness are therefore likely to remain a headwind for housing prices for at least the next several months.”

More evidence that the pain in the mortgage space isn’t going away. Mortgage REIT Invesco Mortgage Capital slashed its dividend as MBS spreads remain wide. Invesco continues to put money into the sector as agency MBS remain the cheapest since 2008. “Our investment portfolio continues to generate strong earnings available for distribution despite the sharp increase in short-term interest rates given a high percentage of our funding is hedged with a relatively low-cost legacy swap portfolio. We reduced our common stock dividend to retain capital and enhance book value by continuing to invest in agency residential mortgage-backed securities (“Agency RMBS”) at historically attractive valuations. We believe this represents a compelling environment for longer-term investors.”

Remember that mortgage REITs like Invesco are the ultimate buyers of the loans that mortgage bankers originate. If MBS are “cheap,” that implies that mortgage rates are lousy compared to the 10 year. This means that mortgage rates can fall quite a bit even if the 10 year goes nowhere. Of course the past decade of QE might be an artificial low in MBS spreads. Much will depend on whether some buyer will step up to replace the Fed as the biggest buyer.

The other driver of wide MBS spreads is interest rate volatility. Since a borrower always has the option to refinance, that option is worth something. The value of that option is a function of interest rate movement (i.e. how close current rates are to the note rate on the mortgage) and also interest rate volatility. The more volatile interest rates are, the more valuable the option. Since the borrower owns that optionality, the MBS investor is “short” that optionality. The increased value of that option is recognized in MBS spreads.

You can see the spike in volatility in the ICE / BofAML MOVE Index, which captures interest rate volatility. Think of it as a VIX for bonds.

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Vital Statistics:

Stocks are higher this morning after First Citizens reached a deal to buy parts of Silicon Valley Bank. Bonds and MBS are down.

First Citizens Bancshares reached a deal with the FDIC to buy Silicon Valley Bank’s deposits and loans. The two banks are roughly the same size in terms of assets and loans. This deal is causing a rally in the regional banks this morning and bonds are getting clobbered. Deutsche Bank is also up this morning.

First Republic is rallying this morning on news that regulators are considering an additional lending facility.

Deposit outflows eased last week, as the top 25 banks gained about $120 billion in deposits, while 850 smaller banks lost $108 billion.

In the upcoming week, we will get housing prices via the FHFA and Case-Shiller numbers, consumer confidence, GDP, personal incomes and outlays, and the University of Michigan consumer sentiment which will have the inflationary expectations numbers. Note that GDP is the final revision of the fourth quarter numbers, so they probably won’t have much of an effect on markets. It is stale data.

Over the weekend, Minneapolis Fed President Neel Kashkari said that the chances of a recession have increased due to the turmoil in the banking sector. “It definitely brings us closer right now” — that was Minneapolis Fed President Neel Kashkari’s response to a question, during a interview, on whether the latest turmoil in the banking sector could bring the U.S. closer to a recession. “What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. And then that credit crunch, just as you said, would then slow down the economy,” he said.

I discussed Neel Kashkari’s comments and also an interesting exchange between ex-Treasury Secretary Larry Summers and ex-Fed President Daniel Turullo in my weekly Substack piece. Check it out, and please consider subscribing.

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