Morning Report: Trump calls for 100 basis points and more QE

Vital Statistics:

 

Last Change
S&P futures 2922 0.5
Oil (WTI) 56.11 0.44
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.78%

 

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

 

No economic data this morning, and we wait for Jackson Hole comments later this week.

 

Trump called on the Fed to cut rates by 100 basis points and should re-embark on quantitative easing. “Our Economy is very strong, despite the horrendous lack of vision by Jay Powell and the Fed, but the Democrats are trying to ‘will’ the Economy to be bad for purposes of the 2020 Election,” Trump tweeted. “Very Selfish! Our dollar is so strong that it is sadly hurting other parts of the world. [Interest Rates] over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well….If that happened, our Economy would be even better, and the World Economy would be greatly and quickly enhanced-good for everyone!”

 

The Home Despot reported better than expected earnings this morning. Falling lumber prices caused them to take down their sales estimates, and they are worried about how tariffs will impact sales. “We are encouraged by the momentum we are seeing from our strategic investments and believe that the current health of the U.S. consumer and a stable housing environment continue to support our business,” CEO Craig Menear said in a prepared statement. “That being said, lumber prices have declined significantly compared to last year, which impacts our sales growth. As a result, today we are updating our sales guidance to account primarily for continued lumber price deflation, as well as potential impacts to the U.S. consumer arising from recently announced tariffs.”

 

Ballard Spahr weighs in on the new disparate impact rule. Disparate Impact is a concept that was intended to put the burden of proof on the defendant, not the plaintiff. If a lender’s customer base doesn’t reflect the demographics of the relevant market, then it is assumed the lender is guilty of discrimination. While a Texas court upheld the concept, it did institute some guardrails to prevent abuse. HUD’s new guidance was intended to reflect that decision.

 

The relief for lenders turns on the use of algorithms to make lending decisions. Since most lenders use DU or LP automated underwriting systems, the big question is whether this insulates them from discrimination charges. Ballard Spahr believes it does. “However, if the use of the model is an “industry standard,” the defendant is relieved from liability if it uses the model “as intended by the third party” that created it.  It appears that the second defense could apply in a variety of situations, including when a mortgage lender uses the automated underwriting systems of Fannie Mae or Freddie Mac.”

 

The Business Roundtable officially ended the era of shareholder value yesterday and declared that it would focus on “all stakeholders.” Though this document is largely symbolic, it is an attempt by business to play along with the new populism emerging in the Democratic Party. “The American dream is alive, but fraying,” said Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. and Chairman of Business Roundtable. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.

 

To me, this document is indicative of several trends: first the emerging populism in both political parties, second a tight labor market, and third the emergence of indexing as the primary long-term investing vehicle. We are seeing the left become more comfortable in their historic role of being a check on big business, while the right is talking about antitrust and Big Tech. Neither party seems particularly hospitable and the “third way” Democrats are battling an increasingly mobilized left. The tight labor market is also playing a part, as companies need to attract employees and this might be the second-to-last resort to try and attract them. Of course the last resort is to raise wages and hire the long-term unemployed, and that may be on the horizon.

 

The indexing angle is probably the most significant. When most of the largest shareholders in the S&P 500 are index funds and ETFs, you have take into account they don’t have the motivations that money managers had a couple decades ago. 20 years ago, money managers were paid to beat the market and pick good stocks. Those that did so were rewarded with inflows and their managers were paid big bonuses. That was the Peter Lynch model. Today, the biggest money managers aren’t interested in beating the market. They aren’t paid to do that. They are paid for minimizing tracking error and fees, which means they aren’t paid much since the skill set is completely different. They couldn’t care less if XYZ Inc’s CEO is a bum who makes bad decisions – as long as their fund holds the requisite 2.49856% of net asset value in XYZ, they have done their job. Indexers largely vote the way Institutional Shareholder Services (ISS) recommends, and ISS has its own set of priorities. Punch line: companies can get away with this because their largest shareholders don’t have any skin in the game.

Morning Report: The Fed is at Jackson Hole this week

Vital Statistics:

 

Last Change
S&P futures 2923 32.5
Oil (WTI) 55.32 0.44
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.78%

 

Stocks are higher on optimism of a trade deal with China. Bonds and MBS are down.

 

The upcoming week will be dominated by Fed-speak as they head to Jackson Hole. Economic data will be sparse, with leading economic indicators, and new home sales the only potential market-moving numbers. Jerome Powell is scheduled to speak on Friday where he is pretty much expected to hint at another rate cut at the September meeting. Note the Fed funds futures are pricing in a 93% chance of a 25 basis point cut, and a 7% chance of a 50 basis point cut.

 

fed funds futures

 

Homebuilder KB Home notes that consumer confidence took a hit in August, and this translates into lower home sales more than interest rates do. “I’ve always maintained over the years that consumer confidence means more than rates to the home buying decision,” said Jeff Mezger, CEO of Los Angeles, CA-based KB Home. “We’ve had some great years where interest rates were 8, 9,10%—because people find a way when they feel confident about the future.” Of course interest rates were way higher during the 80s and 90s and people still bought homes. Nominal wage growth was higher too. Further, he talks about why housing starts are weak: “Frankly, as an industry, that’s what is holding us back from getting to normalized levels,” said Mezger. “We’re only going to invest and build if we can get a return, and it’s difficult to find the combination of land, the cost to produce, the fee structure in that city and then what you can sell a home for based on the incomes in that submarket. So that is the challenge.” So, it is land, labor, and regulations that are the issue. Income growth might be what ends up squaring the circle.

 

Speaking of sentiment, the University of Michigan preliminary survey showed that confidence has dropped. Trade concerns and Fed policy increased fears of a recession, which translated into the numbers.

 

The Administration is set to introduce a new rule to codify lending discrimination and move away from the disparate impact standard that began during the Obama Administration. It appears that lenders will have protection if they use ” – third party systems” – i.e. algorithms – to make lending decisions. The actual guidance (from a leaked memo) is supposedly here.  While they don’t mention any algorithms by name, they are probably proposing that if you use DU or LP for lending decisions, you will have safe harbor from lending discrimination charges. If it turns out that DU or LP are biased, that is on the provider of these algorithms, not the lender. All of this is in response to a disparate impact lawsuit (Texas vs. Inclusive Communities), which allowed disparate impact theory to be used, however it did institute some restrictions on its use. The updated guidance from HUD will be to align current policy with that decision.

Morning Report: Why we aren’t headed for a recession

Vital Statistics:

 

Last Change
S&P futures 2874 24.5
Oil (WTI) 54.62 -0.14
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.78%

 

Stocks are higher on no real news this morning. There is a risk-on feel to the tape after a tumultuous week. Bonds and MBS are down.

 

Housing starts disappointed (again!) coming in at 1.19 million, lower than the 1.26MM street estimate. This is down 4% on a MOM basis, and up about 0.6% on a YOY basis. On the bright side, building permits surprised to the upside, coming in at 1.34 million versus the 1.27 million street estimate. Still, new home construction remains depressed due to labor shortages and lack of buildable lots.

 

Despite these issues, homebuilders remain optimistic. The NAHB / Wells Fargo Builder Sentiment Index rose in August to 66. Current sales conditions improved, while expectations for the next six months moderated. “While 30-year mortgage rates have dropped from 4.1 percent down to 3.6 percent during the past four months, we have not seen an equivalent higher pace of building activity because the rate declines occurred due to economic uncertainty stemming largely from growing trade concerns,” said NAHB Chief Economist Robert Dietz. “Although affordability headwinds remain a challenge, demand is good and growing at lower price points and for smaller homes.” Interesting about the tariff issue – building materials prices are down quite substantially. If tariffs were really that big of a deal, you would expect to see shortages and increases. We aren’t.

 

Given all the chatter about the yield curve and a possible recession, it is worthwhile to step back and take a look at the facts on the ground. The business press is awash with stories about the yield curve and how it is possibly signalling a recession. The yield curve shows interest rates along the spread of maturities, and short term rates are usually lower than long term rates. However, we are flirting with a situation where long term rates are lower than short term rates. That is a yield curve inversion, and historically a yield curve inversion has been a decent (but not perfect) predictor of an imminent recession. The reason for this is that it implies that businesses are taking less risk, which means they must see something wrong in the economy.

 

The problem with the inverted yield curve model is that it gives off a lot of false positives – an old market saw is that an inverted yield curve has predicted “15 of the last 10 recessions.” Many times an inverted yield curve is the result of technical issues in the bond markets, which are temporary and don’t really spill through to the overall economy. This current period is probably one of those cases, and the technical issue is central bank behavior. The Fed, ECB, Bank of Japan have been pushing down long term rates in order to stimulate the economy for years, and now we have negative interest rates in much of the world. Negative interest rates in Germany and Japan (two huge bond markets) is drawing down US bond yields as overseas investors sell things that pay less than nothing (German Bunds and Japanese Government bonds) to buy things that pay something (US Treasuries).

 

The business press is emphasizing the recession angle here because (1) it is a much simpler story to tell, (2) the partisans can blame it on Trump, and (3) many strategists are too reluctant to stick their necks out and discuss the implications of negative rates worldwide – this is a completely new phenomenon and quite simply people don’t know.  We have a bubble in sovereign debt that has been engineered by global central banks – unlike stock and real estate bubbles, and we don’t have any historical analogy. We know that bubbles end eventually, and how this resolves is anyone’s guess.

 

That said, what is the current economic state of play? Europe is doing its same-old Euro-sclerosis thing, which it has been doing for decades. Germany had a flat GDP quarter and most of the Eurozone is slowing down in sympathy. Japan has been in the throes of a sclerotic economy since the New Kids on the Block ruled the charts. China is also tempering its growth. On the other side of the coin, the US has the lowest unemployment rate in 50 years, initial jobless claims are the lowest since we had a military draft, wages are rising, inflation is under control, and the consumer is increasing spending. This simply is not a recipe for a recession. And to take this a step further, tariff income has been about $60 billion since they have been implemented. In the context of a $21 trillion economy, this is insignificant – about 1/3 of 1%. It is a humorous state of affairs with partisan talking heads accusing Trump of destroying the economy over small-beer tariffs, while Trump accuses partisan journalists of sabotaging the economy with negative stories – as if the press had the power to do that.

 

Here is the big picture: The US economy has been strong enough to withstand a tightening cycle from the Fed, and has had 2.6% GDP growth in the immediate aftermath of a tightening cycle. Inflation is low, and is probably going to go lower as Europe and China begin exporting deflation to the US. Oh, and by the way the Fed is now cutting interest rates, which is the equivalent of giving a can of Red Bull to your kid at 9:00 pm on Halloween night. Don’t buy the recession narrative. None of the required pieces are in place.

Morning Report: Strong retail sales

Vital Statistics:

 

Last Change
S&P futures 2857 14.5
Oil (WTI) 54.92 -0.64
10 year government bond yield 1.59%
30 year fixed rate mortgage 3.84%

 

Stocks are up after strong retail sales numbers. Bonds and MBS are flat. The German Bund hit a new low this morning, trading at negative 66 basis points.

 

Strong retail sales numbers out this morning. The headline number was up 0.7%, well above the Street expectations of 0.4%. The control group, which strips out volatile gas and autos, was up 1.0% MOM, exceeding the Street estimate by 0.7%. Note that Trump’s delay of Chinese tariffs means they won’t hit until mid-December, or after the holiday shopping season. These numbers bode well for the back-to-school shopping season, which is the second most important of the year. Note that Walmart also reported strong numbers this morning, another bellwether for the retail sector. Expect strategists to take up their GDP estimates on these figures.

 

In other economic news, initial jobless claims rose to 220,000 last week, while industrial production fell 0.2% MOM and rose half a percent YOY. Capacity Utilization fell to 77.5%. The industrial and manufacturing numbers are probably influenced by trade.

 

Productivity rose 2.3% in the second quarter, way more than expectations as output rose 1.9%, hours worked fell 0.4% and compensation rose 4.8%. The biggest surprise however came in the revisions, where compensation in the first quarter was revised upward from -1.5% to +5.5%! These are inflation-adjusted numbers, so we had real compensation growth of 5.2% in the first half of the year. Where was the growth strongest? Manufacturing.

 

With the inversion of the yield curve, the business press is chattering about an imminent recession. Don’t buy it. Most of them are talking their partisan book and are sticking with their preferred narrative: (Trump’s trade war is causing a recession!). It helps that it is the most convenient and easy to explain scenario, and let’s face it: it is hard to talk about overseas interest rates when most journalists wouldn’t know a Bund if it bit them in the begonias. Reality check: you generally don’t get recessions with a dovish Fed, unemployment at 50 year lows, strong consumer spending and accelerating wage growth. In fact, the bullish case is that with strong wage growth, overseas deflation keeping inflation in check, and a dovish Fed, you could see a scenario similar to the mid / late 90s. Food for thought.

 

The new FHA guidance for condos is available in its unpublished form here. The new rule will become effective 60 days after publication in the Federal Register (which should be any day now) and will make more condos eligible for FHA insurance.

 

Home prices rose 3% in July, according to Redfin. “July home prices and sales were weaker than I had expected, especially given that falling mortgage rates have been luring homebuyers back to the market since early spring,” said Redfin chief economist Daryl Fairweather. “Even though we’ve seen increased interest from homebuyers—especially compared to a year ago when mortgage rates were climbing—uncertainties in the overall economy and talk of a looming recession have people feeling jittery about making a huge purchase and investment. But I think the odds are that we won’t see a recession within the next year. If rates stay low and the economy continues to grow, we’ll see more homebuyers come back in a serious way in 2020, and the market will be much more competitive.” Home sales were down 3.4%, while supply fell by the same amount. In terms of price, the previously hot markets of San Jose and Seattle fell, while many of the laggards (like Cleveland and Rochester) rose.

 

Redfin price chart

Morning Report: The US yield curve inverts

Vital Statistics:

 

Last Change
S&P futures 2890 -41.5
Oil (WTI) 55.49 -1.64
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.88%

 

Stocks are lower after disappointing overseas economic data. Bonds and MBS are up on the flight to safety.

 

Overnight, the US yield curve officially inverted with 2s/10s trading at negative 1.7 basis points.  This has historically been considered a recession indicator. You can see the chart below, which plots the difference between the 10 year bond yield and the 2 year bond yield, and not that the shaded grey bars (which represent recessions) have historically followed after the line goes to zero. One caveat to keep in mind however: In the past, we didn’t have the sort of activism out of central banks that we have now. Quantitative easing (where the central bank tries to directly influence long term rates) are a new phenomenon, and therefore investors should take that signal with a grain of salt. Still, it does speak to a global slowdown, and that will inevitably pass through to the US.

 

2s10s

 

The German Bund yields negative 64 basis points, which is a record low. Their economy contracted by 0.1% last quarter. This is what is driving stocks lower and bonds higher. The trade war is being blamed on their economic weakness. China reported the slowest industrial growth since 2002.

 

The FHA announced they will widen the credit box for condos, in an attempt to revive the entry-level condo market and help the first time homebuyer. “This is set to really expand homeownership,” said Ben Carson, secretary of the Department of Housing and Urban Development, which oversees the FHA. FHA will now begin insuring loans in unapproved buildings, provided no more than 10% of the units have a FHA loan.

 

Mortgage applications increased 21.7% last week as purchases increased 2% and refis increased 37%. The average contract interest rate fell from 4.01% to 3.93%, and has dropped about 80 basis points this year. The government refi index is at the highest level since 2013, driven by VA refis.

Morning Report: 30 year bond yield near record lows

Vital Statistics:

 

Last Change
S&P futures 2871 -14.5
Oil (WTI) 54.49 -0.44
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.85%

 

Stocks are lower this morning after the Argentinian markets blew up overnight and the Hong Kong airport remains occupied by protesters. Bonds and MBS reversed their rally and are down after the Trump Administration announced they would delay the tariff increases on Chinese goods until mid-December. They were scheduled to take effect September 1.

 

The German Bund yield has hit a record low at negative 61 basis points. While the 10 year bond yield is still some 30 basis points from a record, the 30 year bond is getting close at a yield of 2.13%. Note that with the 10 year yield of 1.63% is lower than the dividend yield of the S&P 500.

 

30 year bond yield

 

Some economic data this morning: the consumer price index rose 0.2% MOM / 1.8% YOY, which was a touch higher than the Street forecast. Ex-food and energy, it rose 0.3% / 2.2%. The CPI remains pretty much where the Fed wants it, and is not going to be the driver of Fed policy, at least in the near term. Like it or not, the Fed is watching the markets and following them even if the signal-to-noise ratio is heavily distorted.

 

Small Business Optimism continued to increase as the index improved in July. Despite all of the handwringing in the business press over growth small business continues to grow and invest. Biggest headwind? Labor. The top concern of business was finding quality labor at 26%, which is a record. 57% reported capital expenditures, which means they have enough confidence to invest in infrastructure to grow their businesses. Only 3% of businesses reported not having their credit needs met, which is close to historical lows and kind of begs the question of what the Fed hopes to accomplish with lowering rates.

 

Mortgage delinquency rates continued to fall, hitting 20 year lows for most of the country. 30 day DQs fell to 3.6% and the foreclosure rate fell to 0.4%. The only areas with elevated DQ rates are in the Midwest and Southeast and are the result of flooding.

 

delinquencies

 

Fitch is out saying that GSE reform will probably not result in near-term downgrades.

Morning Report: Trump talks down the dollar

Vital Statistics:

 

Last Change
S&P futures 2905 -14.5
Oil (WTI) 54.68 0.64
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.86%

 

Stocks are lower after a bunch of non-US political headlines over the weekend. Bonds and MBS are up.

 

Overseas, currencies and bond yields are focusing on elections in Italy and Argentina, as well as protests in Hong Kong. Protestors shut down the Hong Kong airport over the weekend.

 

The week ahead will have a few important data points, but nothing likely to be market-moving. We will get inflation at the consumer level tomorrow, retail sales / productivity / industrial production on Thursday, and housing starts on Friday. There doesn’t appear to be any Fed-speak this week, so things should be quiet absent overseas political developments. Congress is on vacation until Labor Day, so things should be quiet in DC as well.

 

Building materials prices rose 0.7% (NSA) in July, but are down overall year-over-year. Despite tariffs, softwood lumber prices are down 20% over the past year, while other products like gypsum are down less. Roofing materials (tar / asphalt) were flattish-to-down as well. Rising home costs are due more to labor, land, and regulatory costs than they are due to sticks and bricks.

 

After rising for a decade, average new home sizes are falling as builders pivot away from luxury buyers to first time homebuyers. In 2018, the average size of a single family dwelling was 2,588 square feet, down from 2,631 the year before. Builders had largely decided to relegate the first time homebuyer to the resale market and focused on McMansions and luxury urban apartments during the immediate aftermath of the housing crash. Townhomes are also increasing in popularity, with 69,000 sales last year, the most since 2007. This is the sector growing the fastest.

 

Prepay speeds were released on Friday, and we saw some eye-popping CPRs on the government side: 2018 FHA had a CPR of 30.7%, while VA was almost 50%. People who loaded up the boat on MSRs in 2017 and 2018 have been killed.

 

The Fed is looking at the idea of a countercyclical capital buffer as a way to mitigate the credit cycle. The idea would be to have the banks hold more capital (i.e. lend less) when the economy shows signs of overheating and then allow them to hold less (i.e. lend more) when the economy goes into a down cycle. This would only apply to the Citis and JP Morgans of the world – banks with more than 250 billion in assets. “The idea of putting it in place so you can cut it, that’s something some other jurisdictions have done, and it’s worth considering,” Fed Chairman Jerome Powell said at a late July press conference. It is an interesting idea, although reserves are typically sovereign debt, and this sounds a bit like adding buying pressure to a market that certainly does not need it.

 

Trump tweeted about the dollar, arguing that it should be weaker. Note this is a yuge departure from the strong dollar policy that every other president has supported. “As your President, one would think that I would be thrilled with our very strong dollar,” he tweeted. “I am not! The Fed’s high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field. With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition. We have the greatest companies in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?”

 

The strength in the dollar is more due to the relative strength of the US economy versus its trading partners, along with various carry trades. A carry trade is where you borrow money in a low yielding currency like the Japanese yen and invest the proceeds in a high-yielding government bond like the US Treasury. The net effect of a strong dollar is to make our exports more expensive to foreign buyers, make imports cheaper for US consumers and to lower interest rates in the US. The problem is that the ones who benefits from a weaker dollar (exporters) are loud and visible, while the beneficiaries (everyone else) aren’t even aware they are benefiting from it. Note that as the US has pivoted from a manufacturing-based economy to a service / IP based economy, the currency has a smaller and smaller impact on things.

 

Chart US dollar index (1989 – Present):

 

dollar

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