All Things in Moderation

Vital Statistics:

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

Ordinarily the week after the jobs report is often a snoozer economically, but that has changed as inflation now takes center stage. We will get some big numbers this week with the Consumer Price Index on Tuesday, Productivity and Costs on Wednesday and the Producer Price Index on Thursday.

Friday’s strong jobs report caused a hawkish shift in the Fed Funds futures contracts. The September meeting now has a 2/3 probability of a 75 basis point hike and a 1/3 probability of a 50 basis point hike. The December futures are centering around a Fed Funds range of 3.5% to 3.75%, which is up 25 basis points from before the report.

Former Treasury Secretary Larry Summers made some hawkish comments about inflation over the weekend. On the jobs report, he said: “Everything in this number says to me overheating, not yet under control, not yet on a path to being under control,” said Summers, a Harvard University professor and paid contributor to Bloomberg TV. “My concern was actually magnified,” he said.

He also pointed out that core inflation is running at about 5%, which is higher than it was when Nixon put on wage and price controls in the 1970s.

On the assessment that the Fed is close to a neutral policy, he said: “I don’t think the Fed has the thread right now,” Summers said. Without significantly boosting real interest rates — which are adjusted for some gauge of inflation — “then we’re just setting the stage for stagflation”

His point about real interest rates is important, since the real interest rate is a moving target. The Fed Funds rate is a nominal interest rate which doesn’t take into account inflation. By any measurement, with core inflation running around 5% and the Fed Funds rate at 2.25%, real interest rates are still negative.

Even Paul (Dr. Cowbell) Krugman had to admit that the Fed needs to do more to get inflation under control.

Meanwhile, the Atlanta Fed’s GDP Now index predicts Q3 GDP will come in 1.4%, though this was before the jobs report. While 1.4% is still positive, it is by no means strong. The Fed would characterize 1.4% GDP growth as “modest.” And this is before all of the tightening we have just experienced gets felt by the market. We won’t see the economic effects of this tightening begin until after Labor Day at the earliest.

Rithm Capital aka New Residential reported that origination volume was down 29% QOQ to $19.1 billion. This is down 19% from a year ago, but I suspect last year’s numbers don’t include Caliber. Gain on sale margins increased to 1.95%, however the company said on the earnings call that it was de-emphasizing origination going forward because the gain on sale margins weren’t there. 1.95% was the highest number over the past year, so I found that interesting.

Like every originator out there, MSR valuations saved the day, and the strategy is all about cost cutting. Rithm sees the mortgage company operating at roughly breakeven for the foreseeable future.

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Vital Statistics:

Stocks are lower this morning after the hot employment situation report. Bonds and MBS are down.

The July employment situation report was exceptionally strong. The economy added 528,000 jobs and the unemployment rate ticked down to 3.5%. Job gains were most pronounced in leisure / hospitality and business / professional services. The unemployment rate is back to pre-pandemic levels. The interesting thing is that the labor force participation rate and the employment-population ratios remain well below their pre-pandemic peaks.

Average hourly earnings seem to be accelerating again. Month over month, average hourly earnings rose 0.5%, which was a pickup from the 0.3% reported in June. On an annual basis, they rose 5.2%.

Bottom line: the labor market is strengthening, not weakening. This makes the Fed’s job harder, but it also means that any recession we get will fell milder than normal.

Rocket reported second quarter numbers yesterday. Volume was down a whopping 58% on a YOY basis, although gain on sale margins improved. Earnings per share came in at $0.02. Like most originators, servicing income has offset declining origination income. The company continues to build out its ancillary businesses such as Rocket Homes and Rocket Money.

Rocket has been hit by the disappearance of the rate / term refinance, but purchases are suffering too as a combination of higher home prices and higher rates dampen buyer sentiment. The company has been cutting costs, but it will also maintain some excess capacity so it can grow in the future.

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Vital Statistics:

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

US employers announced 25,810 job cuts in July, according to outplacement firm Challenger, Gray and Christmas. This is down 21% from June but up about 36% compared to a year ago. For the first 7 months of the year, companies announced about 159,000 job cut which is a series low going back to 1993.

Automakers, retailers and financial firms were the biggest sectors announcing layoffs. “The job market remains tight, and large-scale layoffs have not begun. There are some indicators that hiring is slowing after months of growth, however,” said Andrew Challenger, Senior Vice President of Challenger, Gray & Christmas, Inc. “Job cut levels are nowhere near where they were in the 2001 and 2008 recessions right now, though they may be ticking up. If we’re in a recession, we have yet to feel it in the labor market,” said Challenger.

Separately, initial jobless claims continue to tick up. There were 260k initial claims last week, an increase from 254k the week before.

PennyMac Financial services reported that volumes fell 20% QOQ and 56% YOY to $26.7 billion. Like most originators out there, servicing income is making up for lost origination income. This shows the benefit of retaining servicing as a hedge for the origination business.

That said, with rates seeming to level out here, and a plethora of mortgage banks looking to sell servicing portfolios to increase liquidity, I suspect we might be at peak valuations for mortgage servicing rights. Delinquencies are low, but will almost certainly increase if the job market deteriorates.

The US Homeownership rate ticked up from 65.4% in the first quarter to 65.8% in the second quarter, according to the Census Bureau. The rental vacancy rate ticked down from 5.8% to 5.6%.

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Vital Statistics:

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

Bond yields had been falling over the past few days based on hope that the Fed will pivot to a more normal policy as the economy weakens. So far, we haven’t seen much in the way confirmation from Fed officials, and at least some of it might be wishful thinking. That said, the Fed funds futures still see another 100 basis points in hikes through the end of the year, and then the cycle appears to be over.

Mortgage applications increased 1.2% last week as purchases rose 1% and refis increased 2%. The drop in rates spurred the activity. “Mortgage rates declined last week following another announcement of tighter monetary policy from the Federal Reserve, with the likelihood of more rate hikes to come,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Treasury yields dropped as a result, as investors continue to expect a weaker macroeconomic environment in the coming months.”

The service economy expanded in July, according to the ISM Services Index. It was an improvement from June’s reading which had shown some softening in demand and prices. Most importantly, the prices index fell for the third month in a row. You can see the trend in prices in the table below:

Retailers in particular are noticing that demand is softening as consumers are switching from discretionary goods to essentials. The employment sub-index improved.

One of the respondents discussed the housing market: “Interest rates have significantly impacted the homebuilding market. Cancellation rates have increased, as homebuyers can no longer afford the monthly payment. Traffic to our communities is down. Inflation has sidelined many would-be buyers.” [Construction]

Filed under: Economy | 1 Comment »

Vital Statistics:

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

Job openings fell by 600k in June, according to the JOLTS jobs report. Most of the decrease came in retail, as consumers are beginning to curtail their spending due to rising prices for necessities. The quits rate (which tends to lead wage inflation) remained at 2.8%. Overall, this report shows that the labor market is beginning to cool off.

Home prices continued to appreciate in July, according to the Clear Capital Home Data Index. The usual suspects – Raleigh, Miami, Tampa were the leaders again, but some of the laggards are beginning to heat up. Topping the list with nearly 11% QOQ growth was Rochester, New York. A couple other MSAs – Milwaukee WI and Hartford CT made the list of top 15 MSAs. Interestingly, some of the slowest appreciating MSAs were the ones that led the rally – San Jose, San Francisco, Seattle etc.

I wonder if work-from-home will cause some of these MSAs to equalize. As inflation continues to sap disposable income, perhaps people will relocate to cheaper places

One of the big drivers of home price appreciation has been a lack of homes for sale. Inventories are down some 54% from the average of 2017-2019, according to Black Knight. That said, it looks like inventory is beginning to increase again, as the number of homes for sale rose by 114k over the past two months. It would take a year of similar gains to get back to pre-pandemic normalcy. That said, we are still a long way from a balanced market. The US has underbuilt since the crisis, and is now stymied by shortages of labor and materials.

A balanced market is about 6 to 7 months’ worth of inventory. You can see how this metric has trended since the bubble days.

Inflation is beginning to negatively affect the finances of younger, lower-income Americans, which is causing them to build balances on their credit cards. Delinquencies have yet to take off, but non-mortgage debt is increasing.

For consumers with a mortgage, rising home prices has meant that they are increasing home equity. Debt consolidation cash-out refinances can be an attractive way to lower the monthly payment for people with lots of credit card debt.

Rocket is getting into home equity loans. The company will offer fixed rate home equity loans for a 10 or 20 year terms up to a 90 LTV. Rocket isn’t the only one getting into this line of business: New Residential, Guaranteed Rate and Loan Depot are as well.

Filed under: Economy | 44 Comments »

Vital Statistics:

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

We have a big week of data coming up, with the ISM data, job openings, and the employment situation report on Friday. Note that the ADP Employment Report is on hold while ADP works on their model.

Interest rates continue to fall, which is triggering margin calls for originators. This is not just a US-driven phenomenon. The German Bund (a proxy for European interest rates) yields 0.77%, which is down 100 basis points from late June. Global interest rates tend to correlate, and the European economy is weakening.

I sat down with Mike Savino of National Mortgage Professional and did a podcast on the state of the economy. You can access it here.

The manufacturing economy decelerated in July, according to the ISM Manufacturing Index. New Orders and production declined, which shows the economy slowing. On the bright side, prices are beginning to moderate. From the report: “The month-over-month decline of 18.5 percentage points is the fourth biggest decline on record (since 1948) and the steepest since a 22.1-percentage point drop in June 2010. “The slowing in price increases is being driven by (1) volatility in the energy markets, (2) softening in the copper, steel, aluminum and corrugate markets and (3) a significant decrease in chemical demand. Notably, 21.5 percent of respondents reported paying lower prices in July, compared to 8.3 percent in June,” says Fiore. A Prices Index above 52.6 percent, over time, is generally consistent with an increase in the Bureau of Labor Statistics (BLS) Producer Price Index for Intermediate Materials.”

Much of this is due to falling commodity prices, which is partially due to the dollar. The US dollar has been on a tear lately, and since commodities are quoted in dollars, when the dollar rises, commodity prices fall. That said, the Fed will breathe a sigh of relief as one of the big components of our current inflation eases.

Construction spending fell 1.1% MOM in June, according to the Census Bureau. Residential construction was down 1.6% MOM but up 15.4% YOY. I don’t think the construction spending data is inflation-adjusted so that would account for the big YOY increase despite falling housing start.

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Vital Statistics:

Stocks are flat after GDP came in negative for the second consecutive quarter. Bonds and MBS are up.

The Fed hiked the Fed Funds rate 75 basis points yesterday as expected. The vote was unanimous. Jerome Powell made hawkish remarks during his press conference. The prepared remarks are here. The money quote:

My colleagues and I are strongly committed to bringing inflation back down, and we are moving expeditiously to do so. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses…. From the standpoint of our Congressional mandate to promote maximum employment and price stability, the current picture is plain to see: The labor market is extremely tight, and inflation is much too high.

The September Fed Funds futures contracts are pricing in a 80% chance of a 50 basis point hike and a 20% chance of a 75 basis point hike. For the end of the year, the December futures are seeing the Fed Funds rate up either 75 or 100 basis points from here. The June 2023 futures see lower rates than December. In other words, we are probably about 75% of the way through this tightening cycle. Of course the economic effect of tightening starts to be felt in six to 9 months, so late 2022 / early 2023 will be when the impact really begins to be felt.

The advance estimate for second quarter GDP came in at -0.9%, which is the second consecutive quarter of declining GDP. GDP was negatively affected by inventory investment, government spending, and housing. Personal Consumption Expenditures were positive. The PCE Price Index rose 7.4%, the same as the first quarter. Note this is probably not going to influence the Fed much given it is older data.

As I am sure you will hear in the media and from the Administration, two consecutive quarters of negative GDP growth is not an official recession. The National Bureau of Economic Research makes the final determination, and given the strength of the labor market they have the leeway to say we aren’t in one.

Of course as the economy weakens due to the recent rate increases, the NBER might have to bow to reality and declare one. But they will probably hold off as long as they can. Note that initial jobless claims are ticking up again, hitting 256k last week. The prior week’s 251k reading was revised upward to 261k.

The GDP print and the Fed’s hawkishness is pushing the bond market up (rates down), which is creating an interesting dynamic. The yield curve inversion remains, with the 2s / 10s spread at negative 21 basis points. If the Fed raises rates another 50 basis points in September and the 10 year stays here, we will have a fully inverted yield curve. You can see below the 2s / 10s spread going back to the 1980s. It has been a decent recessionary indicator, although you could argue we are in one now.

Mr. Cooper’s earnings came in better than expectations, and the stock traded up about 5 bucks on the news. Net income came in at $151 million, which was driven primarily by servicing, although origination income was positive as well. Volume fell 33% QOQ to $7.8 billion. Mr. Cooper is valuing its servicing book at 155 basis points.

Mr. Cooper has held up better than most originators during this environment due to the relative size of its servicing book. If rates stabilize or start heading downward, that tailwind will probably weaken.

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Vital Statistics:

Stocks are higher this morning as we await the Fed de Bonds and MBS are up.

The Fed decision is slated to come out at 2:00 pm today. The Fed Funds futures implied probability graph shows about a 3/4 chance of a 75 basis point hike and a 25% chance of a 100 basis point increase.

Retail inventories rose 2%, (higher than expected) in June, which probably bodes well for the advance estimate of second quarter GDP which comes out tomorrow. Wholesale inventories rose 1.9% as well. These numbers suggest that the supply chain issues of the past two years are working themselves out. Note that WalMart is cutting prices to deal with excess inventory.

“The increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars. We’re now anticipating more pressure on general merchandise in the back half; however, we’re encouraged by the start we’re seeing on school supplies in Walmart U.S.” said Doug McMillon, Walmart Inc. president and chief executive officer.

Food and fuel price inflation seems to be turning the corner however. The GSCI commodity index is heading back downward, although we are still well above levels seen last year:

As the old saying goes, the cure for high prices is high prices. Eventually demand falls and supply increases. Case in point: corn, which is down 26% from its April highs.

Mortgage Applications fell 1.8% last week as purchases fell 0.4% and refis fell 2%. “Mortgage applications declined for the fourth consecutive week to the lowest level of activity since February 2000,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Increased economic uncertainty and prevalent affordability challenges are dissuading households from entering the market, leading to declining purchase activity that is close to lows last seen at the onset of the pandemic.”

Homebuilder Pulte reported second quarter earnings yesterday. Demand remains strong for housing, however increasing mortgage rates are having an impact. One thing that stood out to me was the increase in gross margins, which rose to 30.9%, an increase of 430 basis points compared to last year and 190 basis points from the first quarter. Whatever cost increases that Pulte is dealing with (labor and material costs) are more than covered by rising prices.

The other thing I notices was a decent uptick in the cancellation rate, from 7% to 15%, as well as the 8% drop in orders. Backlog decreased slightly on a unit basis, but rose 18% on a dollar basis. It is strange to think that housing starts remain low when building homes seems to be pretty profitable and the demand is there. Perhaps it is nothing more than a skilled labor shortage, although the company didn’t mention it.

The fallout from Sprout continues. California lender New Wave is suing the company for defaulting on a purchase agreement for $32.8 million worth of loans. New Wave ended up selling the loans to a different buyer and Sprout is refusing to return the holdback amount.

Pending Home Sales fell 8% last month, according to NAR. Year-over-year, transactions are down 20%. This (along with the end of rate / term refis) explains why mortgage originators are struggling compared to the past two years.

“Contract signings to buy a home will keep tumbling down as long as mortgage rates keep climbing, as has happened this year to date,” said NAR Chief Economist Lawrence Yun. “There are indications that mortgage rates may be topping or very close to a cyclical high in July. If so, pending contracts should also begin to stabilize.”

Mortgage rates may indeed be stabilizing, as the yield curve continues to invert. The spread between the two-year and the 10-year is now negative 29 basis points. Mortgage rates are affected by bond market volatility, and if we get some stability in the 10 year, we should see mortgage rates work lower compared to Treasuries.

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Vital Statistics:

Stocks are lower this morning as we get a slew of important earnings and the Fed meeting begins. Bonds and MBS are up.

Home price appreciation appears to be decelerating, according to the FHFA House Price Index. Home prices rose 1.4% MOM in May, which was a decrease from the downward-revised 1.6% in April. On a YOY basis, home prices are still up some 18.3%.

Separately, the Case-Shiller Home Price Index rose almost 20% in May. Prices remained the strongest in the South and Southwest. Rising mortgage rates will make gains like this unsustainable soon enough.

Agency mortgage REIT AGNC Investment reported that the mortgage backed securities market (where lenders sell their loans) was difficult in the second quarter. Tangible book value per share fell about 13%.

“Financial markets remained under significant pressure in the second quarter as the Federal Reserve indicated a more aggressive path of monetary policy tightening,” said Peter Federico, the Company’s President and Chief Executive Officer. “The expectation of materially higher short-term rates drove significant interest rate volatility and increased the probability of a recession. This challenging monetary policy and macro-economic environment led to broad-based financial market weakness during the second quarter. Agency MBS were no exception, as the spread between Agency MBS and swap and Treasury rates widened meaningfully in April and again in June.

“Looking ahead, while the near-term outlook continues to be uncertain, the longer-term outlook for Agency MBS has improved substantially. At current valuation levels, Agency MBS are extremely attractive relative to historical levels. The Federal Reserve has begun to reduce its portfolio organically, but that runoff will occur at a slower pace than previously anticipated as a result of reduced prepayments. Finally, and perhaps most importantly, the net supply of Agency MBS is now expected to be meaningfully lower than prior expectations.

“These positive developments provide reason for optimism that this period of weakness in the Agency MBS market is nearing its end. The favorable returns associated with Agency MBS in this wider spread regime and an improving technical outlook for mortgage supply and demand should provide a supportive backdrop for Agency MBS investors. Moreover, in this compelling investment environment, we believe AGNC is well-positioned to generate strong risk-adjusted returns for our stockholders.”

What all this means is that AGNC was hit hard by weakness in the mortgage backed securities market. When the company says that “spreads widened” it means that the interest rate on mortgages rose faster than the yield on the 10-year. However, the relative valuation of mortgage backed securities is the best it has been in a while, which means that spreads should tighten as volatility wanes. This means that mortgage rates will probably move lower if the 10 year stays here. This is good for origination, though we probably won’t see a return of the rate / term refi business unless rates move materially lower.

New home sales fell 8% MOM and 17% YOY to a seasonally-adjusted annual rate of 590,000. This came in well below consensus. Homebuilding (and the real estate sector in general) continues to punch below its weight.

Consumers confidence continues to fall, according to the Conference Board. “Consumer confidence fell for a third consecutive month in July,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The decrease was driven primarily by a decline in the Present Situation Index—a sign growth has slowed at the start of Q3. The Expectations Index held relatively steady, but remained well below a reading of 80, suggesting recession risks persist. Concerns about inflation—rising gas and food prices, in particular—continued to weigh on consumers.”

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