All Things in Moderation

Stocks are flat this morning as the East Coast braces for Hurricane Florence. Bonds and MBS are flat.

Mortgage Applications fell 1.8% during the Labor Day week as purchases increased 1% and refis fell 6%. The refi index is now at an 18 year low. We saw a 5 basis point increase in rates, which drove the drop in refis. As rates rise, cash-outs, fixed-for-ARM, and FHA for conventional are about the only game in town.

Despite tariffs and increases in raw materials prices inflation at the wholesale level remains under control. The producer price index fell 0.1% last month but rose 2.8% on an annualized basis. Ex-food and energy, the number was down 0.1% MOM and up 2.3% YOY. So, despite the increase in wages we saw in the jobs report, inflation overall remains subdued.

Yesterday’s JOLTs report showed the quits rate (which is considered a leading indicator for wage inflation) hit the highest level since early 2001. Construction job openings increased to set another post-bubble high. Hurricane Florence will only exacerbate the labor shortage as workers get drawn into repair jobs. This probably means disappointing housing starts numbers for the rest of the year.

Below is a chart which shows that average hourly earnings and the quits rate tend to correlate pretty closely.

Here are some things that homeowners in the path of Florence can do in order to prepare for impact. Note that the hurricane is expected to stall out once hit hits land, so you should expect some flooding inland. Servicers should prepare for an uptick in delinquencies.

Redfin has a good retrospective on the top lasting impacts from the financial crisis. Probably the biggest surprise was that a leftist president presided over a huge jump in inequality. Given that Fed policy in the aftermath of the crisis was aimed at supporting asset prices, this shouldn’t be a surprise. The other big surprise was the complete drop off in housing construction despite a tight housing market. 10 years down the road, it is still a head-scratcher. Everyone has a theory about the driver, from gun-shy builders, to labor shortages, to zoning restrictions. The places where the demand is greatest (CA and Seattle) have tight restrictions on building, and such an expensive market that businesses are relocating somewhere cheaper. On the other side of the coin, the Rust Belt is growing again, and that area has a surfeit of housing already built.

Stocks are lower this morning on trade and weather fears. Bonds and MBS are continuing their post jobs-report sell-off.

Job openings hit a record high in July, hitting 6.9 million, according to the JOLTS survey. Job openings increased in finance and insuring, but fell in retail and government. The quits rate increased to 2.4%, the highest level since 2001.

Small business optimism set a record last month, hitting 108.8 and beating the previous high set in July 1983. The number of businesses saying it is a good time to expand hit a high, and plans for capital expenditures and inventory investment also hit pre-crisis highs. The NFIB index had a discontinuous jump upward starting in late 2016, but that was primarily driven by expectations of hiring and investment. Now the index is being driven higher by actual hiring and investment and that is driving GDP growth. Labor shortages continue to be a problem.

Same store sales continued their recent strength, rising 6.3% last week. All of this points to a strong Q4.

Signs of building wage pressures? Leaders for the United Steelworker’s Union are demanding pay increases as steelmakers get a profit boost from tariffs. They are targeting US Steel and Arcelor Mittal. Steel prices are up 30% – 40% this year, which is boosting profits. This issue of course is that these increases will probably prove to be temporary as the tariffs are a negotiating tool. That said, expect to see more of this as the labor market tightens. US Steel has offered the union a 4% wage increase next year, and 3% the following two years. After that, base pay will increase by 1%, but profit-sharing bonuses will be implemented.

Finally, a note on 9/11

I was on the trading floor at Bear, Stearns in London. It was just after lunch. A headline went across Bloomberg saying a plane had hit one of the WTC towers. CNBC mentioned the story as well, but no one was thinking “terrorism.” I emailed one of my friends at Merrill Lynch (right across the street at the World Financial Center) and he wasn’t even aware of what happened. The European markets were down a bit on the day, but didn’t really react to the first hit.

By the way, I am still searching for a senior capital market role at a mortgage bank. If anyone is hearing of anyone looking, I would appreciate the head’s up.

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

In terms of economic data, we will get CPI and PPI on Wed and Thursday and retail sales on Friday. There will be little in terms of Fed-speak. The Fed Funds futures continue to up the probability of a Dec hike (Sep is in the bag), which is now sitting at 79%.

We are coming up on the 10 year anniversary of Lehman’s collapse. Expect a lot of handwringing articles about whether we are set up for another collapse (we aren’t). Residential real estate bubbles are rare events (the previous one was in the 1920s) and the psychological basis for bubbles to inflate requires decades and decades of bull markets to build up that sort of complacency. Not saying that we can’t see pockets of decline, but a broad-based drop of 20% or more? Highly unlikely.

Boston Fed President Eric Rosengren would like to see two more rate hikes in 2018 as the economy strengthens. He sees the economy expanding at a 3% pace for the rest of the year, and believes the Fed needs to keep going: “Going beyond just the next two hikes, I see no reason why we wouldn’t want to be at a more normalized rate, given the economic conditions we currently have, unless something changes dramatically that we’re not anticipating.” He also advocated that the Fed impose the counter-cyclical buffer, which requires banks to set aside additional capital in good times to draw upon when credit tightens.

Hurricane Florence is looking more and more likely to hit the East Coast, with North and South Carolina as the center of the projected path. It is expected to reach the coast late Thursday night / early Friday morning. Lots of areas are already waterlogged so flooding will be an issue even inland.

Canada sees reasons for optimism in NAFTA discussions and thinks we could see a deal. Any major changes will require legislation, but a tweak here and there will allow Trump to declare victory and move on.

Interesting map of the average age of homes in the US. In the Northeast, the average age of an owner-occupied home is over 50 years. Most of these MSAs have been losing population over the past 10 years.

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

Jobs report data dump:

• Payrolls up 205,000
• Unemployment rate 3.9%
• Average hourly earnings up 2.9%
• Labor force participation rate 62.7%

In response to the jobs report, the December Fed Fund futures raised their 2 hike probability to 75%.

The Trump administration continues to hammer out a trade deal with Canada and Mexico. Separately, the deadline passed for an additional 200MM in Chinese tariffs, which means he can implement them at any time.

Rep. Jeb Hensarling penned an editorial in the Wall Street Journal yesterday, where he laid out a framework for dealing with the GSEs. His solution will be to run everything through Ginnie Mae, with private capital taking the first loss position, and the taxpayer taking a catastrophic loss position. It would create a common securitization platform and still maintain some sort of affordable housing fund. Originators would have to get a private credit enhancer to guarantee the loan. The private credit enhancer would have to be market-based and have a bank-like balance sheet. Note that this is the first bipartisan housing reform bill, which means we may be getting closer to having the political will to de-nationalize the US mortgage market.

Skilled construction labor is hard to find. 83% of builders report some sort of shortage for rough carpenters. It is even worse for subcontractors. With those sorts of shortages, we should see wages accelerate. It is inevitable. The 9-occupation trade shortage is as big as it has ever been.

Stocks are flattish despite the continued rout in emerging markets. Bonds and MBS are down small.

Lots of labor market data this morning.

Initial Jobless Claims fell to 203,000, which is the lowest level since late 1969. That said, job cut announcements did pick up, according to the Challenger and Gray job cut report.

Productivity came in at 2.9% in the second quarter, according to BLS. This was driven by a 5% increase in output and a 2% increase in hours worked. Unit Labor costs fell 1% as compensation increased 1.9% and productivity increased 2.9%. The jump in productivity is important, not only because it generally portends higher wages, but because it portends non-inflationary wage inflation, which will allow the Fed to continue on its slow interest rate hike path.

The economy added 163,000 jobs in August, according to the ADP report. This is below the Street’s 195,000 estimate for tomorrow’s employment situation report. This is the lowest number in a year. Despite the slowdown, Mark Zandi, chief economist of Moody’s Analytics, said, “The job market is hot. Employers are aggressively competing to hold onto their existing workers and to find new ones. Small businesses are struggling the most in this competition, as they increasingly can’t fill open positions.”

The WH says that wages are growing faster than traditional measures would indicate. The Administration is saying that real wage growth is in the 1.4% to 1.9% range. According to BLS, nominal (non-inflation adjusted) wage growth has been around 2.7%, and with the CPI running at 2.9%, that would imply slightly negative wage growth. What is the difference? First of all compensation includes more than simply wages. It also includes benefits and health care costs have been increasing at well above the rate of inflation. This is a valid (albeit unsatisfying) point. Second, a lot depends on which inflation index one uses. The Personal Consumption Expenditure Index is the one preferred by the Fed and it generally runs slower than the CPI. This is due to a number of reasons, but the primary one is that the PCE takes into account the substitution effect and CPI doesn’t. In other words, the CPI assumes that people’s behavior doesn’t change when presented with increased prices, while the PCE assumes that people will consume less high priced goods and consume more low-priced goods. The classic example of this is that when meat prices rise, people eat more vegetables. Another difference is that PCE looks at costs from the business sense more than CPI does. This is important in wages, because the cost of an employee to an employer is more than just the paycheck. CPI generally ignores this, while PCE takes it into account. Punch line is that partisans are going to cherry pick the inflation index they want in order to push their interpretation of events. Left econ wants to push the narrative that wages are going nowhere and the headline CPI number gets them there. Right econ / the Admin will prefer to use PCE, which shows real wage growth.

Trump administration officials are denying they wrote an anonymous op-ed published in the New York Times that describes cabinet members trying to steer a mercurial executive to do the right things and to blunt his worst impulses. There has been plenty of evidence that has been the case already, especially on trade. Regardless, it just seems to be the latest in the war between Trump and the press, and the markets don’t seem to care.

On the trade front, today is the deadline for public comment on some $200 billion in new tariffs on Chinese goods. Trump is expected to impose these tariffs once the period is over. He also made comments regarding NAFTA and Canada, saying there has been progress on the issue.

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

The highlight of the upcoming week will be the jobs report on Friday, although we will get a lot of Fed-speak on Wednesday. Productivity and costs on Thursday will be an important report as well.

Construction spending rose 0.1% which was lower than the Street 0.4% expectation. Residential construction rose 0.6% MOM and 6.6% YOY.

Manufacturing expanded in August, according to the ISM PMI Index. The August PMI increased 3.1% to 61.3, driven by increases in production and new orders. Employment rose as well. Many of the participants noted that trade is injecting some uncertainty into their business, especially with respect to price negotiations with suppliers. The reading of 61.3 is unusually strong, and is typically associated with 5.6% GDP growth.

The OCC is asking for input regarding the CRA and modernization. “As a long-time banker, I have seen firsthand the benefit of CRA investment and how it makes communities vibrant. I applaud the effort of community development practitioners and bankers who work together to make an important difference in our nation’s neighborhoods,” said Comptroller of the Currency Joseph M. Otting. “I have also seen how limitations in the current CRA regulation can fail to provide consideration to a bank that wants to lend and invest in a community with a need for capital, including many low- and moderate-income areas. Unfortunately, the operation of the current CRA regulation can result in restricted resources. It is time for a national discussion on how we can make the CRA work better.”

Donald Trump was jawboning Canada over trade and threatening China with $200 million in higher tariffs. I think markets are pretty much shrugging off trade threats any more. Note that Trump will need legislation to carry out some of the changes he wants to make with Canada, which isn’t going to happen.

Home prices increased 0.3% MOM and 6.2% YOY in July, according to CoreLogic. They are forecast to rise about 5% over the upcoming year. We are seeing sellers in the hot markets decide to pull properties off the market to see if they can ride the home price appreciation for a bit longer. This is adding to the supply crunch. CoreLogic’s model always seems to predict a slowdown in home price appreciation that never seems to materialize.

An interesting tidbit – the median lot size fell to 8.560 square feet in 2017 (about 1/5 of an acre). Lot sizes had been trending downward, but climbed during the bubble years as more and more building was done in the exurbs. New England has the largest lot sizes at about 0.4 acres, while the left coast has the smallest (.15 acres). Note this study is only looking at single family spec homes. It looks like this is basically a secular trend, and the the bubble years (building in the exurbs) was largely a blip. It also could be a function of building activity being dominated in regions (like the West Coast), where lots are smaller.

The ultra-high end luxury market has been getting whacked as foreign investors step away. Changes in tax laws might be having an impact, but it could have also been driven by overbuilding at the top end. I suspect it is the latter, since we are seeing softness in states like Florida which benefit from the tax law.

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

Donald Trump is suggesting that a new NAFTA could be in place by the end of the week. One sticking point is removing a provision that inhibits the US from pursuing anti-dumping and anti-subsidy cases. Mexico has agreed, but Canada is still fighting it.

Initial Jobless Claims slipped 1K to 213,000 last week.

Personal incomes rose 0.3%  and personal spending rose 0.4% in July, which was right in line with estimates. The PCE inflation index came in at 0.1% MOM / 2.3% YOY, and the core PCE index rose 0.2% MOM / 2.0% YOY. Inflation is pretty much right at the Fed’s target, which means they don’t have to move quickly to increase rates and can still just gradually lift off the lower bound.

A Reuters poll of real estate experts suggests that home prices will rise 6% this year and then begin to taper off the growth. Limited inventory has pushed up home prices well in excess of wage growth and inflation over the past 6 years. That sort of phenomenon can work when interest rates are falling, as the lower mortgage payment offsets the higher prices, but that game is over.

Congress is entertaining legislation that will make it easier for self-employed borrowers to get a mortgage. The bipartisan “Self-Employed Mortgage Access Act” will address the needs of borrowers who don’t have traditional W-2 income. Sponsor Mark Warner said: “An increasing number of Americans make their living through alternative work arrangements, like gig work or self-employment. Too many of these otherwise creditworthy individuals are being shut out of the mortgage market because they don’t have the same documentation of their income – paystubs or a W-2 – as someone who works 9-to-5. This bill will allow these workers to supply other forms of paperwork to verify their income while continuing to protect consumers from predatory lending.” The bill will expand the universe of income documentation to allow these borrowers to fall under QM. The bill is supported by the MBA and the Consumer Federation of America.

The Great Recession left what looks to be a permanent gap between potential GDP and actual GDP, which amounts to something like $70,000 per person. You can see the output gap in the chart below. Interestingly, the word “bubble” appears nowhere in the article – it is as if the financial crisis appeared out of nowhere, which certainly demonstrates a blind spot for the Fed (and central bankers in general).

They don’t take into account that the trajectory of growth (beginning in 1998 through 2006) was artificially boosted due to increasing asset prices. The trajectory begins with the stock market bubble and ends with the real estate bubble. Granted the late 90s growth was also influenced by a boom in productivity, but that ended soon after. I always find it interesting that central bankers believe “too much money chasing too few goods” (i.e. inflation) is a monetary phenomenon, but “too much money chasing too few assets” (i.e. asset bubbles) is not.

Stocks are flat this morning after GDP came in better than expected. Bonds and MBS are down small.

Mortgage Applications fell 1.7% last week as purchases fell 1% and refis fell 3%. This is despite a drop in rates.

Second quarter GDP was revised upward to 4.2% from 4.1%, which was higher than the street estimate of 4.0%. The main revisions were to consumption (downward) and fixed residential investment (upward). Inventories were a drag on GDP, which means that we should see a bump to Q3’s numbers. The GDP price index was also revised up a touch, from 1.8% to 1.9%. All of this provides a good environment for the Fed to ease back from the zero bound.

Mortgage bankers made $580 per loan in the second quarter, an increase from $118 in the first quarter. Banks cut costs aggressively (dropping production costs per loan by about $1,000) however declining volumes offset that, and this turned out to be the weakest quarter since the MBA began keeping records in 2008. That $580 represents a profit of 21 basis points per loan, which was a drop form 24 bps a year ago. Fee income dropped to 341 bps from 370 in the first quarter. Refis continue to decline, with purchases accounting for 81% of all volume.

Here is something wild. Last night, there were no trades in the JGB market (the world’s second largest bond market). This is the 7th time this has happened this year. The Bank of Japan basically controls the market, and trading has dried up. We live in interesting times, at least if you are a central banker.

Pending Home sales fell 0.7% in July, according to NAR. Lawrence Yun, NAR chief economist, says the housing market’s summer slowdown continued in July. “Contract signings inched backward once again last month, as declines in the South and West weighed down on overall activity,” he said. “It’s evident in recent months that many of the most overheated real estate markets – especially those out West – are starting to see a slight decline in home sales and slower price growth.” Blame tight supply, which has driven up prices to unaffordable levels.

The housing slowdown has not been lost on the stocks of the homebuilders, who despite strong earnings (and an incredibly strong stock market) are down 14% YTD. At some point, the sector will be unable to rely on increasing ASPs and will have to pump up volume to show growth. Despite the clear need for new housing, especially at the starter level, builders seem content to meter their growth and plow excess cash into buybacks.