All Things in Moderation

ital Statistics:

Stocks are higher this morning after the Consumer Price Index came in weaker than expected. Bonds and MBS are up on the benign CPI print and the fact that China cut interest rates overnight.

The consumer price index rose 0.2% MOM in June, according to the BLS. On an annual basis, prices rose 3%. If you strip out food and energy, prices rose 0.2% MOM and 4.8% YOY. Shelter was the biggest contributor to the index, accounting for 70% of the increase, while energy was the biggest drag. Shelter rose 7.8% year-over-year. Home prices peaked in June of 2022, so the YOY increases will go flat starting with next month’s report.

The report didn’t have much of an impact on the July Fed Funds futures, which still see a 92% chance of another 25 basis points. All of the Fed-speak seems to indicate that the central bank will hike rates next week.

We are still elevated compared to the past 10 years, but are returning to normal

Mortgage Applications increased 0.9% last week as purchases increased 2% and refis fell 1%. “Incoming economic data continue to send mixed signals about the economy, with the overall impact leaving Treasury yields higher last week as markets expect that the Federal Reserve will need to hold rates higher for longer to slow inflation. All mortgage rates in our survey followed suit, with the 30-year fixed rate increasing to 7.07 percent, the highest level since November 2022,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “The jumbo rate also increased to 7.04 percent, a record high for the jumbo series, which dates back to 2011. Purchase applications increased, but remained at a very low level and are 26 percent lower than the same week last year. The rise in purchase activity was driven by increases in both FHA and VA purchase applications. The refinance index dropped to its lowest level since early June, as demand for rate/term and cash-out refinances remains extremely low with mortgage rates over 7 percent.”

Mortgage credit availability increased in June, according to the MBA. “Mortgage credit availability was essentially unchanged in June, remaining close to the lowest level since early 2013, as the industry continues to operate at reduced capacity,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Lenders are streamlining their operations by offering fewer loan programs, with some exiting certain channels. Data from our Weekly Applications Survey indicated that June mortgage applications were more than 30 percent lower than a year ago and at the slowest pace since December 2022.”

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Vital Statistics:

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

The upcoming week will have some important inflation data with the consumer price index and the producer price index. We will also kick off earnings season with the big banks reporting on Friday. Investors will be particularly interested in whether the banks take provisions on their commercial real estate portfolios. Interestingly, we don’t have much Fed-speak despite the fact the the quiet period for the July meeting starts next week.

The Fed Funds futures are pricing in a 92% chance of a 25 basis point hike at the July meeting. The December futures are pricing in a roughly 1-in-3 chance for another 25 basis point hike by the end of the year.

Chicago Fed President Austan Goolsbee thinks the US can avoid a recession while still defeating inflation: “What the Fed’s overriding goal right now is to get inflation down. We’re going to succeed at it and to do that without a recession would be a triumph,” Goolsbee told CNBC’s Steve Liesman during a “Squawk on the Street” interview. “That’s the golden path, and I feel like we’re on that golden path. So I hope we keep putting off the recession to forever. Let’s never have a recession again.”

This sort of thinking: that that Fed can “fine tune” the economy and override the business cycle goes back to the 1960s. Goolsbee’s professors at the University of Chicago probably taught him that this is impossible since the Fed has an information lag. Regardless, economic central planning – i.e. industrial policy – seems to be back in vogue, and with it comes the idea that the Fed can engineer away the business cycle. Color me skeptical.

Housing affordability is a big problem right now, with affordability back at the levels we saw during the ’04-’06 housing bubble. Affordability is a function of three things: house prices, mortgage rates and incomes. The most effective lever is mortgage rates, but we need the Fed out of the way. “The Fed has engineered a massive increase in interest rates in order to combat high inflation. We expect it to cut the federal-funds rate aggressively in the coming years, driving the [Federal funds] rate down from 5% currently to below 2% by 2025,” wrote economists at Morningstar. “Once the Fed wins the battle against inflation, its priority will shift to jump-starting economic growth, which will require much lower interest rates, in our view.” Morningstar predicts that interest rates will stay low long-term due to demographic trends such as an aging population and depressed fertility rates.

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Vital Statistics:

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

The economy added 209,000 jobs in June, according to the Employment Situation Report. This was more or less in line with expectations and much lower than the ADP report yesterday. The unemployment rate slipped to 3.6%, while average hourly earnings increased 0.4% MOM and 4.4% YOY. Job openings fell 500k to 9.8 million. After declining for two months, the quits rate increased to 2.6%, which is leading indicator for wage growth.

Wage inflation is the Fed’s biggest concern now, and it seems to have plateaued around this level for the past several months after declining in the second half of 2022. Pre-pandemic, average hourly earnings were increasing at around 3.5%, so we still have some ways to go in order to get back to a level the Fed is comfortable with.

The 10 year bond yield is off slightly from yesterday’s highs, but we are still solidly above 4%. The two year is up as well, trading at 4.97%.

If you look closely at the chart above, despite the increases in rates, the yield curve remains highly inverted. The distance between the two lines indicates yield curve inversion. The bigger the distance, the more inversion. The labor data is indicative of a roaring economy, but the yield curve is blaring recessionary signs.

Lock volume increased 31% in June according to the MCT Rate Lock Index. “We saw originations towards the end of May slow down, so this is likely a summertime pickup in originations”, said Andrew Rhodes, Senior Director and Head of Trading at MCT. “Rates, housing supply, and affordability will continue to be the forces behind the lack of new originations.”

The ISM Services Index increased in June, which was the sixth consecutive expansion. New orders and business activity increased, while prices moderated. “There has been an uptick in the rate of growth for the services sector. This is due mostly to the increase in business activity, new orders and employment. Increased capacity, backlog reduction and continued improvements in logistics have impacted delivery times (resulting in a decrease in the Supplier Deliveries Index). The majority of respondents indicate that business conditions remain stable; however, they are cautious relative to inflation and the future economic outlook.”

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Vital Statistics:

Stocks are lower this morning after the FOMC minutes from June indicated that some members wanted to hike rates. Bonds are down, and the 10 year has a 4-handle on it again.

The FOMC minutes were released yesterday, and the market reacted to the revelation that the unanimous decision to pause was not without some opposition:

Some participants indicated that they favored raising the target range for the federal funds rate 25 basis points at this meeting or that they could have supported such a proposal. The participants favoring a 25 basis point increase noted that the labor market remained very tight, momentum in economic activity had been stronger than earlier anticipated, and there were few clear signs that inflation was on a path to return to the Committee’s 2 percent objective over time.

Separately, Dallas Fed President Laurie Logan said it would’ve been “entirely appropriate” to raise the benchmark lending rate at the Fed’s June meeting. However, she said “in a challenging and uncertain environment, it can make sense to skip a meeting and move more gradually.”

The July Fed Funds futures are close to a lock for another 25 basis point hike at the July meeting in 3 weeks.

The private economy added almost half a million jobs in June, according to the ADP Employment Report. This is well above the 213k the Street is looking for in tomorrow’s jobs report. “Consumer-facing service industries had a strong June, aligning to push job creation higher than expected,” said Nela Richardson, chief economist, ADP. “But wage growth continues to ebb in these
same industries, and hiring likely is cresting after a late-cycle surge.” As usual, leisure / hospitality was the biggest contributor to job growth, adding 232k jobs, while construction added 90k. White collar and manufacturing jobs fell. Wage growth fell to 6.4% from 6.6% for job stayers, and fell to 11.2% for job changers. Job changers received the lowest annual increase since October 2021.

In other labor-related indicators, announced job cuts fell 49% to 40,709 according to Challenger and Gray. Tech, retail and finance have seen the most job cuts this year. Initial Jobless Claims remain low at 248k.

Mortgage Applications fell 4.4% as purchases fell 5% and refis fell 4%. “Mortgage applications fell to their lowest level in a month last week as rates for most loan types increased. As mortgage-Treasury spreads remained wide, the 30-year fixed rate increased to 6.85 percent, the highest rate since the end of May,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications decreased for the first time in a month, as homebuyers remained sensitive to rate changes. Rates are still over a percentage point higher than a year ago, and housing affordability is still a challenge in many parts of the country. However, the average loan size for a purchase application declined to $423,500 – its lowest level since January 2023. This was likely driven by reduced purchase activity in some high-price markets and more activity in some of the lower price tiers as buyers searched for more affordable options.” The composite index is at the lowest levels since 1997.

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Vital Statistics:

Stocks are lower this morning on the escalating chip war between the US and China. Bonds and MBS are up small.

There isn’t much in the way of economic data this morning, but we will get the June FOMC minutes at 2:00 pm today. It will be interesting to see the Fed’s thoughts on commercial real estate and any potential impacts on the banking sector. Office is definitely a problem, and we have seen some pain in retail as well.

Manufacturing contracted in June for the 8th consecutive month, according to the ISM Manufacturing Report. The weakness was across the board, with new orders, production, prices and employment all in contraction. “Demand remains weak, production is slowing due to lack of work, and suppliers have capacity. There are signs of more employment reduction actions in the near term. Seventy-one percent of manufacturing gross domestic product (GDP) contracted in June, down from 76 percent in May. More industries contracted strongly, however, as the share of manufacturing GDP registering a composite PMI^® calculation at or below 45 percent — a good barometer of overall manufacturing weakness — was 44 percent in June, compared to 31 percent in May,” says Fiore.

PeerStreet has filed for bankruptcy. The company built a marketplace for individual loans however rising rates killed the company. It went from 281 employees to 28 over the past year.

Construction spending rose 0.9% MOM and 2.4% YOY to a seasonally adjusted annual rate of $1.93 trillion. Interestingly, residential construction was down over 11% on a year-over-year basis. Single family construction was down 11.6% while multi-family was up 20%.

I talked about whether we are finally seeing the turn in homebuilding in my latest Substack posting.

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Vital Statistics:

Stocks have a “risk-on” feel as we round out the second quarter. Bonds and MBS are down.

Personal Incomes rose 0.4% in May, according to the BEA. Personal Outlays (spending) rose 0.1%. On the inflation front, the PCE Price Index rose 0.1% MOM and 3.8% YOY. If you strip out food and energy, the PCE Price Index rose 0.3% MOM and 4.6% YOY.

The annual increase in the PCE Price Index ex-food and energy (the core rate) is the Fed’s most important inflation indicator. If you look at the highlighted line below, it has bumped back and forth between 4.7% and 4.6% this year.

This report probably doesn’t change anything in the Fed’s thinking. They are going to hike 25 basis points in July.

The BEA has a good charting application which shows the 3 legs for the inflationary stool: goods, housing, and services ex-housing. The dark blue line at the bottom is durable goods, which rose rapidly during 2021 and was the initial driver of inflation. The top orange line is housing, which is about to plateau as home prices peaked around this time last year. The middle line is services ex-housing and that is the portion that the Fed is most concerned about. This part is basically wages. Once housing begins to have year-over-year declines, the headline inflation number will fall. But until the middle line flattens the Fed will remain hawkish.

Pending Home sales fell 2.7% in May, according to NAR. The Northeast saw increases, while the three other regions declined. “Despite sluggish pending contract signings, the housing market is resilient with approximately three offers for each listing,” said NAR Chief Economist Lawrence Yun, “The lack of housing inventory continues to prevent housing demand from being fully realized.”

We are pretty much back to the bad old days of the COVID lockdowns and the Great Recession. The bright side is that we are seeing increased homebuilding activity.

Consumer Sentiment rose in June, according to the University of Michigan Consumer Sentiment Survey. Inflationary expectations decreased, falling to 3.3% in June versus 4.2% in May. This is certainly encouraging and we know the Fed pays close attention to this statistic. Longer-run inflationary expectations remain at 3%, which is where they have been for the past couple years. Prior to the pandemic, longer-term inflationary expectations were in the 2.2%-2.6% range.

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Vital Statistics:

Stocks are higher this morning after a positive GDP revision. Bonds and MBS are down.

The heads of the Federal Reserve, ECB, Bank of England and Bank of Japan participated in a panel on monetary policy yesterday and Jerome Powell stressed that rates are still going up and will be at these levels for some time. He sees another couple of 25 basis point hikes this year. “We feel there’s more tightening power to do… we believe there’s more restriction coming,” Powell said. A good part of the reason is due to the strong labor market, he said. “Though policy is restrictive, it may not be restrictive enough” and it hasn’t been restrictive for very long, he said.

The point about not being restrictive for long is important. For most of 2022, the Fed Funds rate was well below the inflation rate, which means that real interest rates were negative which is incredibly stimulating to the economy.

The central bankers were asked about how they can increase their credibility to the markets, and Jerome Powell, Christine Lagarde and Andrew Bailey stressed their resoluteness to fight inflation and bring the target back down to 2%. The outlier was Bank of Japan Governor Kazuo Ueda who basically said the BOJ would print more money, which drew chuckles from the crowd. When the panelists were asked to discuss lags in monetary policy, most talked about how some of the rate hikes had yet to be felt. Meanwhile Ueda joked that in Japan, the lag has been decades. The Bank of Japan has been fighting deflation since 1990.

Finally, Jerome Powell said that he didn’t envision the Fed returning to its 2% inflation target until 2025. So, unless there is an economic shock coming don’t look for rate cuts any time soon. The hope for people in the mortgage space is that MBS spreads begin to narrow as volatility subsides in the bond market.

Agile, a groundbreaking fintech bringing mortgage lenders and broker-dealers together on a single electronic platform, today announced the appointment of Greg Vacura as company president. Mr. Vacura will be working to fulfill Agile’s mission to create a better mortgage-backed securities (MBS) market through increasing liquidity and automation in TBAs, MBS pools, and AOTs. If you have questions or would like more information on Agile, please contact us today. 

First quarter GDP was revised upward from 1.3% to 2.0% in the final revision. The increase in real GDP in the first quarter reflected increases in consumer spending, exports, state and local government spending, federal government spending, and nonresidential fixed investment that were partly offset by decreases in private inventory investment and residential fixed investment. The PCE price index was revised downward slightly from 4.2% to 4.1%. The core rate, which excludes food and energy was revised downward from 5.0% to 4.9%.

In terms of industries, health care / social assistance was the biggest contributor to GDP while finance / insurance was the biggest laggard.

The Federal Reserve released the results of its stress tests for the US banking sector yesterday. They showed that the top 23 banks have sufficient capital to absorb a half a trillion hit and still extend credit. While many banks have unrealized losses on their investment portfolios, the scenarios envision falling interest rates, which will reverse some of these losses.

Interestingly, the report didn’t mention Silicon Valley Bank or Signature Bank. The stress tests didn’t envision the scenario we had earlier this year when rates would rise in an inflationary environment.

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Vital Statistics:

Stocks are lower this morning as market darling Nvidia is down pre-market. Bonds and MBS are flat.

Chip stocks are down this morning after a report that the Biden Administration is considering curbs on AI chip exports to China. The recent rally in the stock market has been incredibly narrow, focusing on a few AI-driven stocks.

Jerome Powell is speaking on a panel of central bankers in Europe this morning. I don’t expect anything market-moving, but just be aware.

Mortgage Applications increased 3% last week as purchases and refinances increased by the same amount. “Mortgage rate changes varied across loan types last week, with the 30-year fixed rate increasing slightly to 6.75 percent. The spread between the jumbo and conforming rates widened to 16 basis points, the third week in a row that the jumbo rate was higher than the conforming rate. To put this into perspective, from May 2022 to May 2023, the jumbo rate averaged around 30 basis points less than the conforming rate,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications increased for the third consecutive week to the highest level of activity since early May but remained more than 20 percent lower than year ago levels. New home sales have been driving purchase activity in recent months as buyers look for options beyond the existing-home market. Existing-home sales continued to be held back by a lack of for-sale inventory as many potential sellers are holding on to their lower-rate mortgages.”

Truist has upgraded Boise Cascade and Louisiana Pacific on a bullish bet for building materials. The homebuilding sector has been seeing activity lately as potential homebuyers are stuck with picked-over existing homes and are looking at new construction. Builders are using buydowns and upgrades to entice buyers. Separately, Wedbush upgraded Beazer Homes this morning.

The Fed will release the results of bank stress tests after the close today. The markets will focus particularly hard on the regional banks.

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

New home sales rose 12% MOM in May to a seasonally-adjusted annual rate of 763,000. This is up 15.5% compared to May of last year. The median new home price fell 7.6% on a YOY basis to 416,300. The average sales price fell 6.6% to 487,000. It looks like the affordability issue has caused builders to focus more on lower-priced properties than luxury houses.

Home prices rose 0.7% MOM in April, according to the FHFA House Price Index. They were up 3.1% on a YOY basis. That said, we did see YOY declines in the West and the Mountain states.

Separately, the Case-Shiller Home Price Index reported an annual decrease of 0.2% in April. “The ongoing recovery in home prices is broadly based. Before seasonal adjustments, prices rose in all 20 cities in April (as they had also done in March). Seasonally adjusted data showed rising prices in 19 cities in April (versus 14 in March)…. If I were trying to make a case that the decline in home prices that began in June 2022 had definitively ended in January 2023, April’s data would bolster my argument. Whether we see further support for that view in coming months will depend on the how well the market navigates the challenges posed by current mortgage rates and the continuing possibility of economic weakness.”

We did see some big declines in certain MSAs: -12.4% in Seattle, -11% in San Francisco, -6.6% in Las Vegas, -5.6% in San Diego, -6.1% in Phoenix.

Did fraudulent PPP (Paycheck Protection Plan) loans artificially inflate home prices? According to new research, it may have happened.

Pandemic fraud facilitated by FinTech lenders exhibited significant geographic concentration, which makes it a unique setting to examine the effects of excess local stimulus cashflow on local purchases and prices. We first examine effects on a highly immovable local good—housing. At the individual level, fraudulent PPP loan recipients significantly increase their home purchase rate after receiving the loan the program compared to non-fraudulent PPP recipients. At the zip code level, house prices in high fraud zip
codes increase 5.7 percentage points more than in low fraud zip codes within the same county, with similar effects even after controlling for land supply, prior house price growth, teleworkability, population density, net migration, distance to central business district, and previous rates of remote work. This effect is entirely driven by fraudulent loans from FinTech lenders, and non-fraudulent lending has no such effect. Matching, synthetic controls, and an instrumental variables identification strategy based on social connections to distant zip codes yield similar results. Outside of the housing market, local PPP fraud also predicts consumer spending at the census tract level in 2020 and 2021 with a return to normal in 2022.

Consumer confidence improved in June, according to the Conference Board. Interestingly, there is a big divergence between the Present Situation Index, and the Expectations Index. The present situation index (how things actually are right now) is at 155 while the expectations index is 79. The chart below is more or less the average of the two. Inflationary expectations fell to 6% (still way above what the Fed would like to see), however this was the lowest since December 2020.

“Although the Expectations Index remained a hair below the threshold signaling recession ahead, a new measure found considerably fewer consumers now expect a recession in the next 12 months compared to May. Meanwhile, on a six-month moving average basis, plans to purchase autos and homes have slowed, after picking up earlier in 2023. This may reflect rising costs to finance big-ticket items as the Fed continues to raise interest rates. Meanwhile, vacation plans within the next six months continued to flag, led largely by declines in plans to travel domestically. This is an important indicator of desires to spend on services ahead, which may be a signal that post-pandemic ‘revenge spending’ on travel may have peaked and is likely to slow over the rest of this year.”

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Vital Statistics:

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

The upcoming week will contain housing data, with the FHFA House Price Data, Case-Shiller, the third revision of first quarter GDP and Personal Incomes / Outlays which will contain the PCE inflation number. Jerome Powell will also speak on Wednesday.

The regional bank crisis has had some effects on the homebuilding sector, according to research from the NAHB. Loans for land acquisition / development and spec single family construction have become more scarce. In multi-family the effect is even more pronounced. Multi-family construction has been hitting on all cylinders and the number of buildings with 5 or more units is at a record.

The regional bank contagion may be a factor in this, however I suspect declining real estate prices are the bigger component. Commercial real estate is particularly problematic, and this is probably the driver.

Jerome Powell’s comments last week pretty much stuck the fork in bets for rate cuts this year. While the comments didn’t impact the July futures all that much, the December futures now predict that the Fed Funds rate at the end of the year will be 25 basis points higher than it is now. Interestingly, they are not predicting the two hikes that the dot plot predicted.

It wasn’t that long ago, that the futures were handicapping a Fed Funds rate around 4.5%. The Fed has instituted a drastic tightening policy, the likes of which we haven’t seen in 40 years. Historically tacking on 500 basis points of tightening would cause a recession, and we simply haven’t seen one yet.

Why haven’t we seen a recession yet? The biggest reason is the labor market, which has remained remarkably resilient. Companies had a difficult time finding workers during the COVID-19 pandemic and are probably reluctant to let them go. Second, companies took advantage of low rates to refinance their existing debt, and now they are paying rates that are pretty much close to the inflation rate. This is the equivalent of free money. And don’t forget the government has been handing out money like candy since COVID began and that spigot will eventually get turned off one way or another.

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