All Things in Moderation

Vital Statistics:

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

Janet Yellen discussed the strong economy on Sunday, and again hinted that we will see another rate hike in December. The hurricanes will probably depress growth slightly, but the economy should rebound by year’s end. The consumer is still pretty strong, according to Friday’s retail sales report. Persistently slow inflation has been a surprise, however.

Manufacturing was strong in the NY area according to the Empire State Manufacturing Survey. The index came in at 30, which is the highest reading in 3 years. An increase in shipments and hiring drove the increase, which is one data point that shows the increase in sentiment indicators is actually translating into more business.

Boston Fed President Eric Rosengren thinks we might see 3-4 rate hikes in 2018. This assumes that employment continues to rise and inflation begins to pick up. Friday’s consumer price index report was weak, however with core inflation rising 0.1% MOM and 1.7% YOY, below the Fed’s 2% inflation target.

This week is the 30 year anniversary of the Crash of 87, and given the run up in the market, people are looking for another one. A lot will depend on earnings season, which is just starting. Given that the market is now dominated by high frequency traders that basically turn off their machines once volatility spikes you could see selling into a vacuum. Cheap commissions and sub-penny bid/ask spreads have pretty much eliminated the market-makers and the NYSE specialist from the game.

Average home sizes are falling in the US after rising for pretty much 3 decades. The average square footage decreased to 2420 square feet from the record of 2520 set in 2015. The Baby Boomer McMansion trend has run its course and builders are beginning to focus on starter homes in order to attract the Millennials.

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Vital Statistics:

Stocks are flat this morning after the FOMC meeting yesterday. Bonds and MBS are up small.

The Fed raised the Fed Funds rate a quarter of a point yesterday as expected, but the dot plot was what garnered all the attention. At the September meeting, the FOMC members were forecasting two more rate hikes in 2017, and now they are forecasting 3. That hit bonds, which sent the 2 year note yield up 12 basis points and the 10 year up 13 basis points. Overall, the language of the statement didn’t change much, and neither did the economic forecasts. Aside from a small uptick in their forecast for 2017 GDP growth, most everything else was the same. You can see the change in the central tendency for 2017 in the comparison of the dot plots below. September’s plot is on the right, and December is on the left. The yellow line represents the central tendency.

Due to the volatility, most lenders shut down their lock desks, so mortgage rates didn’t really move all that much, but expect to see at least some movement, although mortgage rates tend to lag the moves in the 10 year, sometimes quite substantially. The last few tightening cycles have seen a flattening of the yield curve, so an anticipated increase of 75 basis points in the Fed funds rate doesn’t necessarily translate into a 75 basis point increase in the 10 year. Mortgage rates will almost undoubtedly increase by less than the increase in the 10 year. And if rates are going up for the right reasons (economic growth) that means the purchase business should offset some of the losses of the refi business.

Janet Yellen’s press conference was largely a non-event. She spent it dodging questions about how Donald Trump looks at the world and stressed the Fed will remain data-dependent. The issue of productivity kept coming up, and how Trump will use policies to improve on it (via regulatory reform and corporate tax cutting). Productivity growth should translate into non-inflationary wage growth, which is what everyone is hoping for.

Bottom line: The Fed is going to fade into the background again, and Donald Trump will be driving the news cycle and bond yields. If Congress adds fiscal stimulus, the Fed will probably be more aggressive. Note the dot plot is only a forecast. In fact, many of those dots represent forecasts for people who are not voting members on the FOMC. The Fed might hike 3 times in 2017, but the 10 year yield probably won’t go up as much, and mortgage rates will go up even less. 

Technical analysts are calling for the end of the secular bond bull market which began about 25 years ago.

Inflation at the consumer level increased 0.2% last month, and is up 1.7% YOY. The core rate (excluding food and energy) is up 0.2% MOM and 2.1% YOY. Healthcare and rent drove the increase.

We have some manufacturing data as well: Industrial production fell 0.4% MOM and manufacturing production fell 0.1%. Capacity Utilization was flat at 75%. The Philly Fed manufacturing index jumped to 22 from 10 and the Empire State Manufacturing Index improved to 9 from 6. Finally business inventories fell 0.2%.

Initial Jobless Claims fell 4k last week to 254,000. These are the lowest levels since the early 70s.

The median house price rose almost 8% in November, according to RedFin. According to their numbers, the median house price is 274k and months of inventory is 3.4 (meaning they see the inventory situation much tighter than NAR does in their existing home sales report).

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Vital Statistics:

Stocks are mixed this morning after the Fed maintained interest rates. Bonds and MBS are down.

The Fed maintained interest rates at current levels yesterday. The meat of the statement: The labor market continues to strengthen, household spending is improving while business spending remains a weak spot. Inflation is ticking up but remains below the target rate. Esther George and Loretta Mester dissented, wanting to hike at this meeting. Bonds rallied maybe a basis point on the statement.

This morning the Bank of England said that it doesn’t plan on cutting interest rates this year, which is causing a global sell-off in sovereign debt.

Announced job cuts fell 31% to 30,740 according to outplacement firm Challenger Gray and Christmas. This report looks at press announcements of job cuts, which may or may not ever materialize. Regardless, it does make the case that companies are holding onto their workers. In fact, this was the lowest October since 1999. Job cuts were most in the computer industry (largely related to HP), while cuts in the energy patch are slowing down considerably from earlier this year.

Initial Jobless Claims ticked up to 265k last week, which is still an extraordinarily low number. Separately, the Bloomberg Consumer Comfort Index ticked up.

The ISM Non-Manufacturing Index dropped to 54.8 from 57.1 in September. This means the service economy is growing, however growth is decelerating. Transportation and Construction is leading the charge, while mining and educational services are lagging.

Productivity broke out of its long slump with a 3.1% increase in the third quarter. Output increased 3.4% and unit labor costs increased 0.3%. Increasing productivity is good news as it means wages can increase without generating inflationary pressures. Productivity has been disappointing ever since the economy bottomed, however.

Both Republicans and Democrats look back wistfully on the 50s and the 60s. These years were an economic glory time, where unemployment was extraordinarily low, jobs were plentiful and high paying, and a single income was sufficient to support a family. The Third Quarter of the 20th Century basically began with the end of the Korean War and concluded with the oil shocks of the early 70s. Both parties want to bring back those times. Is that realistic? Probably not. The postwar decades were an extraordinary period where the US had no international competition, and not only had to satisfy its own demand, it had to satisfy the demand of Europe and Asia. The US earned what economists call “economic rents” and they were split between organized labor and government. By the late 70s, Europe was back on its feet and both old and new competitors were emerging from Asia. These economic rents were competed away (as they inevitably are). While this was good news for consumers and stockholders, it was bad news for union workers in general. Anyone who wants to bring back the salad days of the 50s and 60s needs to come up with a plan to get Angela Merkel to invade Poland. Donald Trump’s vision of pre-free trade America won’t get you there. Neither will the left’s vision of an “smart” paternalistic regulatory state and 90%+ marginal tax rates.

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Vital Statistics:

Stocks are down again after getting roughed up yesterday. Bonds and MBS are down as well.

Mortgage applications fell 6% last week as purchases fell 3% and refis fell 8%.

Job openings decreased by 400k to 5.4 million in August, according to the BLS. The quits rate (which is probably the best indicator for strength in the labor market) was steady at 2.1%. I wonder if we are seeing employers begin to hire the long-term unemployed, which would account for the drop in openings and the flat quits rate. The labor force participation rate is beginning to pick itself off the floor, as we saw in the latest jobs data.

We will get the FOMC minutes from the September meeting at 2:00 pm EST today. Be aware of possible market movement around then, especially if the minutes turn out to be a bit more dovish than expected. On Sunday, Fed Vice Chairman Stanley Fischer said that September’s decision to wait on hiking rates was a “close call.” The minutes will hopefully shed further light on that statement.

The biggest problem with QE is what to do with all of these assets that now sit on the Fed’s balance sheet. The Fed can’t sell the Treasuries it bought without withdrawing liquidity from the system. That would be contractionary, and the economy (or at least the financial system) might be too fragile to handle it. That would be the case even if the Fed just lets it run off by not re-investing maturing proceeds. There is now a school of thought that the Fed’s balance sheet should simply remain the size it is now, and we shouldn’t return to pre-bubble levels. The thinking is that governments should simply consolidate the Fed’s assets onto its own balance sheet. (called “permanent monetization”) Given that central banks are ultimately owned by the government, its Treasuries would effectively “cancel out” the debt issued by the government. This is why looking at the debt to GDP ratio is somewhat misleading: about a quarter of our debt is owned by the central bank. It is like taking out a loan and leaving the money in your savings account. In nominal terms, your debt is up, but your net worth is unchanged. One thing is for sure: none of this is in the econ textbooks. We are all making it up as we go along.

A Federal Appeals court ruled yesterday that the CFPB’s structure is unconstitutional. The director of the CFPB is appointed for a 5 year term, and can only be fired for cause by the President. The court found that this structure puts too much power in the hands of one person, and is more or less unaccountable. Rob Chrisman takes a look at what is going on.

A study from the Urban Institute forecasts that the homeownership rate will continue to decline. The question ultimately rests on whether the Millennials are going to follow a different path than previous generations, or are they simply late bloomers who will eventually marry, have kids, and want a place in the suburbs. Note that the homeownership rate started going vertical in 1994, with the Clinton Administration’s policies to encourage homeownership, as a tool for social engineering. Post-crisis, the rates has returned to its previously undisturbed rate.

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Vital Statistics:

Markets are higher after the Fed maintained interest rates yesterday. Bonds and MBS are up.

The Fed kept interest rates unchanged yesterday, and released new economic projections. Most members expect the Fed to hike another 25 basis points this year according to the dot plot. They tweaked their economic projections slightly, taking down their GDP forecast for 2016 and inching up their unemployment forecast. Longer term projections were unchanged. Three members dissented, wanting to hike rates in September.

In her press conference, Janet Yellen was careful to say the Fed was confident in the economy: “Our decision does not reflect a lack of confidence in the economy, Conditions in the labor market have strengthened and we expect that to continue, and while inflation remains low we expect it to rise to our 2 percent objective over time.” She also guided that the default path was for one more rate hike this year, assuming no major changes in the economy: “I would expect to see (a rate increase this year) if we continue on the current course of labor market improvement, and there are no major risks that develop and we stay on the current course.”

Bonds rallied on the Fed’s announcement, and that is carrying over this morning as markets rally worldwide.

FWIW, Bill Gross isn’t buying that the Fed is “data dependent.” He thinks they are “market dependent.”

In other economic news this morning, initial Jobless Claims fell to 252k last week.

The Chicago Fed National Activity Index fell to -.55 last month, which confirms the slowdown we have seen in other indicators. The 3 month moving average is slightly negative, which means the economy is growing, albeit below trend.

Delinquencies and foreclosures continued to fall in August, according to Black Knight Financial Services. The rally in bonds from Brexit caused prepayments to spike, with prepayment speeds hitting a 3 year high. 4.24% of all homes are delinquent and just over 1% are in foreclosure.

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Vital Statistics:

Markets are in a holding pattern ahead of Janet Yellen’s speech in Jackson Hole today. Bonds and MBS are flat

Janet Yellen will give a speech today at 10:00 am, discussing the tools in the Fed’s monetary policy toolkit. Speeches at Jackson Hole are generally not market-moving, however the markets have been adjusting ahead of this one. Expect to hear Yellen push for fiscal policy to improve the economy.

The markets are now assigning a 33% chance of a rate hike in September. Somewhat hawkish Fed-speak out of different Fed heads largely accounts for the increase. The Fed Funds futures markets are also assigning a 58% chance of a hike through December.

GDP came in at 1.1% in the second quarter, which was a downward revision from the first estimate of 1.2%. The price index was up 2.3% on a year-over-year basis, which was a little hotter than expected.

Corporate profits fell 2.2% in the second quarter. Tough to reconcile a near-record stock market with falling profits. Something has to give.

For all the talk in Washington about the need for more infrastructure spending, states are beginning to take advantage of low interest rates to issue bonds to raise money for infrastructure spending. When municipalities can borrow money for 30 years at 2.23%, it is kind of a no-brainer. Both Donald Trump and Hillary Clinton are talking about increasing infrastructure spending, so it looks like we will probably have something out of DC next year as well.

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