All Things in Moderation

Vital Statistics:

Stocks are lower this morning despite a positive CPI report. Bonds and MBS are up.

Consumer prices fell 0.1% in December, according to the Consumer Price Index. They rose 6.5% on an annual basis. The core rate, which excludes food and energy rose 0.3%. The decrease in the headline rate was due mainly to falling gasoline prices. The core rate did increase from November, however that was due primarily to housing. The trend overall has been down, which should be good news for the Fed, with emphasis on the should. I did a deep dive over the weekend why the action we are seeing in the CPI is a necessary, but not sufficient, condition for the Fed to stop tightening.

Bonds definitely liked the data however, with the 10 year bond yield falling below 3.5%.

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Initial jobless claims came in at 205,000, which is still exceptionally low by historical standards.

Philly Fed President Harker said that the era of aggressive rate hikes are over and it will probably make sense to increase in smaller, 25 basis point increments. “I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed,” Harker said in the text of a speech. “In my view, hikes of 25 basis points will be appropriate going forward.”

If “a few more times” = three more hikes, then we will be looking at a range of 5% – 5.25% by the May meeting. This would comport with the end-of-year forecast by the Fed in December.

Note the Fed Funds futures are still more dovish than the Fed.

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

Jerome Powell spoke yesterday and it doesn’t appear that he had much to say in terms of current monetary policy. The issue at hand was central bank independence. Powell acknowledged that rate hikes will be unpopular politically, but welcomed the absence of political control over monetary policy. I suspect this is temporary, and if the economy slows dramatically the Fed will see pressure from Congress to cut rates.

Powell also acknowledged that the Fed is getting pressure to “act on climate.” This means he is getting pressure from activists to use the Fed’s supervisory authority to discourage investment in fossil fuels. Climate Action 100 is a consortium of banks and investment firms that have pledged not to lend to energy companies, and I suspect the activists want the Fed to either explicitly prohibit fossil fuel lending or to use some other lever to discourage it. Powell pushed back on this: “But without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals.  We are not, and will not be, a “climate policymaker.”

Mortgage Applications fell 1.2% last week as purchases fell 1% and refis fell 5%. Total applications are down 48% on a YOY basis and refis are down a whopping 86%. “Mortgage rates declined last week as markets reacted to data showing a weakening economy and slowing wage growth. All loan types in the survey saw a decline in rates, with the 30-year fixed rate falling to 6.42 percent. Purchase applications continued to be hampered by broader weakness in the housing market and declined slightly over the week, with the index slipping to its lowest level since 2014,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “There was an increase in refinance activity as a result of the 16-basis-point decline in rates, as both conventional and government refinance applications increased. However, the overall pace of refinance applications was lower than November and December’s 2022 averages, and over 80 percent lower than a year ago. Refinances were about 30 percent of all applications last week — well below the past decade’s average of 58 percent.”

Wells is drastically shrinking its mortgage footprint. It will exit correspondent and will only originate mortgages for its own clients and borrowers in minority communities. Not too long ago, Wells was the biggest mortgage banker in the US. “We are acutely aware of Wells Fargo’s history since 2016 and the work we need to do to restore public confidence,” [Chief Consumer Lending Officer] Santos said in a phone interview. “As part of that review, we determined that our home-lending business was too large, both in terms of overall size and its scope.”

Wells will also be significantly shrinking its servicing portfolio. It is amazing how much capacity is being wrung out of the mortgage business over the past year. This should translate into higher margins into 2023.

Are we seeing signs of a turn in housing? Perhaps. The Fannie Mae Home Purchase Sentiment Index increased in December, albeit it is barely higher than the all-time low set in October. “In December, the HPSI inched upward slightly, as consumers reported increased expectations that mortgage rates and home prices may decrease over the next year – perhaps reflecting recently observed declines in mortgage rates and average home prices,” said Doug Duncan, Fannie Mae Senior Vice President and Chief Economist. “However, the HPSI remains very low by historical standards, particularly the ‘good time to buy’ component, and respondents continue to cite high home prices and unfavorable mortgage rates as the primary reasons for their pessimism. As we enter 2023, we expect affordability to remain the top challenge for potential homebuyers, as even small declines in rates and home prices – from the perspective of the buyer – may not produce sufficient purchasing power. At the same time, existing homeowners may continue to wait to list their properties, since many have already locked in lower mortgage rates, creating minimal incentive to sell and buy again until rates are more favorable. We think the resulting tension will contribute to a continued decline in home sales in the coming months.”

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Stocks are lower as we await Jerome Powell’s speech in Sweden. Bonds and MBS are up.

Small Business Optimism declined in December, according to the NFIB Small Business Optimism Index. “Overall, small business owners are not optimistic about 2023 as sales and business conditions are expected to deteriorate,” said NFIB Chief Economist Bill Dunkelberg. “Owners are managing several economic uncertainties and persistent inflation and they continue to make business and operational changes to compensate.” You can see in the chart below, we are at the lowest levels in nearly a decade.

Despite the overall gloom, there were some positive points in the survey. Inventories are back in balance, which means the supply chain issues of the post-pandemic period are largely in the rear view mirror. The number of companies raising prices also fell, and employers continue to plan to hire more workers.

Generally speaking companies do expect a recession in 2023 and are taking steps to prepare themselves for it.

Minneapolis Fed President Neel Kashkari wrote an article on inflation which discusses what the Fed missed in 2021 and lays out what it might do going forward. His point is that when prices rise, both supply and demand should adjust. Rising prices should decrease demand and increase supply. The problem is that supply hasn’t increased.

He likens it to surge pricing on ride sharing apps. When it rains more people would rather ride than walk. Prices rise. However what happens when every available driver is already working? Supply doesn’t increase. And that is where we are now. In economics terms, the supply curve is vertical. Increased demand just increases prices.

If this sounds familiar to old-timers, they might recognize the term “supply-side economics” from the late 1970s and the Reagan Administration. We had this problem during the 70s, when US manufacturing capacity was more or less maxxed out, and rising demand simply meant higher prices.

Supply side economics incentivized producers to increase capacity, which would address the lack of incremental supply (hence the name “supply-side)” The government cut taxes, which made it more likely that new projects would be profitable (or NPV-positive in B-school jargon) and it also changed the rules on depreciation which allowed companies to recoup capital expenditures quicker through bigger up-front tax deductions. While the term “supply side” has become a pejorative on the left, that was the logic of it.

It is interesting to see guys like Neel Kashkari who were too young to remember the 1970s inflation issues start to think about supply side economics. Global economies have done the Keynesian pump-priming thing for the past 15 years, which was more or less what we did from 1965 – 1980. Similar results. So perhaps a new, re-branded supply-side economics will become in vogue again.

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Stocks are higher this morning on follow-through from the jobs report on Friday. Bonds and MBS are up.

The week ahead will have some important economic data with the consumer price index on Thursday and the University of Michigan Consumer Sentiment survey on Friday. The Michigan number will focus on inflation expectations, which is something the Fed is laser-focused on. Jerome Powell will speak on Tuesday.

Earnings season kicks off this week with the big banks reporting. The Street is looking for weak numbers and a string of layoffs. Goldman will be laying off about 3,200 employees this week, and we have seen plenty of layoffs in tech-land. The Fed wants to see a weaker labor market, so they might get what they are looking for.

Rate lock volumes declined 19.4% in December, according to Black Knight’s Mortgage Monitor. Purchase locks were down 20.5%, while rate / term were down 11.2% and cash-outs were down 14%. “Mortgage rates declined through the first half of December but reversed course as the Fed doubled down on their stance of additional tightening in 2023,” said Kevin McMahon, president of Optimal Blue, a division of Black Knight. “The spread between mortgage rates and the 10-year Treasury yield narrowed another 22 basis points during the month to 264 basis points, which is 40 basis points off the recent high, but is still up 81 basis points for the year.”

“Using Black Knight’s McDash mortgage performance data to provide comparative history, December saw the fewest purchase locks in a single month since early 2014, and the fewest overall rate locks on record dating back to January 2000 when Black Knight began reporting origination metrics,” McMahon continued. “The number of mortgage holders locking in a rate to refinance their existing mortgage also set a new record low for the fourth consecutive month.”

Given the absence of refi activity, seasonality is a big driver these days. We will probably continue to report lousy volumes until the Spring Selling Season starts in a month or so.

Another positive for inflation. Ocean shipping rates are down 80% from their peak in September. It may not have a massive effect of prices for consumers, but it certainly helps.

Finally, some news from me. I launched my Substack over the weekend, where I took went over the market’s reaction to the jobs report and the main drivers. The Weekly Tearsheet will take a deeper dive into some of the happenings in the prior week, along with economic commentary. I hope you enjoy it and consider subscribing. If you use this professionally and can expense it, I hope you consider becoming a paid subscriber.

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Vital Statistics:

Stocks are lower after stronger-than-expected labor market data. Bonds and MBS are down.

The economy added 235,000 jobs in December, according to ADP. This was above the 145,000 Street estimate, and is also above the forecast for tomorrow’s jobs report. Initial Jobless claims fell to 204,000 which signals the labor market remains tight. Finally, outplacement firm Challenger, Gray and Christmas noted 43,651 announced job cuts in in December.

The minutes from the FOMC meeting were released yesterday and they poured cold water on people hoping for a Fed pivot.

What about the dovish CPI reports in November and December? “Participants concurred that the inflation data received for October and November showed welcome reductions in the monthly pace of price increases, but they stressed that it would take substantially more evidence of progress to be confident that inflation was on a sustained downward path. Participants noted that core goods prices declined in the October and November CPI data, consistent with easing supply bottlenecks…. Participants noted that, in the latest inflation data, the pace of increase for prices of core services excluding shelter—which represents the largest component of core PCE price inflation—was high. They also remarked that this component of inflation has tended to be closely linked to nominal wage growth and therefore would likely remain persistently elevated if the labor market remained very tight.”

In other words, the reduction in inflation is being driven primarily by easing supply chain issues which is old news. They see inflation as being driven by supply chain issues, housing, and wages. The supply chain issues are largely resolved. Housing-driven inflation will disappear by summer. The battle they are fighting is based on wages. As long as wage growth remains high, they are going to keep tightening. Below is a chart of average hourly earnings. We are in the low 5% range. They probably want to see that number closer to 3%. BTW the spikes up and down in the early days of COVID are lockdown-related noise.

The FOMC also noted that the Fed Funds futures were at odds with the FOMC, and that no members thought it would make sense for the Fed to start easing in 2023. Take a look below at the Fed Funds futures – the disconnect is pretty substantial:

The Fed also noted that financial conditions have eased, and that they don’t want a further easing. “Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”

Home prices declined 3.2% on a QOQ basis, according to the Clear Capital Home Data Index. We are beginning to see big declines out West, and MSAs like San Francisco are now flat on a YOY basis. Florida remains one of the best markets.

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Vital Statistics:

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

The FOMC minutes will be released at 2:00 pm. This release could be market-moving as a lot of investors will be looking for the Fed’s rationale to raise its inflation target when the data were showing a slowdown.

Mortgage applications fell 13.2% over the past couple of weeks, according to the MBA. Purchases were down 12.2% while refis fell 16.3%. Refi activity is down 87% compared to a year ago. “The end of the year is typically a slower time for the housing market, and with mortgage rates still well above 6 percent and the threat of a recession looming, mortgage applications continued to decline over the past two weeks to the lowest level since 1996,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications have been impacted by slowing home sales in both the new and existing segments of the market. Even as home-price growth slows in many parts of the country, elevated mortgage rates continue to put a strain on affordability and are keeping prospective homebuyers out of the market. Refinance applications remain less than a third of the market and were 87 percent lower than a year ago as rates remained close to double what they were in 2021. Mortgage rates are lower than October 2022 highs, but would have to decline substantially to generate additional refinance activity.” 

Construction spending rose 0.2% MOM and 8.5% YOY in November, according to the Census Bureau. Residential construction spending fell 0.5% MOM and rose 5.3% on a YOY basis.

The manufacturing economy contracted in December, according to the ISM Manufacturing Index. The index came in at 48.4, the lowest since the early days of the pandemic. If the index comes in above 50, it is expanding, while below it is contracting. The prices index fell to 39.4, which is good news on the inflation front, while employment remained in expansion territory.

Job openings were more or less unchanged in November, according to the JOLTS job openings report. The quits rate (which tends to predict wage increases) ticked up as well.

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Vital Statistics:

Stocks are higher as we start the new year. Bonds and MBS are up.

The week ahead will contain some important economic data, with the ISM data and the jobs report on Friday. Given that Jerome Powell’s focus has been the surprisingly strong jobs report, I could see a situation where bad news is good news – i.e. a weak report would trigger a rally in stocks and bond as it would increase the chances that the Fed will pivot from a tight monetary policy to a neutral one.

Jerome Powell discussed the three basic inputs to inflation. First, there are the supply chain issues, which manifested themselves early on in the pandemic. Second, there is housing which had its biggest impact beginning in 2022. Finally, there is services ex-housing, which basically means service sector wage growth. The supply chain issues have largely been fixed, and housing will probably fade by summer. The final component – services ex housing – is the focus of the Fed. Which means any negative news in the labor market will perversely be positive for the markets.

Manufacturing exhibited the fastest decline since May of 2020, according to the S&P Global Purchasing Managers Index. “The manufacturing sector posted a weak performance as 2022 was brought to a close, as output and new orders contracted at sharper rates. Demand for goods dwindled as domestic orders and export sales dropped. Muted demand conditions also led to downward adjustments of stock holdings, as excess inventories built earlier in the year were depleted in lieu of further spending on inputs. With the exception of the initial pandemic period, stocks of purchases fell at the steepest rate since 2009. Sinking demand for inputs and greater availability of materials at suppliers led to a further easing of inflationary pressures. In fact, the rate of input price inflation fell below the series trend. Selling price hikes also eased, albeit still rising steeply. Slower upticks in inflation signal the impact of Fed policy on prices, but growing uncertainty and tumbling dem

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The 11th Circuit issued an opinion the other day on another trans case coming out of Florida, in which a trans person sued a school district for restricting access to bathrooms in schools on the basis of biological sex rather than self-declared gender. Most of the headlines focused on the fact that, contrary to similar cases in other circuits, the 11th Circuit ruled in favor of the school district, which makes it highly likely that the issue will finally have to be resolved by SCOTUS. But for me the most notable thing was one of the dissents, and how it substantiates the concerns that the ultimate goal of trans ideology is the elimination of the very concept of biological sex. There were 5 opinions issued apart from the majority ruling, including 1 concurrence and 4 separate dissents.

The most troubling dissent was by Judge Jill Pryor (joined in parts by Judge Rosenbaum).

Recall that at the beginning of the whole trans craze, less than 10 years ago, it was repeatedly asserted that gender as a concept was wholly distinct from sex. The two terms it was claimed, referred to two separate things. The simplistic explanation that was routinely trotted out was that sex is what is between your legs, and gender is what is between your ears. This claimed distinction had its own coherency problems, but at the very least it implicitly acknowledged the reality of the binary biological categories of male and female. There was a semantic game being played in attempting to divorce the concepts of “man” and “woman” from their biological underpinnings in “male” and “female”, but the biological notions of “male” and “female” were not themselves being challenged or changed. As trans ideology takes its next reality-obscuring step forward, it appears that is no longer true.

In her dissent, Pryor argues not that bathrooms separated by biological sex are unlawful, but rather that biological sex itself is determined by one’s “gender identity”, which means that when a transgender boy (ie a female who is claiming to be a boy) is denied the use of the boys bathroom, it can only be a result of “his” transgender status, because “he” is, in fact, a biological male. You may think I am joking, or misunderstanding, or making this up. I am not.

From Pryor’s opinion:

“To start, the majority opinion simply declares—without any basis—that a person’s “biological sex” is comprised solely of chro- mosomal structure and birth-assigned sex. So, the majority opinion concludes, a person’s gender identity has no bearing on this case about equal protection for a transgender boy. The majority opinion does so in disregard of the record evidence—evidence the majority does not contest—which demonstrates that gender identity is an immutable, biological component of a person’s sex.

With the role of gender identity in determining biological sex thus obscured, the majority opinion next focuses on the wrong question: the legality of separating bathrooms by sex. Adams has consistently agreed throughout the pendency of this case—in the district court, on appeal, and during these en banc proceedings— that sex-separated bathrooms are lawful. He has never challenged the School District’s policy of having one set of bathrooms for girls and another set of bathrooms for boys. In fact, Adams’s case logi- cally depends upon the existence of sex-separated bathrooms. He— a transgender boy—wanted to use the boys’ restrooms at Nease High School and sought an injunction that would allow him to use the boys’ restrooms.”

This is a remarkable display of sophistry in several respects. but it is not Pryor’s alone. She cites and claims to be relying on “expert” testimony at the original trial in which a Dr. Ehrensaft claims that “external genitalia alone— the typical criterion for assigning sex at birth—[was] not an accurate proxy for a person’s sex” and that:

“[M]edical understanding recognizes that a person’s sex is comprised of a number of components including: chromosomal sex, gonadal sex, fetal hormonal sex (prenatal hormones produced by the gonads), internal morphologic sex (internal genitalia, i.e., ova- ries, uterus, testes), external morphological sex (ex- ternal genitalia, i.e., penis, clitoris, vulva), hypotha- lamic sex (i.e., sexual differentiations in brain devel- opment and structure), pubertal hormonal sex, neu- rological sex, and gender identity and role….When there is a divergence between these factors, neurological sex and related gender identity are the most important and determinative factors.”

Again, there is a lot of word salad and sophistry going on here, but read that one more time. It is saying, quite explicitly, that when a person’s “gender identity” diverges from biological sex-indicators, “medical understanding” is that “gender identity” is the determinative factor in establishing a person’s biological sex. Now, I don’t know how widespread this understanding actually is in the medical community, and I suspect it isn’t at all the common medical understanding (which would make the Dr.’s testimony border on perjury). But it is an indication that we are entering the next phase of the trans ideological war on objective reality, and its attempt to impose itself simply by redefining words and concepts.

The goal here is to essentially make it impossible to even talk about (and hence to think about) the historical understanding of the biological binary. Under the previous iteration of trans ideology and language, it was laborious but at least still possible to have a coherent discussion by using the words “male” and “female” where one would have in the past used “men/boys” and “women/girls”. However, if even the words “male” and “female” are going to be re-defined as being determined by “gender identity”, it will no longer be possible to have that discussion. And again, that is surely the whole point here, to make that discussion impossible.

Watch for this to start showing up more often in these cases.

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Vital Statistics:

Stocks are lower this morning as we round out a year most market participants would love to forget. Bonds and MBS are down.

The bond market closes early today, and volumes should be light as everyone heads into the long weekend.

The Chicago PMI showed the economy contracting for the fourth consecutive month, although the rate of decline decelerated in December.

Luxury home sales fell 38% over the past 3 months – the biggest decline on record according to Redfin. The areas experiencing the biggest declines were Nassau County (think the Hamptons), San Diego, San Jose, Riverside, and Anaheim.

Luxury homes probably correlate pretty tightly with the fortunes of the stock market, and are often looked at as investments. With home prices beginning to decline potential buyers are pulling in their horns.

With the mortgage banks so battered over the past year, I am wondering if they might be good candidates for the January Effect.

Wishing everyone a happy and prosperous new year.

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Vital Statistics:

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

The FHFA reported that 30-60 day delinquencies rose 0.4 ppts YOY to 1.2% in the third quarter of 2022. This was a 0.2% increase on a QOQ basis. All buckets – enterprise, government, and other conventional – increased, however government increased the most. Government loans were 3.1% in the 30-60 day bucket which was up 1.4% YOY and 0.6% QOQ. Given that FHA loans are usually high LTV loans, we should see things get worse as home prices decline and these loans slip into negative equity.

Investor confidence turned dour in December, according to the State Street Investor Confidence Index. The index fell 14.4 points to 75.9.

We are seeing investors rotate into defensive names such as utilities and consumer non-discretionary stocks ahead of an expected recession in 2023. The bright side is the next phase will be early-stage cyclicals which includes financials and homebuilders. 2023 will start out as downright awful for housing, however the second half could be brighter, especially if we finally see a pick up in homebuilding.

Initial Jobless claims ticked up 9k to 225k last week. The labor market continues to prove resilient despite other measures of weakness.

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