All Things in Moderation

Vital Statistics:

Stocks are lower as investors return from a 3 day weekend. Bonds and MBS are flat.

We don’t have much in the way of economic data this week – the highlight will be existing home sales on Thursday and the FOMC minutes on Wednesday. Other than that, it should be a quiet week.

Industrial Production in January fell by 0.6%, while manufacturing production fell by 0.9%. Capacity Utilization fell to 78.2%, down from 78.8% the prior month. Volatile vehicle production largely accounted for the decrease. Note that December’s numbers were strong, which means the average for the two months was a modest gain.

Due to the government shutdown, Q4 GDP numbers have been delayed until Feb 28. Right now, the consensus seems to be for a high 1% / low 2% print – a definite slowdown from Q3, which would put 2018 annual growth around 2.8%. These forecasts are from Merrill, Goldman, and the NY / Atlanta Fed. Holiday retail sales disappointed, and some of the industrial data showed a slowdown as 2018 ended.

Mortgage delinquencies dropped to an 18 year low, according to the MBA. Fourth quarter DQs fell to 4.06%, which is down from 5.17% a year ago. The foreclosure rate ticked up to .25%. “The overall national mortgage delinquency rate in the fourth quarter was at its lowest level since the first quarter of 2000,” said Marina Walsh, MBA’s Vice President of Industry Analysis. “What’s even more noteworthy, the delinquency rate dropped from the previous quarter and on a year-over-year basis across all loan types and stages of delinquency. With the unemployment rate near a 50-year low, wage growth trending higher and household debt levels relative to disposable incomes at a 35-year low, homeowners are in great shape, and mortgage performance is quite strong.”

HomeStreet Bank is greatly reducing its footprint in the mortgage business, and has retained Keefe, Bruyette to sell its retail mortgage operations. MountainView will auction off the MSR portfolio. HomeStreet will not exit mortgages entirely, but it will move to more of a traditional mortgage business built around its bank branches. Interestingly, the divestiture comes after pressure from an activist investor. Banks have historically been pretty immune from shareholder pressure – hostile takeovers in the banking sector are rare events. it will be interesting to see if this starts a trend of shareholder activism in the sector. One of the best trades ever was holding onto the pieces of AT&T when it was broken up by the government in the 1980s. With so many banking giants, I wonder what would happen if, say, Bank of America decided to spin off Merrill Lynch and its mortgage business. Could the 3 parts be worth more than the sum? As the banking sector deals with its first secular bond bear market in 40 years, it may turn out that the strategies that worked in the bull market (consolidation) won’t work in a rising interest rate environment. Note that the Elizabeth Warrens of the world would likely push in this direction as well, which makes it conceivable we could see a return of venerable names like Salomon Brothers or Smith Barney, Chemical Bank, or Manufacturers Hanover.

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Vital Statistics:

Stocks are higher this morning as earnings continue to come in. Bonds and MBS are up.

We have some inflation data, with the consumer price index flat MOM and up only 1.6% YOY. Ex-food and energy, the index rose 0.2% MOM and 2.2% YOY. At the wholesale level, the producer price index fell 0.1% and 2% YOY. Ex-food and energy, the index rose 0.2% MOM and 2.5% YOY. Inflation remains under control, despite rising wage pressures which is a bit of a Goldilocks scenario, especially with respect to the Fed.

December retail sales were disappointing, falling 1.2%. The control group, which excludes volatile sectors like autos and building materials, fell 1.7%. This data was delayed by the government shutdown – we should be getting Jan numbers tomorrow.

Initial Jobless Claims rose to 239,000 last week.

It looks like Trump is going to sign the spending deal hashed out in Congress that provides some of the money he requested for the southern wall. He will continue to look for other options to get funding as well. Whether that includes declaring a national emergency to siphon fund from DOD is anyone’s guess.

Mark Calabria is set to testify before the Senate today as it considers his nomination to run FHFA, the housing regulator that oversees Fannie and Freddie. Calabria is a libertarian, and has questioned the government’s role in the mortgage market – particularly the support it gives the 30 year fixed rate mortgage, which is a distinctly American product which wouldn’t exist without government subsidies. Calabria has also been critical of the whole mortgage securitization market in general, believing that banks should hold (and service) more of their loans. The vote is expected to fall along party lines, with Republicans voting in favor and Democrats voting against.

The 30 year fixed rate mortgage is an anomaly that doesn’t exist anywhere else in the world that I am aware of. In most other countries, mortgages are adjustable rate, and banks hold them without government backstopping the credit. In other words, the borrower bears the interest rate risk, and the bank bears the credit risk. In the US, the lender bears the interest rate risk and the taxpayer bears the credit risk. Calabria has been critical of this product, arguing that it artificially inflates housing values which is a valid criticism. Of course the 30 year fixed rate mortgage isn’t the only subsidy out there – the tax treatment of mortgage interest is another, and flood insurance is another. These programs makes housing more affordable relative to incomes, which means it will be vulnerable to shocks. Does that mean these programs cause bubbles?  Not necessarily, since we have seen housing bubbles in several countries that don’t have these supports.

Mortgage delinquencies continue to fall, as the 30 day DQ rate hits the lowest level in 10 years. 30 day DQs fell from 5.2% to 4.1% over the past year, while foreclosures fell from 0.6% to 0.4%. CoreLogic CEO Frank Martell said, “On a national basis, we continue to see strong loan performance. Areas that were impacted by hurricanes or wildfires in 2018 are now seeing relatively large annual gains in the share of mortgages moving into 30-day delinquency. As with previous disasters, this is to be expected and we will see the impacts dissipate over time.”

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Vital Statistics:

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

It looks like a shutdown may be avoided, as Congress has come up with a plan to allocate some funds to a smaller, cheaper border wall than Trump was looking for. The President hasn’t committed to signing anything yet, but it looks like he will go along.

The labor market continues to be on fire, as the number of job openings hit 7.3 million, a series record. The number of job openings exceeds the number of unemployed by over 1 million. Construction led the increase with a jump of 88,000, some of which is probably seasonal. The quits rate was unchanged at 2.3%, although it increased for the private sector while decreasing for government. The quits rate is a leading indicator for wage growth.

Mortgage Applications fell 3.7% last week as purchases fell 6% and refis fell .01%.

Ellie Mae is being taken private in a $3.7 billion transaction. Private Equity firm Thomas Bravo will pay $99 a share for the stock, and has allowed a 35 day “go-shop” provision, which permits Ellie Mae to seek higher bids.

Small business optimism is returning to normal levels after spiking to all time highs in 2017 and 2018 according to the National Federation of Independent Businesses. Uncertainty in Washington, exacerbated by the lengthy government shutdown is making small business worried about the future. That said, they continue to hire, though they are more cautious about expansion plans.

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Vital statistics:

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

There is a possibility we could see another government shutdown at the end of the week. Talks over the weekend concerning border security funding went nowhere. For the financial industry, it will make funding loans for government employees more difficult, but everything else should be transparent.

Consumer staples companies are raising prices as commodity prices, transportation and labor costs increase. “The good news is that competitors are raising [prices] in those categories as we speak,” Church & Dwight Chief Executive Matthew Farrell said on a conference call last week when the company reported higher quarterly sales and lower profits. The Fed has been anxious to create more inflation, and it looks like they have finally succeeded. Does this mean we are headed for a repeat of 1970s inflation? Probably not – at least not in the near future. But it does mean the Fed Funds futures might be a touch too sanguine about monetary policy in 2019.

Speaking of inflation, we will get the consumer price index and the producer price index this week, which should be the only market-moving data.

Maxine Waters thinks the STI / BBT merger requires “serious scrutiny” “This proposed merger between SunTrust and BB&T is a direct consequence of the deregulatory agenda that Trump and Congressional Republicans have advanced,” Waters said in a statement to American Banker. “The proposed merger raises many questions and deserves serious scrutiny from banking regulators, Congress and the public to determine its impact and whether it would create a public benefit for consumers.” IIRC, all the “deregulaton” did was raise the ceiling for stress tests to $250 billion in assets. And that was due to the fact that many small banks were spending a lot on compliance and risk management for a portfolio of traditional bank loans. While it is entirely possible that someone at East Podunk Savings and Loan may blow himself up selling protection on a basket of CDO squareds, it is highly unlikely as well. And imposing all sorts of regulatory burdens on these banks under the guise of tackling systemic risk was on the wrong side of the cost / benefit ledger.

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Vital Statistics:

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

Initial Jobless Claims increased to 234,000 last week.

When was the last time we saw a big bank merger, at least one that wasn’t a shotgun wedding organized by the government? BB&T and Suntrust are merging in a stock-for-stock merger of equals. BB&T is already a player in the national mortgage market, while Suntrust is still more of a super-regional commercial bank. Bank mergers had a moratorium in the aftermath of the financial crisis amidst worries about too big to fail. Despite those concerns, the US banking system is probably the least concentrated in the world – most other countries have a handful of giants that dominate the market. Note as well for the Glass-Steagall nostalgics: the US was the only country in the world that separated commercial and investment banking, or even drew a distinction between the two.

The BEA has announced they will combine the first and second estimates for GDP and release them on Feb 28. Of course this assumes the government will be open on the 28th, which is not a given.

Older baby boomers aging in place is supposedly making it tougher for younger Americans to break into homeownership. That is an interesting theory, however I think older boomers are primarily concentrated in the move-up and luxury markets, especially since in the years after the crisis, the homebuilders focused on the only sector that seemed to be working – luxury and urban. Starter home supply is probably more of a function of the REO-to-rental trade, which should probably start being unwound.

The House Financial Services Committee is going to hold a hearing on credit scoring: “Who’s Keeping Score? Holding Credit Bureaus Accountable and Repairing a Broken System.” Not sure what the hot-button issues are, but they probably concern data security, fixing false information, and potential disparate impact issues.

House Democrats are introducing a bill to require lenders who originate more than 25 mortgages per year to release detailed reports to the government regarding the demographic data and quality of these loans. House Republicans raised the limit to 500 loans last year in an attempt to ease the regulatory burden on smaller lenders.

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Vital Statistics:

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

Donald Trump stressed bipartisanship and unity at the State of the Union address, and reiterated his demands for border wall funding but stopped short of invoking emergency powers to get one built. Predictably, the reaction to the speech fell along partisan lines.

Mortgage Applications fell 2.5% last week as purchases fell 5% and refis rose 0.3%. This was a disappointment given that rates fell about 7 basis points, however the prior week had the MLK holiday adjustment so maybe there is some technical adjustment noise happening. Despite lower rates on a YOY basis, applications are down about 2% annually.

The service sector continued to grow in January, albeit at a slower pace, according to the ISM Non-Manufacturing Report. Some of this may have been government shutdown-driven. Employment rose, while new orders fell.

Foreclosure starts in 2018 decreased to 576,000, the lowest level in 18 years. Foreclosure completions were 175,000, another 18 year low. These numbers are 40% below their pre-recession averages. Higher loan quality in the aftermath of the credit crisis is a contributing factor, however the performance of refinances are better than purchases, which also is driving these numbers.

Housing reform and CFPB regulations may be headed for a conflict if what is called the “GSE patch” is not renewed when it expires in 2021. The CFPB discourages loans with debt to income ratios above 43%, but also permits GSE backed loans to fall under the QM umbrella, even though they permit DTIs up to 50%. Roughly a third of GSE loans fall in the 43-50% DTI range, which could become non-QM loans once the patch expires. The Urban Institute recommends that the GSEs replace the DTI rule with a 150 basis point cap over APOR to determine eligibility under QM.

Home prices rose 0.1% MOM and 4.7% YOY according to CoreLogic. Since house prices have been rising faster than incomes, affordability has suffered. Falling interest rates masked that issue most of the post-crisis period, but the music has stopped. CoreLogic now estimates that 33% of the housing stock in the US is now overvalued.  Separately, Redfin now estimates that the West Coast is a buyer’s market.

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Vital Statistics:

Stocks are flattish this morning on no real news. Bonds and MBS are flat as well.

The upcoming week will be data-light, as is typical the first week of every month. Jerome Powell speaks on Wednesday, and that is about it. Productivity and costs on Wed could be interesting, but there just isn’t going to be much to move bonds.

The money for the government runs out on Feb 15 and we are back to a possible shutdown. Judging by the jobs report, it doesn’t appear the government shutdown had much (if any) effect on the overall economy. If we have another shutdown, we should probably see the same old situation of the inability to process VOEs for Federal employees, but that is it.

Rental prices for 1 bedroom apartments fell a couple of percent last year. Not sure about the methodology for the study, but it does comport with several other studies that show rental prices falling, at least in luxury areas. For the real estate sector, this is probably good news. One of the best post-crisis trades has been the REO-to-Rental trade, where professional investors and hedge funds purchased distressed foreclosures, fixed them up and rented them out. Cap rates in the aftermath of the crisis were high single digits, which were super attractive given the 0% interest rate environment. Tack on home price appreciation and you have a phenomenal trade. Unfortunately, phenomenal trades rarely stay that way, and between rising mortgage rates and falling rents, cap rates are getting squeezed, and it might be time for some of these investors to exit the trade. Ultimately that means we should see a lot more starter homes for sale which will alleviate the inventory problem we are currently experiencing.

Bill Gross is retiring from money management. The Bond King ruled the Great Bond Bull Market of 1982 – 2016 and is stepping out as we head into what should be a decades-long secular bear market in bonds.

Fannie and Fred will be released from Federal conservatorship subject to tight market-share restrictions under a new plan released by Senate Republicans. Fan and Fred would retain their role as mortgage guarantors, and would be subject to competition. “We must expeditiously fix our flawed housing finance system,” Crapo, an Idaho Republican, said in a statement. “My priorities are to establish stronger levels of taxpayer protection, preserve the 30-year fixed-rate mortgage, increase competition among mortgage guarantors and promote access to affordable housing.” That is a tall order and pretty much forecloses any sort of radical change of the housing finance system. If the social engineering aspect (affordable housing) and the subsidies (30 year fixed rate mortgage) will remain, we are pretty much looking at the same system we had pre-bubble. The model that seems to have gained the most traction is putting the government in the second-loss position, with PMI taking the first loss position. It would represent a bit of a step of re-introducing free market economics in what is one of the most nationalized housing finance systems on earth.

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Vital Statistics:

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

Jobs report data dump:

• Nonfarm payrolls up 304,000
• Labor force participation rate 63.2%
• Unemployment rate 4%
• Average hourly earnings up 3.2% YOY
• Employment-population ratio 60.7%

Overall, an exceptionally strong report. The uptick in payrolls was almost double the market expectations, and the government shutdown had no appreciable effect (Furloughed employees were counted as “employed” by the survey.  The uptick in wages probably knocked bonds down a touch, but we have been seeing real wage gains in the employment situation report and the employment cost index. Sad trombone for partisans and the business press rooting for a shutdown-depressed report.

The unemployment rate has been rising, but that is actually good news as it means more and more of the long-term unemployed are being drawn back into the labor force. The labor force participation rate is a bit of a nebulous number because people who have been unemployed for a long time may not count as unemployed. The employment-population ratio is a much better measure, although you have to deal with demographic noise. The employment-population ratio rose 0.1% to 60.7%. A year ago it was 60.2%. While that is much higher than the 58.5% we saw at the depths of the Great Recession, it is still lower than the 62% – 63% pre-crisis level. Retiring baby boomers are being replaced by Millennials, but there is a lag.

New home sales rose to a seasonally-adjusted average of 657,000 in November. The new home sales number is extraordinarily volatile – it is up 17% from October, but down 8% from a year ago – but it is somewhat encouraging as we head into the spring selling season, which despite the polar vortex upon us, unofficially starts about now.

Employment compensation costs rose 0.7% in the fourth quarter, as wages and salaries rose 0.6% and benefit costs rose 0.7%. For the prior 12 months, employment compensation costs rose 2.9%, with wages and salaries rising 3.1% and benefit costs rising 2.8%. With core inflation stuck around 2%, we are seeing over 1% real wage growth, which is strong indeed.

Wapo published a story about Trump possibly naming erstwhile R politician Herman Cain to the Fed. Cue the snide jokes: Can’t wait for his 3-3-3 plan: 3% Fed funds rate, 3% interest on excess reserves, 3% of QE portfolio runoff per year. In all seriousness though, he ran the Kansas City Fed from 92-96. So what appears at first to be an applause line in fact might not be. That said, these jobs generally go to academics and he is not one.

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Vital Statistics:

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

The FOMC held interest rates steady at their January meeting. The statement was taken as dovish, but it is hard to read much into it. The Fed noted that job gains and household spending was “strong” while inflation remained “muted.” They said they can remain “patient” with respect to future moves. In his press conference, Powell mentioned there was talk about slowing the pace of balance sheet reduction, which will make interesting reading once the minutes come out. Bonds initially yawned at the decision, but picked up momentum throughout the afternoon to close on their highs.

The Fed funds futures cut the probability of another hike in 2019 from about 19% to 10% and bumped the probability of a cut up to 12% as well. The consensus remains no changes for all of 2019 however.

Mortgage applications fell 3% last week as purchases fell 2% and refis fell 6%. There is some noise from the MLK Birthday holiday. Rates were largely unchanged.

The economy added 213,000 jobs in January, according to the ADP jobs report. This was well above expectations and is much higher than the 158,000 estimate for tomorrow’s jobs report. So far, it looks like the government shutdown didn’t spill over into the real economy, which makes sense – it was only a partial government shutdown – and the whole thing was more about tribal signalling than anything else.

Pending Home Sales fell 2.2% in December, according to NAR. Year-over-year contract signings were down 10%, which is the 12th consecutive month of declines. All geographies saw a drop, with the South being affected the worst. Blame higher rates and home prices which are decreasing affordability.

FINRA has again delayed the implementation of Rule 4210, which mandated risk limits and margin requirements for TBA transactions, spec pools, and CMOs. The net effect will be to increase liquidity for smaller mortgage originators. The rule has been delayed until March 2020. The rule treats mortgage originators (who hedge their pipeline with TBAs) the same as hedge funds who speculate in commodity contracts, which doesn’t make a lot of sense.

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Vital Statistics:

Stocks are higher after good numbers out of Apple. Bonds and MBS are flat.

The FOMC announcement is scheduled for 2:00 pm EST. Nobody expects the Fed to make any changes to the Fed Funds target rate, but there is talk that the Fed might announce an early end to balance sheet reduction. Note there will be a press conference after the announcement – apparently Powell will hold one after every meeting, unlike Janet Yellen who only held them after the Mar, Jun, Sep and Dec meetings.

Pulte reported fourth quarter numbers that disappointed the Street, but the 11% drop in orders is what got everyone’s attention. Gross margins also fell. The company said that traffic decreased YOY in October and November, but rebounded in December. That said, the company said there is less certainty about demand heading into this spring selling season than the industry has experienced in recent years. The stock was down about 6% early in Wed trading.

Home price appreciation continues to slow, according to the Case-Shiller Home Price Index. Prices rose 5.2% YOY, down from 5.3% the prior month. “Home prices are still rising, but more slowly than in recent months,” says David M. Blitzer, Managing
Director and Chairman of the Index Committee at S&P Dow Jones Indices. “The pace of price increases are being dampened by declining sales of existing homes and weaker affordability. Sales peaked in November 2017 and drifted down through 2018. Affordability reflects higher prices and increased mortgage rates through much of last year. Following a shift in Fed policy in December, mortgage rates backed off to about 4.45% from 4.95%. Housing market conditions are mixed while analysts’ comments express concerns that housing is weakening and could affect the broader economy. Current low inventories of homes for sale – about a four-month supply – are supporting home prices. New home construction trends, like sales of existing homes, peaked in late 2017 and are flat to down since then. Stable 2% inflation, continued employment growth, and rising wages are all favorable. Measures of consumer debt and debt service do not
suggest any immediate problems.”

The Trump Admin poured cold water on the notion that they would release Fannie and Fred from government control without Congressional involvement. Earlier in January Joseph Otting, head of the FHFA said:  “The Treasury and White House viewpoint is that the [FHFA] director and the secretary of Treasury have tremendous authority and that they would act, I think, independent of legislation if they thought it was the right thing to do.” This was taken as bullish for the stocks, sending Fannie Mae up from about $1.00 at the end of 2018 to close to $3.00. Since housing finance reform is going to be politically difficult, investors have been betting that the government would be more likely just to recapitalize and release the GSEs.

Freddie Mac’s survey is out for 2019. They anticipate one more Fed Funds rate hike, and think mortgage rates will average around 4.7% and GDP growth will slow to 2.5% in 2019 and 1.8% in 2020. They anticipate a slight uptick in housing starts, to 1.3 million per year, which is still well below the historical 1.5 million level. Home price appreciation is set to decelerate as well, to 4.1%. Mortgage originations are expected to finish 2018 at $1.6 trillion and increase to $17 trillion next year.

Home prices are falling in Silicon Valley – the first YOY declines since 2012. In San Jose, prices fell 8%, although they are so high – the median price is almost a million – that they are probably still overvalued by a wide margin. What is driving this? Believe it or not, the stock market. Many buyers rely on stock compensation to make the downpayment, and with the FAANG stocks having sold off, that is getting harder to do. Second, high house prices have made people reluctant to move there – after all a high salary is not as enticing if you end up giving it all back in rent or mortgage payments.

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