Morning Report: Decent jobs report 11/3/17

Vital Statistics:

Last Change
S&P Futures 2579.0 2.3
Eurostoxx Index 395.2 0.3
Oil (WTI) 54.8 0.3
US dollar index 87.7 0.0
10 Year Govt Bond Yield 2.34%
Current Coupon Fannie Mae TBA 102.875
Current Coupon Ginnie Mae TBA 103.938
30 Year Fixed Rate Mortgage 3.95

Stocks are up small after the jobs report. Bonds and MBS are up small.

Jobs report data dump:

  • Nonfarm payrolls up 261,000 versus 325,000 expected
  • 2 month payroll revision up 90,000
  • Unemployment rate 4.1% versus 4.2% expected
  • Labor force participation rate 62.7% vs 63% expected
  • Average hourly earnings flat / up 2.4% YOY.

Overall, a decent report. Payrolls disappointed, but the 2 month revision more than made up for the miss. The unemployment rate is now the lowest since 2000. The drop in the labor force participation rate and flat hourly earnings were disappointing, however. This report won’t make any difference to the Fed’s thinking for December, and the market is basically calling a 25 basis point hike a sure thing at this point.

Note that the miss in average hourly earnings was driven in part by the hurricanes. Restaurant and bar jobs were hit the hardest in the areas affected, and they are lower paying jobs. The loss of these low-paying restaurant and bar jobs in September artificially increased average wages overall. That effect was reversed in October.

The PMI for services was flat in October, while the ISM Services index increased to 60.1. Hurricane effects could be coming into play here as well.

Factory orders increased 1.2% in September, as the manufacturing sector continues to expand.

If you heard a snap yesterday, that was the sound of McMansions in places like Darien, CT and McLean, VA cracking on the proposed sharp reduction in the mortgage interest deduction. Luxury homebuilder Toll Brothers was down 6% yesterday on the proposal, which lowers the MID cap to $500,000 and ends the deduction for second homes. The homebuilder ETF was only down 2.5%. Automaker Tesla was also hit 7% on the proposed elimination of the $7,500 electric car tax credit. I also wonder how this will affect jumbo delinquencies and demand for jumbo MBS.

The NAHB is warning that the change in the mortgage interest deduction could trigger a housing recession. Their point is that it will cause weakness in some high end markets and that weakness will spread to others. FWIW, I think the sheer lack of inventory is the most important characteristic of the current housing market and that will dominate. That said, it won’t be good for home prices in the million dollar range at the margin, and some markets in California could see a moderation of home prices.

Morning Report: More on tax reform 9/28/17

Vital Statistics:

Last Change
S&P Futures 2499.5 -5.0
Eurostoxx Index 385.4 -0.3
Oil (WTI) 52.4 0.3
US dollar index 86.4 -0.1
10 Year Govt Bond Yield 2.33%
Current Coupon Fannie Mae TBA 103.05
Current Coupon Ginnie Mae TBA 103.98
30 Year Fixed Rate Mortgage 3.88

Stocks are higher this morning after a strong GDP number. Bonds and MBS are down.

Second quarter GDP was revised upward to 3.1%, while the PCE price index was steady at 1%. Consumption was unchanged at 3.3% while after-tax incomes rose 3.3%.  This is a Goldilocks type report for the economy, with strong growth and muted inflation. Residential Construction was a weak spot, falling 7.3%, the biggest drop since 2010.

In other economic data, Initial Jobless Claims came in at 272k, a touch lower than expectations. Claims in Texas are getting back to normal, while claims in Florida are still elevated. Retail inventories rose 0.7% while wholesale inventories rose 1%. Corporate profits rose 7.4%.

Tax reform could cause a quick jump in jobs, assuming it plays out the way its drafters hope. One provision that is getting attention is the accelerated depreciation idea. Accelerated depreciation will let companies expense new capital investment in the year it is made instead of having to depreciate it over a longer time period. The net effect is to make reported profit (and therefore the tax liability) lower than it would otherwise be, and that actually adds to the cash flow of the company. The big question is whether it will encourage job growth, and that is a question that divides economists almost 50/50 and largely falls along ideological lines. Liberal economists believe that this will only reward investors, while more right-leaning economists believe that the tax effect makes some marginal projects begin to make sense economically. If you are a leftie, you think the tax savings will get plowed back into dividends and buybacks. If you are a rightie, you think the tax savings will encourage investment in the business and hiring.

Note that one provision of tax reform includes a repatriation tax credit, which could cause bond yields to rise if companies sell Treasuries en masse to bring cash back to the US. The amount of money isn’t trivial: Microsoft alone holds $133 billion in cash overseas, largely sitting in Treasuries.

Tax reform at the individual level is still sketchy, and it looks like there will be winners and losers. The winners will be people in low-tax states as well as the super-rich. The losers will be upper middle class taxpayers in high tax states like NY and CT. Historically, the upper middle class taxpayer has been the “third rail” of tax reform and it is likely that hitting them will doom tax reform at the individual level. There is probably more support for corporate tax reform given that we have the highest statutory corporate tax rates in the world, and US corporations that don’t have overseas exposure (generally the smaller ones) are disadvantaged relative to the bigger guys.

Equifax’s CEO resigned over the hacking episode and the new CEO has unveiled free credit locking for life. To prevent identity theft, locking means that a new creditor cannot access your credit file unless you specifically request it, for example if you are getting a new car or opening a new credit card. This presumably prevents someone from opening a credit line in your name. So far, we have not heard about issues with mortgage loans and the inability to access credit reports from borrowers who have locked their accounts, but the hack is still relatively recent.

Housing credit risk increased in the second quarter, according to CoreLogic. Credit risk is still within the benchmark range of 2001-2003, before the housing bubble began to inflate in earnest. It seems that there have been two opposing phenomenons going on – first an increase in investor and condo loans has increased credit risk, while better DTIs and FICO scores have lowered it. The average credit score for new mortgages is 745, which is up 9 points YOY. DTI ratios were flat at 36%, while LTV ratios fell from 87.5 to 85.5. The increase in FHA loans over time has increased the number of 95+ LTVs by over 50% since 2001.

Tennessee Senator Bob Corker said he will not stand for re-election. Corker is a big name on the Banking Committee and is instrumental in GSE reform. This will accelerate the push for GSE reform in his last 15 months in office. GSE reform is difficult and cleaves strongly down ideological lines. Bob Corker and Senator Mark Warner came up with a bill that made it out of committee, however the left opposed it. The right wants to limit exposure to the taxpayer and introduce more competition. The left wants to ensure that low-income and targeted lending are not compromised. In the current state, Fannie and Fred remain under conservatorship, with all profits going to Treasury.

Thinking outside the box in Albuquerque:


Morning Report: Tax reform to be unveiled today 9/27/17

Vital Statistics:

Last Change
S&P Futures 2500.8 5.3
Eurostoxx Index 385.4 1.4
Oil (WTI) 51.9 0.0
US dollar index 86.5 0.4
10 Year Govt Bond Yield 2.29%
Current Coupon Fannie Mae TBA 103.24
Current Coupon Ginnie Mae TBA 104.21
30 Year Fixed Rate Mortgage 3.87

Stocks are up this morning as Washington pivots to tax reform. Bonds and MBS are down.

Janet Yellen spoke yesterday and said that it would be “imprudent” to wait until inflation hits 2% to start hiking rates. Those comments were taken as support for a December hike and the Fed Funds futures took up the odds of a rate hike in December to 81%.

Bonds were also under pressure due to the possibility of some sort of tax deal. Here is a preview of the tax plan. Trump plans on releasing the details today. Apparently the big pieces involve cutting the corporate tax rate falls to 20%, while the top individual income tax bracket falls to 35%. There is an option for Congress to institute a higher bracket. Deductions will be limited while the standard deduction increases. The most contentious deduction will be the state and local tax deduction, which will hit taxpayers in high tax states like NY and CT the most. CT is already reeling from an exodus of high income earners and businesses, and this will only exacerbate that. This won’t be good for real estate prices there. While this is largely going to hit blue states, there are enough Republican House members in blue states to deep-six it unless Trump can get some Democrats on board. No word on eliminating or lowering the cap on the mortgage interest deduction.

Pending Home Sales fell by 2.6% in August, according to NAR.

Mortgage applications fell half a percent last week as purchases rose 3% and refis fell 4%. The hurricanes did depress activity in Florida and Texas, however increasing rates and a lack of home inventory were the biggest drivers.

Durable goods orders rose 1.7% in August, which beat consensus estimates. Ex-aircraft, they were up 0.2%. Capital Goods orders rose 0.9%, which is an indication that business expects to see further activity and is increasing their capacity. The bump in capital goods orders is being driven by the rebound in oil prices and drilling activity in the energy sector. Capacity Utilization rates are still low compared to historical standards.

The bond market has been in a tight range for this entire year. In fact, the 62 basis point range has been the tightest in over 50 years. Historically, that range has been closer to 175 basis points. The article is somewhat misleading, as the range is going to fall naturally when rates fall from 10% to 2%. Using volatility measured in sigma is better. That said, it isn’t just the US bond market: volatility in general is down. The VIX (the volatility measure for the stock market) has been in the single digits. Historically that has been a warning sign (When VIX is high, time to buy. When VIX is low, time to go).

Morning Report: Corporate tax reform 12/9/16

Vital Statistics:

Last Change
S&P Futures 2250.0 2.0
Eurostoxx Index 354.2 2.0
Oil (WTI) 51.3 0.4
US dollar index 91.8 0.4
10 Year Govt Bond Yield 2.41%
Current Coupon Fannie Mae TBA 103
Current Coupon Ginnie Mae TBA 104
30 Year Fixed Rate Mortgage 4.08


Stocks are higher this morning on no real news. Bonds and MBS are flat.
Slow news day.
Consumer sentiment jumped in November from 94 to 98.
Negative equity fell 0.8% from Q2 to Q3, according to CoreLogic. Currently, 8.4% of all mortgaged homes have negative equity, and another 1.6% are near negative equity. In total, 14.6% of all mortgaged homes in the US have less than 20% equity. Home price appreciation has been one driver of this, as well as borrowers who have been switching to 15 year mortgages which pay down principal faster. Over the past year, the average homeowner has picked up $12,500 in home equity.
One of the best chances for bipartisanship next year is corporate tax reform. While Republicans and Democrats disagree on how much revenue corporate taxes should bring in, most everyone agrees that our current system isn’t working. Over the past 16 years, virtually all of our competitors cut corporate taxes, however the US has maintained its 35% rate. You can see how much the market has shifted over the past 16 years in the chart below. The new plan would eliminate the incentives that companies use to shift revenues and costs to various jurisdictions in order to minimize taxes. Rates would fall, however interest would no longer be deductible.

A notable bond bear believes the tipping point in the bond market is 3% yields on the 10-year. At yields above that, he believes the stock market and the bond market would suffer a vicious sell-off.

Morning Report: RIP the mortgage interest deduction? 10/10/16

Vital Statistics:

Last Change
S&P Futures 2158.0 12.0
Eurostoxx Index 341.2 1.6
Oil (WTI) 50.6 0.8
US dollar index 87.6 -0.2
10 Year Govt Bond Yield 1.72%
Current Coupon Fannie Mae TBA 103.3
Current Coupon Ginnie Mae TBA 104.2
30 Year Fixed Rate Mortgage 3.54

Bonds are closed today, but overseas bond markets are weaker. Stocks are up.

No economic data today. The week after the jobs report is typically data light to begin with, and there really isn’t anything market-moving this week, except for may the PPI on Friday.

Dave Stevens of the MBA raised the issue of eliminating the mortgage interest deduction, albeit with the caveat that it be done in the context of tax reform, with lowering rates and eliminating deductions. He wasn’t advocating eliminating it in a vacuum.

If Donald Trump wins, tax reform is a definite possibility. If Hillary wins, will she be more like her husband, willing to deal with Republicans to get something done, or will she be more like Obama, where both sides had hardened positions? If you were going to eliminate the mortgage interest deduction, it will certainly make housing less affordable and would have a dampening effect on home price appreciation. That said, with rates as low as they are, interest payments as a percentage of your mortgage payment are at all-time lows. So if you wanted to eliminate it at the time when it causes the least amount of pain, now is the time to do it.

Republicans will never support eliminating deductions without cutting rates, and the historical bargain between right and left (Democrats trading increased taxes and spending for increased defense spending) might not work this time around. Believing in that trade was what got us the sequester, where Obama found his bluff called, as Republicans tolerated lower defense spending in exchange for lower discretionary spending. Given the general war fatigue of the American voter, Republicans are probably not going to be willing to trade increases in defense spending for more social spending, and certainly not for tax increases.

Punch line: the mortgage interest deduction probably isn’t going anywhere.

That said, the US subsidizes the residential real estate market six ways to Sunday, with the mortgage interest deduction, the 30 year fixed rate mortgage (try finding that anywhere else on the planet), taxpayer backing of almost all new origination, and the cornucopia of subsidies for affordable housing. Not to mention the central bank targeting of mortgage rates and real estate prices. And the powers that be still scratch their heads wondering why we had a real estate bubble…

Mortgage credit availability improved in September, according to the MBA.

Thought Experiment 5/26/15

If our federal tax system had a voluntary box for contributions above income tax due, and if the box allowed for contributions to be earmarked for any of eight major federal budget “needs”:
1]  debt reduction
2]  defense and national security
3]  medicaid
4]  highway, dam, and port maintenance
5]  national parks
6] VA
7] ag subsidies
8] health subsidies through ACA
9] Returned Directly to the State Treasury of Your Choice__________________________
10] Existing specific federal budget item of your choice_______
Would you check off for any?  $50?  $500?  $5000?
Which functions do you think would draw the most contributions?
Which the least?
Assuming the earmarks would be honored, would Congress immediately offset the predicted earmarks in the following year’s budget?  Would that be good, in that voters would have changed budget priorities to directly suit themselves, or bad, in that Congress would just waste the money?
Would it make a difference to you if the contribution were tax deductible in the following year?  I exclude the possibility of it becoming a tax credit as that would defeat this mind experiment. But see below.

In the alternate mind experiment, in which one can choose to contribute one’s tax payment to selected budget items, which items do you think would be funded?


I will post this at PL.  The reactions there should be – uh- different.

FYI – a chance to comment on a proposed regulation

The U.S. Department of the Treasury and the Internal Revenue Service (IRS) today will issue initial guidance regarding qualification requirements for tax-exemption as a social welfare organization under section 501(c)(4) of the Internal Revenue Code.  This proposed guidance defines the term “candidate-related political activity,” and would amend current regulations by indicating that the promotion of social welfare does not include this type of activity.  The proposed guidance also seeks initial comments on other aspects of the qualification requirements, including what proportion of a 501(c)(4) organization’s activities must promote social welfare.

The initial guidance is expected to be posted on the Federal Register later today.

There are a number of steps in the regulatory process that must be taken before any final guidance can be issued.  Given the significant public interest in these and related issues, Treasury and the IRS expect to receive a large number of comments.  Treasury and the IRS are committed to carefully and comprehensively considering all of the comments received before issuing additional proposed guidance or final rules.

“This proposed guidance is a first critical step toward creating clear-cut definitions of political activity by tax-exempt social welfare organizations,” said Treasury Assistant Secretary for Tax Policy Mark J. Mazur.  “We are committed to getting this right before issuing final guidance that may affect a broad group of organizations.  It will take time to work through the regulatory process and carefully consider all public feedback as we strive to ensure that the standards for tax-exemption are clear and can be applied consistently.”

“This is part of ongoing efforts within the IRS that are improving our work in the tax-exempt area,” said IRS Acting Commissioner Danny Werfel.  “Once final, this proposed guidance will continue moving us forward and provide clarity for this important segment of exempt organizations.”

Organizations may apply for tax-exempt status under section 501(c)(4) of the tax code if they operate to promote social welfare.  The IRS currently applies a “facts and circumstances” test to determine whether an organization is engaged in political campaign activities that do not promote social welfare.  Today’s proposed guidance would reduce the need to conduct fact-intensive inquiries by replacing this test with more definitive rules.

In defining the new term, “candidate-related political activity,” Treasury and the IRS drew upon existing definitions of political activity under federal and state campaign finance laws, other IRS provisions, as well as suggestions made in unsolicited public comments.

Under the proposed guidelines, candidate-related political activity includes:

1.      Communications

  • Communications that expressly advocate for a clearly identified political candidate or candidates of a political party.
  • Communications that are made within 60 days of a general election (or within 30 days of a primary election) and clearly identify a candidate or political party.
  • Communications expenditures that must be reported to the Federal Election Commission.

2.      Grants and Contributions

  • Any contribution that is recognized under campaign finance law as a reportable contribution.
  • Grants to section 527 political organizations and other tax-exempt organizations that conduct candidate-related political activities (note that a grantor can rely on a written certification from a grantee stating that it does not engage in, and will not use grant funds for, candidate-related political activity).

3.      Activities Closely Related to Elections or Candidates

  • Voter registration drives and “get-out-the-vote” drives.
  • Distribution of any material prepared by or on behalf of a candidate or by a section 527 political organization.
  • Preparation or distribution of voter guides that refer to candidates (or, in a general election, to political parties).
  • Holding an event within 60 days of a general election (or within 30 days of a primary election) at which a candidate appears as part of the program.

These proposed rules reduce the need to conduct fact-intensive inquiries, including inquiries into whether activities or communications are neutral and unbiased.

Treasury and the IRS are planning to issue additional guidance that will address other issues relating to the standards for tax exemption under section 501(c)(4).  In particular, there has been considerable public focus regarding the proportion of a section 501(c)(4) organization’s activities that must promote social welfare.  Due to the importance of this aspect of the regulation, the proposed guidance requests initial comments on this issue.  The proposed guidance also seeks comments regarding whether standards similar to those proposed today should be adopted to define the political activities that do not further the tax-exempt purposes of other tax-exempt organizations and to promote consistent definitions across the tax-exempt sector.

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