All Things in Moderation

Vital Statistics:

Stock futures are largely flat this morning as many overseas investors are on holiday. Bonds and MBS are flat as well.

Bond yields have broken decisively to the downside over the past week as international tensions escalate. North Korea’s failed missile launch, combined with developments in Syria have sent bonds and gold higher. The 10 year yield is at the lowest level since mid-November.

While international tensions have certainly played a part in the bond rally, weak retail sales and inflation data have as well. The Fed Funds futures are now factoring a less-than-50% probability of a June rate hike, down from a 2/3 probability only a week ago.

Business conditions softened in New York State last month after the Empire State Manufacturing Survey fell after two unusually strong months. We are starting to see bottlenecks in the supply chain. Employment rose.

Homebuilder sentiment slipped slightly in April, however sentiment remains strong.

Jamie Dimon of JP Morgan took aim at regulations in his annual letter to stockholders. He was especially critical of the FHA’s use of the False Claims Act to hammer lenders who commit unintentional clerical errors but had no intention of committing fraud. This has caused FHA lending (which is the only game in town for subprime borrowers) to become restricted, especially at the big banks. He also called for new uniform standards for mortgage servicing. The cost of servicing delinquent loans has skyrocketed, and this has caused lenders to further restrict credit. JPM estimates that $1 trillion in additional lending could have increased GDP by half a percentage point.

Rep David Kustoff penned an editorial at CNBC calling for a reform of Dodd-Frank, especially in how it affects smaller community banks. The regulatory burden that was imposed on the system is more easily borne by the JP Morgans and the Wells Fargos of the world than it is by the smaller banks who are the lenders to small business. There is a general bipartisan consensus in DC that something needs to be done to give the smaller lenders some relief, however the political environment is so entrenched and partisan that it is hard to imagine much getting done legislatively.

The MBA sent its proposals to the Senate. The first one includes a request for more clarity from the CFPB, while the second includes a suggestion to widen the QM safe harbor to all loans that satisfy the QM rule and to increase the ceiling for small loan status under QM to $200k from just over $100k now. The remainder of the suggestions largely concern capital requirements for banks and servicing.

Median house prices rose 7.5% to $273,000 according to RedFin. Sales growth was also up a strong 8.9%. Inventories were down 13%, however. The typical home went under contract within 49 days, which is pretty fast for a March. The average sale to list price was 93.7%, which was a decrease. Perhaps the bidding wars in the hottest markets are cooling off a bit. Note this statement by a real estate agent:

“As a seller’s agent, the first thing I do when I receive an offer is ask who the lender is. The best offers come from buyers who are pre-approved by a local lender with a strong reputation for speed and reliability. If I’ve worked with the lender before and know they can fund the loan and close on time, I am sure to highlight that for my client.” — Tiffany Aquino, Redfin Agent in Woodbridge, VA

The Fed is assembling its plan to shrink its portfolio of Treasuries and mortgage backed securities, and may actually begin the process this year. The Fed currently owns just under $2 trillion in mortgage backed securities, and we could see that number cut in half over the next decade, according to a paper released in January. The big question for MBS holders is whether they will stop reinvesting maturing proceeds all at once or whether they will phase that in. Given that QE didn’t materially affect MBS spreads when it was implemented, it is hard to imagine tapering re-investments will make much of a difference either.

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Vital Statistics:

Stocks are lower this morning after a surprisingly weak jobs report. Bonds and MBS are up.

Jobs report data dump:

• Nonfarm payrolls up 98,000. Expectations were for 175k so this is a huge miss
• Unemployment rate down to 4.5%
• Employment to population ratio increased to 60.1%
• Average hourly earnings up 0.2% MOM and 2.7% YOY
• Labor force participation rate flat at 63%

Part of the payroll miss could be explained by bad weather in the Northeast and the Midwest in March. We saw jobs increase in professional and business services while payrolls contracted in retail. The labor force increased by 145k, while the number of employed people increased by 472k and the number of unemployed fell by 326k. The number of involuntary part time employees (people who would like a full time job but can only get a part time one) fell, as did the number of long term unemployed and discouraged workers. While the payroll number will garner all the attention, the internals of the jobs report show the slack is being used up in the labor market, so it isn’t as bad as it initially appears.

The Fed Funds futures took down their probability of a June hike from 71% to 66% on the jobs report.

Two things happened yesterday which could push bond yields lower. First the US attacked air bases in Syria in retaliation for using chemical weapons. International tension is almost invariably bond bullish as investors put on the flight to safety trade. The other is the Democratic filibuster of Neil Gorsuch. This probably forecloses any sort of possibility for bipartisan legislation, particularly stimulus plans or tax cuts. In fact, the debt ceiling battle could become an epic game of chicken as the government is rapidly running out of borrowing capacity. While the second scenario is not necessarily bond bullish the first one definitely is.

Fannie Mae’s Home Purchase Sentiment index fell last month as high prices and low inventories take their toll. The number of people who think it is a good time to buy fell by 10 percentage points while the number tho think it is a good time to sell rose by 9 percentage points. People are less bullish on their economic future as well.

Neel Kashkari disputes Jamie Dimon’s assessment of the regulatory environment for banks, citing the Fed statistic that there is a 70% chance of a bailout in the next century.  Jamie Dimon declared the era of too big to fail is over, while Kashkari disagrees. Forecasting banking scenarios over a 100 year time period is probably a fool’s errand. I wonder what banking regulators thought in 1917 (The Fed had only been established a few years earlier). Kashkari is a bit of a regulatory hawk and thinks the capital standards should be doubled.

San Francisco Fed President John Williams says it should take about 5 years for the Fed’s balance sheet to shrink to a normal level once they start reducing it. Of course the open question is “what constitutes normal?” Prior to the financial crisis, the Fed’s balance sheet was under $1 trillion. It is now pegged at $4.5 trillion.

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Vital Statistics:

Stocks are lower this morning after the FOMC worried about stock prices. Bonds and MBS are down small.

Job cuts rose 17% in March, according to outplacement firm Challenger, Gray and Christmas. Telecom and retail were the two main sectors to trim staff. Note that this report only measures announced job cuts (in press releases), not actual job cuts. We are still seeing losses in the energy patch, however it is much slower than the past two years when we lost over 200k jobs.

On the other side of the coin, hiring announcements continue to hit records, with the Home Despot announcing 80,000 seasonal hires in March.

Initial Jobless Claims fell to 234k last week, while the Gallup Good Jobs index improved. The drop in initial jobless claims was the most in 2 years.

The FOMC minutes showed the Fed is beginning to discount the possibility of a big Trump fiscal expansion. The failure of health care reform means that the available resources for a big infrastructure spend or tax cuts is much less. The Fed also discussed what to do with their $4.5 trillion balance sheet, and how to go about shrinking it. The terms “gradual” and “phase out” were used, which means they probably aren’t going to stop reinvesting maturing principal all at once and will perhaps take a couple of meetings to see how it goes. The Fed’s fear is that the additional contractionary effects of reducing the balance sheet along with rate hikes will be too much and push the economy into a recession.

The staff also noted that stock values are above historical norms, which is undoubtedly another reason for them to go slowly. The worst-kept secret in financial markets is that the Fed targets asset prices and uses them to guide policy.

Goldman Chief Economist Jan Hatzius says that reducing the Fed’s balance sheet is probably a good step to clear the decks for whoever will be the new Fed President ahead of the end of Janet Yellen’s term in early 2018.

The left has set up a new website to keep track of HUD and what they are doing. They want to ensure that affordable housing targets don’t fall by the wayside as HUD works on housing reform. Given the tight housing inventory these days, affordable housing is a huge need.

Donald Trump economic adviser Gary Cohn supports some sort of return to the Glass-Steagall days, where consumer banking is separated from the underwriting and trading functions of investment banks. Some Senators and policy types were surprised to hear a Wall Street type advising that. The conversation regarding deposits will be further complicated by the emerging fintech sector which wants access to those deposits as well.

The Senate is expected to exercise the nuclear option today and eliminate the filibuster for Supreme Court nominees. Neil Gorsuch will probably be confirmed on Friday.

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Vital Statistics:

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

The minutes from the FOMC meeting are coming out at 2:00 pm EST today. Investors will be focused on plans to shrink the balance sheet and also any sort of discussion about DC. Be careful locking around that time – we could see some volatility.

Richmond Fed President Jeffrey Lacker resigned yesterday for making unauthorized disclosures to a consulting firm owned by the Financial Times. Lacker was a non-voter, so it should make no difference to monetary policy.

Mortgage applications fell 1.6% last week as purchases rose 1% and refis fell 4%. Refis fell to 42.8%, the lowest since October 2008.

The ADP jobs number came in at 263,000 which means we should expect a strong employment situation report this Friday. The Street is predicting 178,000 jobs were added in March. Construction added 49k jobs while IT lost 10k. This is the third month in a row with more than 240k jobs added:

The Gallup US Job Creation index also hit a new high. The US PMI Services index fell however. The ISM Services index fell as well.

Don’t forget, we are exiting Q1, which for some reason has been a weak quarter for over a decade. If past trends hold, we should be seeing a pickup during the spring and summer.

Jamie Dimon weighed in on banking regulation in JP Morgan’s annual letter to shareholders. The system is much safer today than it was in 2008, however he argues that many of the regulations put in place were hastily drawn up and should be reviewed. He mentioned that new regulations surrounding mortgage lending have raised costs to consumers and restricted lending to people with low credit scores needlessly. Interesting comment since JP Morgan pretty much got out of the FHA business years ago.

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Vital Statistics:

Stocks are lower this morning after auto sales disappointed. Bonds and MBS are up.

Factory orders rose 1% last month, in line with expectations.

US economic confidence decreased last week, according to Gallup, however confidence is still strong. Meanwhile, consumer spending was flat.

These data points (economic confidence, consumer spending, and auto sales) illustrate the conundrum we have been seeing for the past few months: soft data like confidence and ISM reports show a strong economy, while the hard data like sales have been showing a mediocre economy. Much of this is Washington-driven as investors realize that Trump will have a difficult time pushing through his agenda in the face of unified Democratic opposition and a Freedom Caucus that wants less government, period. Unrealistic expectations are being brought back to Earth. Despite gridlock, much is being done on the regulatory front and with executive orders which don’t require Congressional approval. That will help. But there seems to be a shift in the psychology of investors: the markets seem to be worrying less about the Fed and worrying more about tepid growth. Bonds have noticed as well, with the 10 bond yield down about 30 basis points over the past 3 weeks.

Home prices rose 7% YOY in February, according to CoreLogic. We are seeing the highest price appreciation at the lower price points. The first time homebuyer is getting hit with a double-whammy of higher prices and borrowing costs.

Housing’s share of GDP came in 15.6% in the fourth quarter. Historically, that number has been around 18%. Housing continues to punch below its weight, as evidenced by tight inventory. It is hard to know exactly why homebuilding continues to be weak – credit is an issue, as is the general post-bubble caution, along with local land use regulations.

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Vital Statistics:

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

The ISM Manufacturing Report ticked up slightly in March. New orders and production slipped while employment gained. Prices rose as well. The reading of 57.2 would correspond historically with about a 4.4% increase in real GDP.

Construction spending rose 0.8% MOM in February and is up 3.0% annualized. Residential construction rose 1.8% MOM and is up 6.3% YOY.

We have a relatively news heavy week coming up with the FOMC minutes and the jobs report. We will also get the ISM data this week.

This week will give will also be important politically. Republican Supreme Court nominee Neil Gorsuch will be voted on in the Senate. Minority leader Chuck Schumer has demanded a 60 vote threshold to confirm him (here is the current state of affairs there), and Mitch McConnell has said Gorsuch is getting confirmed one way or the other, which is a threat to change Senate rules on judicial nominations (the nuclear option). If the Democrats filibuster Gorsuch and McConnell changes the rules, it pretty much poisons the well for any sort of bipartisan legislation like health care reform, tax reform, or financial reform. This would be good for rates at the margin.

Cash-out refinances are about 44% of all refis these days, which is a pickup from the depths of the bubble, but nowhere near the heady times of the bubble years where people used cash out refis to fund consumption. Today, cash-out refinances are used more to refinance debt, especially credit card debt.

As a general rule, when stocks and bonds disagree, go with what bonds are telling you. Mohammed El-Arian breaks that rule to say the bond market has it wrong. His point is that the bond market is underestimating how assertive the Fed is becoming.

Good article for the first time homebuyer.. All the stuff that can come up and surprise you. Bonus tip: Don’t load up on credit for all the things you will need for your new house until after your loan closes.

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Vital Statistics:

Stocks are lower this morning as investors take some profits after a good quarter. Bonds and MBS are flat.

Personal Incomes rose 0.4% MOM while consumer spending rose 0.2%. The savings rate increased 0.2% to 5.6%. The PCE Index (the Fed’s preferred measure of inflation) rose 2.1% YOY, while the core index, which strips out some volatile commodity prices rose 1.8%.

The Chicago PMI Index rose slightly in March as new orders rose and employment fell.

Consumer sentiment retreated slightly in March, according to the University of Michigan Consumer Sentiment survey. Note that the spread between the “soft” economic data (like sentiment indices) and the “hard” economic data (like actual spending numbers) has never been higher. This is probably being driven by expectations of regulatory relief.

Dallas Fed President Robert Kaplan is worried about Washington and the effect policy will have on consumer spending. The fear is that any sort of protectionism via a cross-border tax or policies that could increase health care inflation would crimp spending, especially for older folks. Of course there is a demographic effect happening as well – older people tend to spend less. Their kids are still just starting out, but they will hit their peak spending years soon enough. And before everyone starts wringing their hands over the savings rate, it is still pretty low by historical standards:

Want a good statistic to demonstrate how tight the housing market is? 57% of all realtors have been involved in a sale with at least 10 offers on a single property in the past year. In fact, only 2% have not experienced a bidding war in the last year. We are starting to see home sales contingent on the seller finding a place to buy.  This is part of the problem for the first time homebuyer: The move-up buyer can’t find (or afford) a better place so they are staying put.

William Dudley of the NY Fed prefers the Fed go slowly in reducing the size of its balance sheet. So far, the consensus is that the Fed will just let maturing bonds roll off and not re-invest those proceeds back into the market. Dudley wants to be even more cautious than that, and taper the re-investment, which would mean they would start by reinvesting only half of maturing proceeds back into the market, and then stop altogether later. Regardless of how the Fed handles it, any sort of balance sheet change should have a minimal effect on MBS spreads. If QE had a de minimus effect on spreads then ending the reinvestment policy should have little to no effect. Note Dudley is also concerned about the effect this will have on long term rates, which could restrict credit.

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Vital Statistics:

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

We will have Fed-speak all day, with 4 speakers. The bond market is still digesting hawkish statements from yesterday.

The final revision to fourth quarter GDP came in at 2.1%, an uptick from the previous 2.0% estimate, based on higher consumption. The PCE price index came in at 2%, bang in line with the Fed’s inflation target.

Initial Jobless Claims came in at 258k, a slight downtick from the week before. Consumer comfort slipped.

Corporate profits rose 22% in the fourth quarter compared to a year ago to just over $1.7 trillion. While the stock market may have overreacted to the Trump reflation trade, the backdrop of increasing corporate profits provides basis for increasing stock prices.

Federal Reserve Bank of Boston Head Eric Rosengren suggested the Fed should hike rates 3 more times this year and warned about pushing unemployment too low. “The perception seems to be that the outcome of each FOMC meeting depends on nuances of incoming data, with the base case being no change in rates,” Rosengren said in a speech in Boston Wednesday. “My own view is that an increase at every other FOMC meeting over the course of this year could and should be the committee’s default.” Rosengren used to be a dove, and now has turned hawkish. Again, the big question is whether the unemployment rate of 4.7% is a true reflection of the labor market given the low labor force participation rate. The true “tell” is going to be wage growth, and that is improving after a long slumber, but is nowhere near igniting inflation. Remember, the Fed has two goals here: 1) to prevent inflation from getting out of control, and 2) to get off the zero bound. The Fed is soft-pedaling goal #2, but that is what is really going on here.

A bipartisan group of senators has warned FHFA Chairman Mel Watt to not suspend Fannie Mae’s dividends to Treasury, as it would affect efforts to revamp the housing finance system. Note that the dividends from Fannie Mae have been used to prop up Obamacare, and the constant draining of capital means that Fannie is becoming less safe and more likely to need a bailout should home prices fall or we have a recession.

Repeal and Replace might not be dead after all. Trump is hinting that he might deal with Democrats if the Freedom Caucus doesn’t come onboard. That may be an empty threat as the bridge across the aisle is pretty much a smoking hulk at this point, but you never know. Trump does have leverage with the Democrats however, if he chooses to use it. Lawsuits against Obamacare still exist, and if the Administration chooses not to defend against them anymore, they could end the subsidies to the insurance companies which would probably end the exchanges in many parts of the country. The Freedom Caucus however is about to learn the first lesson of coalition politics – nobody gets everything they want. Additional progress on this front will generally be bond bearish (in other words sending interest rates higher).

One-of-a-kind waterfront property in VA for under $250k? Yes! Though it is a bit of a fixer-upper.

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Vital Statistics:

Markets are flat this morning on no real news. Bonds and MBS are down small.

Mortgage Applications fell 0.8% last week as purchases rose 1% and refis fell 3%. Rates collapsed at the end of the week due to the failure of health care reform, so it is probably premature to see if that has affected things. Note that mortgage rates invariably lag moves in the 10-year as lenders wait to see if the changes are for real.

Pending Home Sales increased 5.5% in February, which is 2.6% higher than a year ago, and the second-highest reading since the bubble years (the first was last April). A slight uptick in listings drove the increase. Demand is there, supply is not.

Deep Subprime auto loans (loans to borrowers with sub 550 credit scores) have increased to 1/3 of all auto loan ABS. In 2010, they were just 5%. As you can expect, delinquencies are increasing on these. It is surprising that institutional investors are happy to buy bonds securitized by assets that depreciate like sushi, while securitizing an overcollateralized pool of high quality non-QM loans is like pulling teeth.

If there is anything in Washington that should have bipartisan support, it is finding a solution for Fannie Mae and Freddie Mac. The current situation is untenable, as the government is sweeping all of their profits, which is making them more and more undercapitalized. The Trump Administration has indicated that dealing with the GSEs is a high priority, but they have yet to give any sort of indication of how they think the future housing market should look. The model the MBA supports is to turn them into regulated utilities, with a capped rate of return. The Obama Administration supported nationalizing them, while another plan would get them out of the securitization business and into the mortgage insurance business. There are many stakeholders in this discussion, including the affordable housing types who want to ensure underserved areas can get credit, hedge funds who own the common and preferred shares, as well as lenders and borrowers.

Here is a good backgrounder on how hard tax reform is going to be. Every “loophole” will have a constituency which will defend it to the death. The failure to end Obamacare (at least for now) will have taken the biggest “pay for” off the table. That leaves Republicans with a couple choices: Either pass a 10 year tax cut the way George W Bush did, or do revenue-neutral tax reform like Reagan did.

Institutional Investors are implementing artificial intelligence into the stock picking business. How much do you want to bet that everyone’s algorithms will look pretty much the same and will pick the same stocks?

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