All Things in Moderation

Vital Statistics:

Stocks are lower this morning as global rates continue to rise. Bonds and MBS are down.

The resignation of Liz Truss doesn’t seem to have had an impact on UK assets, as the pound and gilts continue to drop. The pain in gilts is spilling over into other sovereign debt with Treasury yields briefly hit 4.34% this morning.

The CFPB’s funding arrangement has been ruled unconstitutional, according to a Federal Appeals Court. Elizabeth Warren’s idea for the CFPB was to have it funded by the Federal Reserve, which is outside the purview of Congress. This would make it impossible for Congress to cut its funding. This potentially could vacate some rulings the Bureau has made in the past. I don’t think there is anything that would affect the mortgage business, however. I believe the actual litigation in question concerns payday lenders.

The Fed Funds futures have been inching upwards. A 75 basis point hike in two weeks is more or less a lock, and the December futures have a 60% chance for another 75 basis points and 40% for only 50. They are then looking at another 25 bps in February, which will put the Fed Funds rate at a range of 4.75% – 5%, where they pretty much remain for the rest of 2023.

Note that a month ago, a target rate of 4.5% – 4.75% wasn’t even considered.

Since monetary policy acts with a lag, the string of 75 basis point hikes starting in June, the economic impact of this has barely begun to hit. The Atlanta Fed’s GDP Now index sees 2.9% in Q3, which seems optimistic, given that one strong retail sales print caused them to revise upward that number from about 0.5% to 2.5%.

I find it hard to believe that we see a massive growth acceleration in the midst of a tightening cycle, but that is what their models are saying.

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Stocks are lower this morning as earnings continue to come in. Bonds and MBS are down.

St. Louis Fed President James Bullard said yesterday that he expects the Fed to end its “front-loading” of aggressive rate hikes by early next year. “In 2023 I think we’ll be closer to the point where we can run what I would call ordinary monetary policy,” he said. “Now you’re at the right level of the policy rate, you’re putting downward pressure on inflation, but you can adjust as the data come in in 2023. Not that there wouldn’t be further adjustments, but they would be more based on the data coming in as opposed to us trying to get off zero and up to some level that’s reasonable.”

Meanwhile, the Beige Book indicated that the economy is experiencing “slight to modest” growth, while prices (inflation) is showing “some degree of moderation.” The labor market appears to be loosening up, with wage increasing beginning to decline.

Speaking of the labor market, initial jobless claims remain quite low, falling to 214,000 last week.

Ally reported earnings yesterday. They are mainly an auto lender (they used to be known as GMAC), however they do have a mortgage origination arm. Their direct-to-consumer mortgage origination volume was $500 million, which was down 85% compared to a year ago. Refinance activity was down 98%.

The Conference Board Index of Leading Economic Indicators fell 0.4% in September, which was below the street expectation of 0.3%. “The US LEI fell again in September and its persistent downward trajectory in recent months suggests a recession is increasingly likely before yearend,” said Ataman Ozyildirim, Senior Director, Economics, at The Conference Board. “The six-month growth rate of the LEI fell deeper into negative territory in September, and weaknesses among the leading indicators were widespread. Amid high inflation, slowing labor markets, rising interest rates, and tighter credit conditions, The Conference Board forecasts real GDP growth will be 1.5 percent year-over-year in 2022, before slowing further in the first half of next year.”

Existing Home Sales fell 1.5% in September to a seasonally-adjusted average rate of 4.71 million. Year-over-year, sales are down a whopping 24%. The inventory of homes for sale declined as well, to 1.25 million units. “The housing sector continues to undergo an adjustment due to the continuous rise in interest rates, which eclipsed 6% for 30-year fixed mortgages in September and are now approaching 7%,” said NAR Chief Economist Lawrence Yun. “Expensive regions of the country are especially feeling the pinch and seeing larger declines in sales.”

The median home prices rose 8.5% YOY to $384,800. Days on market rose to 19, and 70% of properties sold within a month. The first time homebuyer accounted for 29% of sales, which is historically a low amount. Affordability constraints are almost certainly an issue, but low first time homebuyer percentages have been low for the past 15 years.

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Stocks are lower this morning after negative comments from Minneapolis Fed President Neel Kashkari. Bonds and MBS are down.

Minneapolis Fed President Neel Kashkari said the Fed may need to push the Fed Funds rate above 4.75% if core inflation keep accelerating. “Core services inflation — which is the stickiest of all — keeps climbing, and we keep getting surprised on the upside.” This, along with accelerating UK inflation put the kibosh on a two day rally in bonds.

Rising rates and home prices continue to depress housing starts. Starts were down 8.1% MOM and 7.7% YOY to a seasonally adjusted annual rate of 1.44 million. Building permits were up 1.4% MOM to 1.56 million.

Mortgage applications fell 4.5% as purchases fell 4% and refis fell 7%. This is the lowest level in 25 years. “The speed and level to which rates have climbed this year have greatly reduced refinance activity and exacerbated existing affordability challenges in the purchase market,” said Joel Kan, MBA Vice President and Deputy Chief Economist. “Residential housing activity ranging from new housing starts to home sales have been on downward trends coinciding with the rise in rates. The current 30-year fixed rate is now well over three percentage points higher than a year ago, and both purchase and refinance applications were down 38 percent and 86 percent over the year, respectively.”

Fears of a recession and an increase in defaults have pushed up the yields on credit risk transfer securities, which are the insurance for mortgage backed securities issued by Fannie and Freddie. The junk-rated tranches of these securities are now double digits. So far, defaults and delinquencies are under control, but the markets are beginning to show some concern.

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Vital Statistics:

Stocks are higher this morning as earnings continue to surprise on the upside. Bonds and MBS are down.

Industrial Production rose 0.4% in September, according to the Federal Reserve. July and August were revised downward. Capacity Utilization rose to 80.3%. Interestingly, construction was a big contributor to growth, increasing 1.1%. Given the anecdotal evidence we are seeing regarding a housing recession I think there is a decent chance that this might be a spurious data point, although seasonality could be at play here as well.

Builder mortgage applications fell 13% YOY in September, according to the MBA. “New home purchase activity declined in September as prospective homebuyers pulled back in response to higher mortgage rates, increased concern about an impeding recession, and a broader slowdown in home-price growth,” said Joel Kan, MBA Vice President and Deputy Chief Economist. “The average 30-year fixed mortgage rate increased almost a full percentage point in the last month, greatly reducing the purchasing power of many home shoppers. MBA’s estimate of new home sales declined 9 percent in September, partially reversing the 18 percent increase in August during that brief period when mortgage rates decreased.”

Builder confidence continues to fall, as the NAHB / Wells Fargo Housing Market Index declined to 38, half the level it was six months ago. “This will be the first year since 2011 to see a decline for single-family starts,” said NAHB Chief Economist Robert Dietz. “And given expectations for ongoing elevated interest rates due to actions by the Federal Reserve, 2023 is forecasted to see additional single-family building declines as the housing contraction continues. While some analysts have suggested that the housing market is now more ‘balanced,’ the truth is that the homeownership rate will decline in the quarters ahead as higher interest rates and ongoing elevated construction costs continue to price out a large number of prospective buyers.”

Regionally, the Northeast did the best, while the West did the worst.

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

Global sovereign bond yields are falling as the UK reversed its tax plan which weighed on Gilts and the UK pound. Yields on UK Gilts fell 43 basis points overnight, which is pushing down yields on Bunds and Treasuries. IMO this accounts for the rally in Treasuries today. Bottom line: The Bond Vigilantes are back, and they just won a battle.

The upcoming week won’t have much in the way of market-moving data. We will get some housing data, with housing starts, existing home sales and the NAHB Housing Market Index. We will also get the Index of Leading Economic Indicators and industrial production data. The stock market will be driven primarily by earnings.

One thing to keep in mind with bank earnings – we are seeing a big effect from provisions for credit losses. In early 2020, banks took humungous provisions for loan losses due to COVID. Those potential losses never materialized, and by this time in 2021 many banks were reversing these provisions, which has the effect of increasing earnings. In other words, last year’s bank earnings were artificially high, which is creating some strange year-over-year comparisons, especially as banks are beginning to provision for credit losses in anticipation of further slowdowns in the economy. My point is this: year-over-year earnings comparisons should have an asterisk next to them.

Despite all of the fears in the market, residential mortgage backed securities backed by non-QM loans have mirrored their agency counterparts, exhibiting low delinquency rates. As expected, prepay rates have fallen, although that is less of an issue for non-QM RMBS as it is for agency.

Money quote: “Although voluntary prepayment rates have recently fallen, the share of delinquent loans remains low, new delinquency rates are low, serious delinquency cure rates are muted, liquidations are infrequent, loss severity rates are low, and losses are near zero. That said, non-QM RMBS will continue to face growing uncertainties with respect to the near-term economic growth, unemployment rate, household incomes, and home prices. Even if the delinquency rates rise somewhat due to the slowing economy, DBRS Morningstar considers existing non-QM RMBS to have a meaningful cushion to withstand the headwinds, barring a sharp economic downturn coinciding with a sharp drop in home prices.”

IMO, strong performance from non-QM paper should go a long way towards bringing back the buy-side into the non-agency market.

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Stocks are higher this morning after yesterday’s dramatic turnaround. Bonds and MBS are up.

Yesterday’s turnaround was quite dramatic. The S&P 500 briefly broke below 3,500 on its way to a close around 3,670. The 10 year briefly touched 4.05% and this morning yields are back where they were before yesterday’s hot CPI print. The yield curve continues to invert, with 2s-10s now negative 53 basis points.

The strong CPI print from yesterday caused the December Fed Funds futures to price in another 25 basis points in tightening. Pre-report, the consensus was a 75 basis point hike in November and 50 in December. Now we are looking at 75 at both meetings.

JP Morgan reported better-than-expected earnings this morning as third quarter earnings season begins. Mortgage volume declined 45% on a quarter-over-quarter basis to $12.1 billion. A year ago, the company did $41.6 billion in originations in the third quarter, which means JPM’s volumes are down 70% YOY.

Overall revenues rose 7% QOQ and 10% YOY, while earnings per share increased 13% QOQ but fell 17% YOY. JPM is up about 2% pre-open.

Wells reported weaker-than-expected numbers, however there are some special items (litigation expense) that are making comparisons difficult. Q3 mortgage origination volume came in at $21.5 billion, which was down 37% QOQ and 59% YOY.

Despite the miss, Wells is up 5% pre-open.

Retail sales were flat in September, according to the Census Bureau. These numbers are not adjusted for inflation. On a year-over-year basis they rose 8.2%, which more or less matches yesterday’s CPI report.

Consumer sentiment improved in October, according to the University of Michigan Consumer Sentiment Survey. Unfortunately, expectations for the year-ahead inflation rate rose to 5.1%. The Fed pays close attention to this number, so this will encourage the Fed to keep pumping the brakes.

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Stocks are lower this morning after the consumer price index came in hotter than expected. Bonds and MBS are down.

The consumer price index rose 0.4% MOM and 8.2% YOY. Ex-food and energy, it rose 0.6% MOM and 6.6% YOY. Both numbers were higher than expected. Gasoline price declined, while food continued to rise. Shelter increased as well, and will continue to increase as it tends to lag home prices by about 18 months or so.

So far, we aren’t seeing anything that looks like deceleration in the core rate.

We will not get another CPI reading before the Fed meets in November. The FOMC meeting is November 1-2, so this is the number they will focus on, along with the PCE Index.

The Fed Funds futures are a lock for at least 75 basis points at the next meeting, and are beginning to handicap a 100 basis point hike as a possibility.

The FOMC minutes were released yesterday, and here is what they were saying about inflation:

Participants observed that inflation remained unacceptably high and well above the Committee’s longer-run goal of 2 percent. Participants commented that recent inflation data generally had come in above expectations and that, correspondingly, inflation was declining more slowly than they had previously been anticipating…. With respect to the medium term, participants judged that inflation pressures would gradually recede in coming years…

In assessing inflation expectations, participants noted that longer-term expectations appeared to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters as well as measures obtained from financial markets. Participants
remarked that the Committee’s affirmation of its strong commitment to its price-stability objective, together with its forceful policy actions, had likely helped keep longer run inflation expectations anchored…

Participants agreed that the uncertainty associated with their economic outlooks was high and that risks to their inflation outlook were weighted to the upside. Some participants noted rising labor tensions, a new round of global energy price increases, further disruptions in supply chains, and a larger-than-expected pass through of wage increases into price increases as potential shocks
that, if they materialized, could compound an already challenging inflation problem. A number of participants commented that a wage–price spiral had not yet developed but cited its possible emergence as a risk.

Anyone thinking the Fed is considering a pivot should be disabused of that thought from these comments. They noted that credit spreads were stable over the inter-meeting period and they think GDP growth will improve. In other words, they aren’t worried about a recession at all.

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Stocks are higher after the NASDAQ officially hit a bear market. Bonds and MBS are down small.

Inflation at the wholesale level rose 0.4% MOM and 8.5% YOY, according to the Producer Price Index. Ex-food and energy, the index rose 0.3% MOM and 7.2% YOY. The headline number was a touch above expectations, although tomorrow’s Consumer Price Index report will be the main focus.

Mortgage applications hit a 25-year low last week, falling 2% as rates hit their highest mark since 2006. Purchases and refinances fell by the same amount. “Mortgage rates moved higher once again during the first week of the fourth quarter of 2022, with the 30-year conforming rate reaching 6.81 percent, the highest level since 2006,” said Mike Fratantoni, MBA Senior Vice President and Chief Economist. “Mortgage rates increased across all product types in MBA’s survey, with the largest, a 20-basis-point increase, for 5-year ARM loans. The ARM share of applications remained quite high at 11.7 percent – just below last week’s level. Application volumes for both refinancing and home purchases declined and continue to fall further behind last year’s record levels.”

The pain in the real estate sector isn’t only limited to mortgage bankers. Realtors, brokers, and appraisers are adjusting to the new glacial pace of home sales. “There’s going to be a major shakeout,” said Ken Johnson, a real estate economist at Florida Atlantic University who is also a former broker. “There are roughly 1.5mn realtors, but that number will be down 20 per cent within 24 months. And those aren’t the only members of the real estate industry that are very dependent on the volume of transactions. There are these tertiary jobs like the appraisers, the mortgage lenders, all the way down to termite inspectors.”

Much of this overcapacity came as a result of the hiring spree in response to the COVID pandemic. Home sales rose as people fled the cities, and mortgage bankers feasted on easy refinance opportunities. “That growth was much stronger than the home sales opportunities that were available,” said Lawrence Yun, the chief economist for the National Association of Realtors. “The reality is that not everyone’s going to survive.”

Homebuilder sentiment is approaching all-time lows, according to Fannie Mae’s Housing Sentiment Index. For the first time since the beginning of the pandemic, most respondents expect home prices to decline going forward.

“The HPSI declined this month to its lowest level since October 2011,” said Doug Duncan, Fannie Mae Senior Vice President and Chief Economist. “Consumers’ expectation that home prices will decrease matched a survey high, with a higher percentage of consumers believing home prices will decrease rather than increase over the next year – a shift in survey sentiment that had previously only happened in 2011 and at the start of the pandemic in 2020. Moreover, 75% of consumers still think it’s a bad time to buy a home, with most citing high home prices and unfavorable economic and mortgage rate conditions as primary reasons. As long as supply is limited and affordability pressures continue to constrain potential homebuyers via elevated home prices and mortgage rates, we expect home sales will remain sluggish.”

The hits keep coming. Angel Oak is laying off 15% of staff. “Angel Oak Home Loans, a full-service, retail residential mortgage lender, reduced its headcount by 57 employees or 15% of its workforce to better position itself as it manages through the headwinds currently facing the mortgage industry,” the spokesperson said. “Angel Oak Home Loans continues to serve home buyers across the country and maintains staffing levels to meet the changing dynamics of the residential mortgage market.”

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Stocks are lower as the UK continues to support its bond market and supply chain issues impact the chips market. Bonds and MBS are down.

The upcoming week has a lot of important data, especially with the consumer price index on Thursday. We will also get the FOMC minutes on Wednesday. We will also get the University of Michigan Consumer Sentiment data and retail sales on Friday.

Third quarter earnings season kicks off this week with the big banks all reporting late this week.

Small Business Optimism improved in September, according to the NFIB Small Business Optimism Index. Inflation remains the biggest problem, however fewer small business owners are raising prices. Jobs remain tough to fill, and expectations about the future declined.

The small business economy seems to be waiting for the other shoe to drop, as they expect that the economy will weaken as the rate hikes begin to impact the economy. We are looking at another 75 basis points in tightening at the November meeting, and the 225 in hikes since June will begin to have their effect in the coming months. As a general rule, monetary policy acts with a 6-9 month lag, so we are only beginning to feel the impact of these rate hikes. It will get worse before it gets better.

Mortgage credit continues to tighten and has fallen to a 9 year low, according to the MBA. Much of the impact is being felt at the low end of the credit spectrum. We continue to see lenders shrink their FHA footprint and take defensive measures ahead of a potential recession.

“With the likelihood of a weakening economy, which would lead to an increase in delinquencies, there was a smaller appetite for lower credit score and high LTV loan programs, along with a reduction in government streamline refinance programs,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “As mortgage rates have more than doubled over the past year, resulting in a drop in refinance activity, lenders have worked to reduce excess capacity and costs by eliminating underutilized loan programs. All the component indices declined last month, with most of the indices falling to their lowest levels in over a year. In particular, the government credit availability index has declined in seven of the last eight months to its lowest level since April 2013.”

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Stocks are higher this morning after the jobs report. Bonds and MBS are down.

The economy added 263,000 jobs in September, which was above the Street estimate of 250,000 and the ADP estimate of 208,000. The unemployment rate fell to 3.5% and average hourly earnings increased 5% The labor force participation rate fell to 62.3% as the labor force shrank.

Overall, this report won’t move the needle for the Fed either way. The reaction in the bond market was a slight sell-off, with a continued inversion of the yield. curve. The Fed Funds futures still see a 75 basis point hike in November, and another 50 in December. Looking into 2023, it looks like we are seeing another 25 basis points before the March 2023 meeting, and that is it. So we peak out at a range of 4.5% – 4.75%. This comports with what Chicago Fed President Charles Evans said yesterday.

Interestingly, the futures see the December 2023 rate at 4.25% – 4.5%, which means we begin an easing cycle in 2023. If this plays out, we will be looking at 450 basis points of tightening over a year-long period, which is an aggressive cycle historically.

In 1994, the Fed took up the target rate 275 basis points over the course of a year, which blew up the MBS market (and took out a bunch of mortgage arbitrage hedge funds). From 2003 through 2006, the Fed took up the Fed Funds rate by 400 basis points and blew up the residential real estate bubble. The Fed is banking hard on continued strength in the labor market to soften the blow here, which is comparable to the Volcker tightenings of the early 1980s.

Above is a chart of the Fed Funds rate historically. I extended the line to take into account the projected increases. As you can see, we have done a lot of tightening in a short period of time.

Pennymac was the first correspondent lender to reduce the its bets on the new conforming limits. They took down their levels from 715k to 700k, and it looks like everyone is following. The August FHFA Home Price index will come out on October 25, which will give us 11 out 12 index points. As of now, the new conforming limit would be 716k.

Credit Suisse has launched a buyback for some of its senior bonds. I am hearing that some correspondents won’t accept AOTs from them, so it looks like the Street might be backing away. If there is one thing that can stop a tightening cycle in its tracks, it is a financial contagion.

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