All Things in Moderation

Vital Statistics:

Stocks are lower this morning as energy prices continue to rise. The bond market is closed for the Columbus Day holiday.

The upcoming week is relatively data-light, which is typical for the week after the jobs report. We will get inflation data as well as retail sales. The minutes from the September FOMC meeting will be released on Wednesday.

Goldman Sachs cut its US growth forecasts as consumer spending slips. They took down 2021 estimates rom 5.7% to 5.6% and 2022 estimates from 4.4% to 4%. “After updating our estimates of the key growth impulses that drive our consumption forecast—reopening, fiscal stimulus, pent-up savings, and wealth effects—and incorporating a longer-lasting virus drag on virus-sensitive consumer services spending, we now expect a more delayed recovery in consumer spending,” the economists said.  

Semiconductor shortages are forecasted to last until the second half of next year. Ultimately they believe that slowing of fiscal support will be a drag. Again, the Federal Government has spent an extraordinary amount of money over the past year and a half, and even if it falls government spending is still highly stimulative. Again I think we are at the “pushing on a string” point of fiscal stimulus.

The wheels are coming off the Chinese real estate bubble. Evergrande is the face of the bust, but we are seeing additional companies miss debt payments. The canary in the coal mine – the corporate bond market – however is flashing warning signs. The ICE / Bank of America index of Chinese developer corporate bonds shows 24 of 59 companies trading with yields over 20%, which are distressed levels. If 40% of the industry is trading at distressed levels then it looks like the bust is here and it will be almost impossible to reverse.

Japanese bank Nomura estimates that there is $5 trillion in debt that has been raised by developers over the past 5 years. To put that number in perspective, it is about the size of Japan’s GDP, the third largest economy in the world. China has a tight grip on the financial system and it will be a fascinating to watch how they manage it. As I said before I expect them to follow the Japanese model and to prevent any major defaults. The weaker companies will be bought by the stronger companies, and the economy will enter a long recession as the bad debt accumulated during the bubble years gets worked off.

The bust will send another global deflationary wave which will pull interest rates lower and commodity prices lower. The US will probably be able to get away with profligate spending and super-low interest rates for a while longer. The problem is what happens during the next recession. Interest rates are already at the floor, and fiscal stimulus has reached the point of diminishing returns. So during the next recession, the 10 year yield probably hits zero.

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Vital Statistics:

Stocks are higher this morning despite a sizeable miss in the employment report. Bonds and MBS are down small.

The economy added 194,000 jobs in September, which was a sizeable miss compared to the 475,000 street estimate. It was also well below the ADP number of 568,000. Most of the jobs growth occurred in retail, fulfillment and transportation. Leisure and hospitality also rose. Health care employment fell.

The unemployment rate fell to 4.8% which was a positive, however it was driven more by people exiting the labor force than it was by jobs growth. The number of people not in the labor force increased by 338,000. The labor force participation rate slipped 10 basis points to 61.6%, which is still about 1.7 percentage points below pre-COVID levels.

Average hourly earnings increased 0.6% MOM and 4.6% YOY and average weekly hours ticked up.

Overall, this report is a mixed bag. Economic bulls will point to the wage increases and falling unemployment rate, while economic bears will point to the anemic job growth and falling labor participation rate.

Ultimately this report probably won’t have an impact on the Fed’s tapering decision this year. The Fed is banking on supply chain disruptions working themselves out which means they won’t have aggressively tighten. While the economy was more or less picture-perfect heading into COVID, that was almost two years ago, so those conditions are becoming less and less relevant.

Shortages are more and more evident whether one goes to a Kroger or Home Depot. Anyone who has gone to a restaurant and waited 10 minutes for someone to notice sees the staffing shortage. These shortages are going to impact GDP growth at some point. This is going to present a conundrum for the Fed. A weakening economy should be flashing warning signs to go slow. That said, the dual mandate gives them two navigation stars: unemployment and inflation. And if you look at this mediocre jobs report, both indicators are flashing “tighten.” It will be interesting to see how they thread the needle going forward.

Jerome Powell’s term is up in 4 months, and since Trump nominated him in the first place, he is probably gone. Given the Administrations capitulation to its party’s backbenchers, I expect to see someone more dovish (and more hostile to the banks) to take the reins. I would imagine the Fed of 2022 will be a lot more dovish than the Fed of 2021. This would set up a repeat of That 70s Show, as supply bottlenecks and dovish monetary policy conspire to create the mood and economy of malaise.

The parallels are there: the huge expansion of government over the past 2 years is similar to LBJ’s Great Society expansion, especially if Democrats manage to pass their $3.5 trillion spending bill. The economic shock of COVID, with its concomitant supply shocks resemble the Arab Oil Embargoes of the early 70s. Finally, the lack of productivity increases are similar as well. We seem to be getting to the “pushing on a string” point of fiscal and monetary stimulus as well.

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Vital Statistics:

Stocks are higher this morning after yesterday’s rebound rally. Bonds and MBS are down.

It looks like we have a deal on the debt ceiling to move the deadline to December. “Two months seems like plenty of time and (we) think the debt ceiling would be raised through reconciliation by then and do not expect to experience the past week come December,” NatWest analysts wrote in a research note on Wednesday.

I don’t think the markets ever really thought the US would default on its debt – this is something more like theater for the DC crowd. I think the issue here is that the reconciliation process can only be used a limited number of times, and if Democrats punch their reconciliation ticket on the debt ceiling, they won’t have one for their $3.5 trillion spending plan. Mitch McConnell also knows that the closer we get to the 2022 elections the harder it will be to pass major legislation.

There were 17,895 job cuts in September, according to outplacement firm Challenger, Gray and Christmas. For the third quarter, there were 52.560 cuts, which was the lowest number since 1997.

“Companies are in hiring and retention mode, and job seekers have a lot of power to make demands at the moment,” said Andrew Challenger, Senior Vice President of Challenger, Gray & Christmas, Inc. “We know there are millions of open positions, but many employers are having trouble keeping up with their applicants, taking too long to reach out, not making offers fast enough, or losing out to more attractive offers,” he added.

Health care is experiencing an acute shortage as employees are burned out from the never-ending workload. Hiring is increasing as the big retailers staff up for seasonal demand.

Separately, initial jobless claims fell to 326,000 last week. Below is a chart of the last year’s initial claims. While we have made some big improvements, initial claims are still 50% higher than they were pre-COVID

High home prices are weighing on homebuyer sentiment, according to the Fannie Mae Homebuyer Sentiment Index. The most notable statistic was the percentage of people who thought it was a good time to buy, which fell from 32% to 28%. The percentage of those who thought it was a bad time to buy increased from 63% to 66%. Respondents are also getting less bullish on housing prices going forward, however they are quite sanguine about their job prospects, with 82% saying they are not concerned about losing their job.

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Vital Statistics:

Stocks are lower this morning on overseas weakness. Bonds and MBS are down small.

The private sector added 568,000 jobs in September, according to the ADP Jobs Report. This was well above the Street estimate of 428k. The Street is looking for 475k jobs in Friday’s jobs report.

“The labor market recovery continues to make progress despite a marked slowdown from the 748,000 job pace in the second quarter,” said Nela Richardson, chief economist, ADP. “Leisure and hospitality remains one of the biggest beneficiaries to the recovery, yet hiring is still heavily impacted by the
trajectory of the pandemic, especially for small firms. Current bottlenecks in hiring should fade as the health conditions tied to the COVID-19 variant continue to improve, setting the stage for solid job gains in the coming months.”

Mortgage Applications decreased 6.9% last week, according to the MBA. Purchases decreased 2% and refis fell 10%. “Mortgage applications to refinance dropped almost 10 percent last week to the lowest level in three months, as the 30-year fixed rate increased to 3.14 percent – the highest since July. Higher rates are reducing borrowers’ incentive to refinance, as declines were seen across all loan types,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity also fell, driven by a drop in conventional loan applications. Government purchase applications were up over 1 percent, but that was still not enough to bring down the average loan balance of $410,000. With home-price appreciation and sales prices remaining very elevated, applications for higher balance, conventional loans still dominate the mix of activity.”  

Chicago Fed President Charles Evans sees the current level of inflation as transitory that will abate as supply chain bottlenecks get worked out. “I’m comfortable in thinking that these are elevated prices, that they will be coming down as supply bottlenecks are addressed,” he told CNBC’s Steve Liesman during a “Squawk Box” interview. “I think it could be longer than we were expecting, absolutely, there’s no doubt about it. But I think the continuing increase in these prices is unlikely.” His point is that the current level of inflation is not a monetary policy issue – it is a supply infrastructure problem.

Fed Chief Jerome Powell has about 4 months left in his term, and Biden has yet to publicly support him for another term. The left is lining up against him however: Powell “poses a danger to our economy and that’s why I oppose him for renomination,” Senator Elizabeth Warren told CNBC on Tuesday, citing what she sees as his overly lax approach to bank oversight as well as his handling of possible investment trading improprieties by fellow Fed policymakers.

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

Home prices rose 18% in August, according to CoreLogic. Frank Martell, CEO of CoreLogic said: “Home prices continue to escalate at a torrid pace as a broad spectrum of buyers drive demand for a limited supply of homes. We expect to see the trend of strong price gains continue indefinitely with large amounts of capital chasing too few assets.” Some of the states experiencing high appreciation include Idaho (up 32%), Arizona (up 30%), and Utah (up 24%). New York and North Dakota increased less than 5%. CoreLogic sees home price appreciation pretty much ending here, with only a 2.2% increase over the next year.

The number of loans in forbearance fell to 2.89% of servicers’ portfolios last week. “Exits increased and new requests and re-entries declined,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “While 1.4 million homeowners remained in forbearance as of September 26, this number is expected to drop sharply over the next few weeks as many are reaching the 18-month expiration point of their forbearance terms. Most borrowers exiting forbearance through a workout are opting for a deferral plan, which allows them to resume their original payment, while moving the forborne amount to the end of the loan.”

The ISM Services index rose 0.2% in September to 61.9%. “According to the Services PMI^®, 17 services industries reported growth. The composite index indicated growth for the 16th consecutive month after a two-month contraction in April and May 2020. The slight uptick in the rate of expansion in the month of September continued the current period of strong growth for the services sector. However, ongoing challenges with labor resources, logistics, and materials are affecting the continuity of supply.”

The overall theme of the report is that demand is strong, however persistent supply shortages and a lack of workers continue to be a headwind for the economy. Here are some comments from respondents:

We continue to deal with extended delivery lead times and high costs. Stress on the supply chain beginning to be reflected in the quality of products offered and delivered. Current buying strategy is to wait — except with equipment, as (price) increases are expected.” [Utilities]

Continued constrained supply of many key product groups. Also, inflationary pressures in most areas of the business keep driving costs higher. Inconsistent COVID-19 restrictions throughout the country are creating unstable business conditions that are concerning. However, business continues to be strong overall.” [Wholesale Trade]

“Retaining clinical and temporary staffing is critical at this time. With the Delta variant’s spread, we continue to see increased (COVID-19) cases, but not as bad as January 2021. Vaccinations are clearly working. Most inpatient hospitalizations are of unvaccinated patients. The supply chain is still being impacted significantly by increased lead times for equipment and supplies.” [Health Care & Social Assistance]

The Evergrande situation in China continues to snowball. The troubled real estate developer is looking to do a $5 billion property sale, which is a drop in the bucket compared to the $300 billion it owes. Fantasia Holdings, another Chinese developer just missed a bond payment as well.

If the Chinese real estate bubble is indeed finally bursting, this will be a worldwide drag on asset prices and interest rates.

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Vital Statistics:

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

The upcoming week will be dominated by the jobs report on Friday. We will also get the ISM Services Index and some Fed-Speak.

The Street is looking for 475,000 jobs to have been created in September, and for the unemployment rate to fall to 5.1%. The labor force participation rate is expected to be flat at 61.7%, and wage inflation is expected to rise to 4.6%.

Factory Orders rose 1.2% last month. Demand remains strong, however supply is the problem.

New CFPB Chairman Rohit Chopra is expected to run the agency in the mold of Richard Cordray, going after the biggest players.

President Joe Biden nominated Chopra in January. But his March confirmation hearing ended in a tie, which forced the nomination to be brought to the full Senate, after he told the Senate Banking Committee that the CFPB should examine “looming problems when it comes to forbearances.”

“I don’t want to see another foreclosure crisis in this country,” Chopra told the committee. “And we need to do everything we can to make sure the laws are being followed and homeowners can navigate their options.”

“In the mortgage market, fair and effective oversight can promote a resilient and competitive financial sector, and address the systemic inequities faced by families of color,” Chopra said in his opening statement. “Perhaps most importantly, administration of consumer protection laws can help families navigate their options to save their homes.”

The other thing that Chopra will bring back is rulemaking by enforcement, whish is analogous to driving down a highway with no speed limit signs. The only way to discover the speed limit is to get a ticket.

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Vital Statistics:

Stocks are lower as we head into the final stretch for 2021. Bonds and MBS are up.

Personal incomes rose 0.2% MOM in August, which was below expectations. Personal Consumption Expenditures rose 0.8%, which was above expectations. The PCE Price Index (the Fed’s preferred measure of inflation) rose 0.4% MOM and 4.3% YOY. The core PCE Index (which excludes volatile commodity components) rose 0.3% MOM and 3.6% YOY. Inflation is running above the Fed’s target rate of 2%, however they intend to let it run hot for a while in order to bring up the historical average to 2%.

Inflation is rising globally. Eurozone inflation is the highest in 13 years, and German price increases are the highest in 30 years. Blame energy prices. European benchmark yields (Bunds, etc) are up big over the past week or so, which will push up US yields at the margin.

Asking prices increased 12% last month according to Redfin. Prices rose to a record of $361,250. “Home sellers continue to show their optimism with increasing asking prices,” said Redfin Chief Economist Daryl Fairweather. “However, there are already signals from the Fed and markets that mortgage rates are starting to creep up. The hit to affordability that comes with higher rates and higher home prices could let some steam out of the market. It’s never a good idea to overprice your home, but I would be especially wary of overpricing as seasonal cooling trends persist and rising rates take some affordability out of the homebuying equation.”

The ISM Manufacturing index rose to a strong reading of 61.1 in September, driven by higher prices. “Business Survey Committee panelists reported that their companies and suppliers continue to deal with an unprecedented number of hurdles to meet increasing demand. All segments of the manufacturing economy are impacted by record-long raw materials lead times, continued shortages of critical materials, rising commodities prices and difficulties in transporting products. Global pandemic-related issues — worker absenteeism, short-term shutdowns due to parts shortages, difficulties in filling open positions and overseas supply chain problems — continue to limit manufacturing growth potential. However, optimistic panel sentiment remains strong, with three positive growth comments for every cautious comment.”

Construction spending was flat MOM in August, but rose 8.9% YOY, according to Census. Residential construction rose 0.4% MOM and 23.9% YOY. Pandemic-related issues are exaggerating the YOY growth numbers.

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Vital Statistics:

Stocks are higher this morning as we round out the third quarter. Bonds and MBS are down.

The government looks like it will do a temporary move to avoid a shutdown, however the potential for a shutdown remains until the debt ceiling is raised. Generally speaking these sorts of things are nothing more than political theater. That said, we have had temporary shutdowns in the past and it was hard to get 4506-Ts out of the IRS. Plan accordingly.

Pending Home Sales rose 8.1% in August, according to NAR. “Rising inventory and moderating price conditions are bringing buyers back to the market,” said Lawrence Yun, NAR’s chief economist. “Affordability, however, remains challenging as home price gains are roughly three times wage growth. The more moderately priced regions of the South and Midwest are experiencing stronger signing of contracts to buy, which is not surprising,” Yun continued. “This can be attributed to some employees who have the flexibility to work from anywhere, as they choose to reside in more affordable places.”

I suspect the theme of the real estate market going forward will be the flow of people to areas that have become too cheap to ignore.

Initial Jobless Claims rose to 361,000 last week. The continuing high unemployment claims remain a mystery given the plethora of job openings out there.

The final revision to second quarter GDP was inched up to 6.7%, as consumption rose a hair. Estimates for third quarter GDP have been decreasing. The current Atlanta Fed GDP Now estimate is sitting at 3.2%. The much-ballyhooed 2H acceleration doesn’t seem to be playing out.

Jerome Powell addressed the inflation situation yesterday. “It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse,” he added. “We see that continuing into next year probably, and holding up inflation longer than we had thought.”

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Vital Statistics:

Stocks are lower this morning as investors fret about energy costs. Bonds and MBS are down.

Loans in forbearance fell under 3% last week, according to the MBA. They estimate that 1.5 million borrowers are still in forbearance. Fannie and Freddie loans decreased by 3%, while Ginnies rose.

Home prices rose 19.2% YOY in July, according to the FHFA House Price Index. “Record appreciation rates for the U.S. continued in July,” said Dr. Lynn Fisher, FHFA’s Deputy Director of the Division of Research and Statistics. “Although the monthly pace of increase slowed in most Census Divisions in July, four areas experienced year over year growth rates in excess of 20 percent and all saw annual gains in excess of 15 percent.”

With 19% appreciation, we could be looking at new conforming limits for 1 unit properties in the mid 600k next year.

Separately, the Case-Shiller Index rose close to 20%. Get a load of these numbers: Phoenix up 32%. San Diego up 28%. S&P thinks that this could simply be a case of current transactions “borrowing” from future transactions, which would imply a pricing slowdown going forward.

“We have previously suggested that the strength in the U.S. housing market is being driven in part by a reaction to the COVID pandemic, as potential buyers move from urban apartments to suburban homes. July’s data are consistent with this hypothesis. This demand surge may simply represent an acceleration of purchases that would have occurred anyway over the next several years. Alternatively, there may have been a secular change in locational preferences, leading to a permanent shift in the demand curve for housing. More time and data will be required to analyze this question.”

I wonder how much the Evergrande situation in China (and its bursting real estate bubble) will have fallout for the big West Coast cities like Vancouver and San Francisco. When you have this sort of financial crisis, you never sell what you want to, you sell what you can.

Lael Brainard discussed the economy and the Fed’s thinking. I have to say this statement puzzled me: “Many forecasters have downgraded consumer spending in the second half of the year, as Delta has limited the acceleration in services spending that had been anticipated to help offset the drag on activity from fiscal support shifting from being a tailwind to a headwind.” Congress is working on a $3.5 trillion spending package. I know a trillion doesn’t mean what it used to, but characterizing that as a “headwind” seems odd.

That said, I can see where this is going. I expect the chattering classes will soon exhume the term “austerity” which is about the most loaded economic term out there. “Austerity” officially means a decline in stimulus, however it is often conflated with contractionary fiscal policy. If the US runs a $1 trillion deficit and the deficit narrows to $900 billion in the following year, that is officially “austerity.” That doesn’t mean the government is tightening. It doesn’t mean the government is trying to slow the economy. Deficit spending is still highly stimulative to the economy and is still a “tailwind.” Austerity is Newspeak for “the government isn’t spending enough on my priorities.”

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