All Things in Moderation

Vital Statistics:

Stocks are higher this morning as we head into a big week of tech earnings. Bonds and MBS are down as we enter Fed week.

This week is packed with economic data, and the Fed will announce its decision on Wednesday. Aside from the Fed decision, we will get some important data including the first estimate of second quarter GDP, the employment cost index, personal incomes / outlays and house price data. We also get earnings from market heavyweights such as Apple and Amazon.

The Chicago Fed National Activity Index (sort of a meta-index of various economic indicators) was flat in June compared to a downward-revised May. Production and incomes were growing below trend, while the labor force and orders are above trend. Overall, the economy is growing below trend, which means the actions taken by the Fed are beginning to have an effect. One of the The CFNAI was flashing inflationary signs a few months ago, however we are back to normal.

There seems to be a growing consensus that inflation and interest rates have peaked for the year. While the Fed Funds rate is the most visible indicator of Fed tightening, two other levers are acting as well – quantitative tightening (or the reduction of asset purchases) and the stronger dollar. Quantitative tightening has more or less taken the wind out of the sails for the housing market and the dollar is helping on the commodity front. Supply chain issues remain a problem.

The Fed Funds futures are becoming more dovish, with the market now firmly handicapping a 75 basis point increase this month, and then another 100 basis points over the rest of the year. If you look at the far-out futures (basically summer of 2023), the Fed funds forecast is looking lower. In other words, the market thinks the Fed will be cutting rates in 2023.

You can hear the change in sentiment from Wall Street strategists as well. The emerging consensus is that the peak for rates and inflation happened in June, and inflation is beginning to subside as gas prices fall. Note the Philly Fed manufacturing index from last week showed inflation beginning to subside as well, as both the “prices paid” and “prices received” sub-indices fell substantially.

Housing Wire has a good piece on the pain in the non-QM market. Non-QM loans are mortgages which can’t be guaranteed by the government or Fannie / Freddie. These loans have been beaten up in the market due to the rapid rise in interest rates and the inability for dealers to hedge interest rate risk.

When FGMC shut its doors, it had about $418 million in loans on its warehouse lines, with Customers Bank, Flagstar, JVB and Texas Capital having the exposure. Many of these non-QM loans have low coupons and are now trading at “scratch and dent” prices.

John Toohig, a trader with Raymond James said: [There’s] a lot of underwater coupons due to rapidly rising rates,” Toohig said. “The problem with non-QM is that most banks won’t be the liquidity source for those loans in whole-loan form [purchasing] vs. the aggregators putting them into RMBS [private label securitization deals] — which doesn’t work right now [either]. “So, I wouldn’t be surprised that there is some pain coming at the warehouse-line level [revolving lines of credit used to fund mortgage originations] as loans start to age. The good news for prime jumbo [is] banks want to own those loans and balance-sheet them. The same cannot necessarily be said for non-QM.” 

Note that the National Financial Conditions Index seems to be reversing, which is good for riskier assets. Some junk spreads are tightening as well. This is part of what is driving the improving sentiment.

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

The index of leading economic indicators fell 0.8% in June, after falling 0.6% in May. For the first half of the year, it is down 1.8%.

“The US LEI declined for a fourth consecutive month suggesting economic growth is likely to slow further in the near-term as recession risks grow,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Consumer pessimism about future business conditions, moderating labor market conditions, falling stock prices, and weaker manufacturing new orders drove the LEI’s decline in June. The coincident economic index which rose in June suggests the economy grew through the second quarter. However, the forward-looking LEI points to a US economic downturn ahead. Amid high inflation and rapidly tightening monetary policy, The Conference Board expects economic growth will continue to cool throughout 2022. A US recession around the end of this year and early next is now likely. Accordingly, we’ve downgraded our forecast of 2022 annual Real GDP growth to 1.7 percent year-over-year (from 2.3 percent), while 2023 growth was downgraded to 0.5 percent YOY (from 1.8 percent).”

Note that Ford just announced planned layoffs, and initial jobless claims rose to 250k so it looks like the labor market has probably peaked. The recent Atlanta Fed GDP Now index predicts the economy fell 1.6% in the second quarter. According to the classis model of recession (two consecutive quarters of negative GDP growth) we are already in one. That said, the NBER makes the final call, and they can choose to ignore this if they want.

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Vital Statistics:

Stocks are flattish this morning as earnings continue to come in. Bonds and MBS are up.

Mortgage applications fell 6.3% last week as purchases fell 7% and refis fell 4%. “Mortgage applications declined for the third week in a row, reaching the lowest level since 2000. Similarly, with most mortgage rates more than two percentage points higher than a year ago, demand for refinances continues to plummet, with MBA’s refinance index also falling to a 22-year low,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Purchase activity declined for both conventional and government loans, as the weakening economic outlook, high inflation, and persistent affordability challenges are impacting buyer demand. The decline in recent purchase applications aligns with slower homebuilding activity due to reduced buyer traffic and ongoing building material shortages and higher costs.”

You can see the chart below of the MBA refinance index hitting lows last seen around 2000.

Existing Home Sales fell 5.4% in June, according to the National Association of Realtors. This is the fifth decline in a row. Sales fell 14.2% YOY to a seasonally adjusted annual rate of 5.1 million. “Falling housing affordability continues to take a toll on potential home buyers,” said NAR Chief Economist Lawrence Yun. “Both mortgage rates and home prices have risen too sharply in a short span of time.”

The median home price rose 13.4% to $416,000. Days on market hit a record low of 14 days. “Finally, there are more homes on the market,” Yun added. “Interestingly though, the record-low pace of days on market implies a fuzzier picture on home prices. Homes priced right are selling very quickly, but homes priced too high are deterring prospective buyers.”

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Vital Statistics:

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

Homebuilder sentiment collapsed in July according to the NAHB / Wells Fargo Housing Market Index. “Production bottlenecks, rising home building costs, and high inflation are causing many builders to halt construction because the cost of land, construction, and financing exceeds the market value of the home,” says NAHB chairman Jerry Konter. “In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”

The issues surrounding inflation and supply chain bottlenecks are well-known, however it looks like demand is softening, which is new. Fears of a recession, along with high prices and rates are causing potential buyers to put plans on hold for the moment. It will be interesting to see the cancellation rates when the builders start reporting.

Housing starts disappointed again, falling 6.3% YOY to a seasonally adjusted annual rate of 1.55 million. Building Permits were flat at 1.66 million. It looks like activity is primarily slowing in the West, where prices have been soaring. Single family starts are still holding up.

The stock market has noticed the issues surrounding homebuilding, with the S&P SPDR Homebuilder ETF (XHB) down 31% YTD.

The Mortgage Bankers Association reported that applications for new home purchases fell 12% YOY in June. “Higher mortgage rates and heightened economic uncertainty cooled borrower demand in June, leading to new-home purchase applications declining to the lowest level since April 2020,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting. “Additionally, new residential construction and permitting activity weakened from March through May, reducing the number of homes available for home buyers. MBA’s estimate of new home sales for June fell to a pace of 620,000 homes, a 15 percent drop of over 100,000 units compared to May.”

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Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

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Vital Statistics:

Stocks are higher this morning as earnings season begins. Bonds and MBS are flat.

The upcoming week will be dominated by housing data, with housing starts, existing home sales, and the NAHB Housing Market Index. There will be no Fed-speak as we are in the quiet period ahead of the FOMC meeting next week.

The yield curve remains inverted, with 2s / 10s trading at -17 basis points. 2s / 30s is negative as well. The Chinese real estate market is going critical as well, which should provide support of US bonds.

Investors are paring back their hawkish bets on next week’s meeting. The current handicapping is a 33% chance for 100 basis points and 66% chance for 75.

Bank of America reported better-than-expected earnings this morning. Mortgage volumes were down 29% on a YOY basis, and we are seeing a big increase in HELOC activity. The stock is up 7% pre-open.

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Vital Statistics:

Stocks are higher this morning after a positive retail sales number. Bonds and MBS are flat.

The yield curve continues to invert, with the 2s / 10s spread at -20 basis points and the 2s / 30s spread at -5 basis points. The yield curve’s shape isn’t dispositive – there is an old joke that an inverted yield curve has predicted 12 of the last 5 recessions, but it flashing warning signs and we are getting confirmation elsewhere.

Retail Sales rose 1% MOM and 8.4% YOY. Note this number is not adjusted for inflation, which is running right about the same level. Ex-vehicles and gasoline sales rose 0.7%, which was much better that -0.2% Street expectation.

Wells Fargo reported earnings this morning. Earnings per share declined 47% on a YOY basis. Revenues were down 16% YOY, and earnings were mainly affected by provisions for credit losses. The credit losses should really have an asterisk nest to it. Most of the banks over-reserved for losses in the early days of COVID and when the losses never materialized, they reversed them in 2021. Now that we are back to normalcy, they are reserving for credit losses again. So you get a strange YOY comparison, which will be pretty common for all the banks, IMO.

The mortgage banking numbers were pretty lousy, as expected. Home lending earnings were down about 50% (as they telegraphed a month ago), as falling origination income was offset somewhat by increased servicing income. Originations fell 11% QOQ and 36% YOY to $34.1 billion.

Consumer sentiment improved in the preliminary July reading of the University of Michigan Consumer Sentiment Index. More importantly, the inflationary expectations of consumers began to moderate. As we learned from the FOMC minutes from the June meeting, the Fed pays close attention to this number.

Consumer sentiment indices are often nothing more than gasoline price indices – in other words high gas prices depress sentiment. Gas prices are off the highs from a month ago, so I guess it makes sense that inflationary expectations would fall. Regardless, this number is welcome news for everyone.

This highlights one of the big risks at the fed: by adjusting policy to inflationary expectations, the Fed risks chasing oil prices which is the wrong metric to use.

That said, consumers’ financial situation isn’t in the best of places. One of the metrics for this survey asks consumers about their current financial situation. You can see from the chart below, they are in a bad place:

A recent article in the New York Post shows the difficulty in measuring inflation. BMW is now requiring subscriptions to use heated seats or automatically adjusted high-beams. Access to CarPlay requires an up-front fee. It is the Spirit Airlines model – advertise a low price and then charge for the oxygen the passenger breathes.

Now, according to the government, the only relevant number is the price of the car, however if automakers are lowering prices by introducing a slew of add-on charges, then the price growth is understated. It is a different play on shrinkflation, which is evident again to anyone who eats a bagged salad for lunch.

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Vital Statistics:

Stocks are lower this morning as the banks kick off earning season. Bonds and MBS are flat.

JP Morgan reported earnings that missed Street expectations. Earnings per share fell 27% YOY as provisions for loan losses and noninterest expense increased. Mortgage banking revenue fell 14% QOQ and 27% YOY as lower production revenue was offset somewhat by higher servicing income. Origination volumes fell 11% QOQ and 45% YOY to $21.9 billion. The stock is down about 3% pre-open.

The producer price index came in hotter than expected, rising 1.1% on a MOM basis and 11.3% on a YOY basis. The PPI focuses on inflation at the wholesale level, which will translate into higher prices at the consumer level down the road. About half of the increase was attributable to gasoline prices, which thankfully are beginning to fall. Final demand when you strip out food and energy rose 0.4% MOM and 8.2% YOY.

The strength of the dollar is beginning to help in the fight against inflation as commodities generally trade in US dollars. Note that the US dollar just went below parity versus the Euro. The downside will be lower corporate earnings for companies with overseas operations.

The Fed’s Beige Book reported that economic activity expanded at a “modest” pace (“modest” is Fed-speak for “meh”), but several districts reported that they are seeing a decrease in demand and many noted an increased risk for a recession.

The increase in the CPI and PPI has changed the outlook for the July FOMC meeting. The markets are now predicting a 83% chance for a 100 basis point hike in the Fed Funds rate. For the end of the year, the central tendency is a rate of 3.75% – 4%, which would indicate another 125 basis points of increases in September, October and December.

The fact that we are talking about recessionary conditions now, with this much tightening ahead of us and a 9 – 12 month lag for the economic effects to matter bodes ill for the economy by the end of the year and into 2023.

The spread between the 2 year and the 10 year bond has become even more negative, falling to -23 basis points. This recessionary indicator is flashing red.

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Vital Statistics:

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 1.3% month-over-month and 9.1% year-over-year. This is the highest rate in over 4 decades. Energy prices (particularly gasoline) was a big driver of rising prices. Ex-food and energy the index rose 0.7% MOM and 5.9% YOY. On both indices, the monthly rates are rising, which means that inflation is accelerating, not decelerating. This will almost certainly raise alarm bells at the Fed and keep them on a path for increasing rates.

And just like that, the Fed Funds futures for July have a coin flip between a 75 basis point hike and a 100 basis point hike:

On the bright side, we are seeing some commodity prices fall. Oil and natural gas prices are falling, and we are seeing recent weakness in food such as corn, wheat and cattle. Finally, retailers are reporting that they are stuck with inventory they need to liquidate. This means falling prices for lots of finished goods. This has largely been a June phenomenon, so you won’t see it reflected in the the June CPI. It will filter through to the producer price index first, and then will be reflected in final goods.

The shoe that has yet to drop is the price of shelter. Rising home prices affect the CPI with a 12-18 month lag. So the torrid home price appreciation of the past two years is only beginning to impact the numbers. Shelter rose 5.6% YOY, and the monthly numbers are increasing. Given that all the home price indices show high teens increases, more inflationary pressure is coming there. Rents are only beginning to reset to higher levels.

The rapid increase in the Fed Funds rate is almost certainly going to cause a recession, and if the Atlanta Fed’s GDP Now index is correct, you could argue that we are in one already, though that determination is subjective and made by the NBER. The spread between the 2-year and the 10 year Treasury is now negative by 14 basis points, and this indicator is flashing red.

If we hit a recession, you know what is going to take a hit? Servicing values. The first shoe to drop will be rising delinquency rates, and then the second will be falling long-term rates as markets anticipate the Fed taking its foot off the brakes. I suspect this was the issue with First Guarantee and its backer PIMCO. While FGMC dabbled in the jumbo and NQM space, it was known primarily for being the home for low quality FHA loans. Since there are no LLPAs in GNMA securitization, the gain on sale margins for a low FICO FHA can be huge. But, there is a catch.

GNMA servicing rules are exceptionally harsh regarding advances and modifications. I suspect PIMCO pulled the plug on FG because they could see what was coming for that servicing book if the economy rolls over. For them, it was an unbounded liability given that lenders never fully recover servicing advances on GNMA loans. Also, I am hearing rumblings that loan mods are going to be problematic this time around due to the various CFPB rules that never anticipated a rapid increase in rates.

Mortgage Applications fell 1.7% last week as purchases fell 4% and refis fell 2%. The index includes an adjustment for the 4th of July holiday. “Mortgage rates were mostly unchanged, but applications declined for the second straight week,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Purchase applications for both conventional and government loans continue to be weaker due to the combination of much higher mortgage rates and the worsening economic outlook. After reaching a record $460,000 in March 2022, the average purchase loan size was $415,000 last week, pulled lower by the potential moderation of home-price growth and weaker purchase activity at the upper end of the market.”

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Stocks are up this morning as oil prices fall. Bonds and MBS are up.

Small Business Optimism declined again, according to the National Federation of Independent Businesses. “As inflation continues to dominate business decisions, small business owners’ expectations for better business conditions have reached a new low,” said NFIB Chief Economist Bill Dunkelberg. “On top of the immediate challenges facing small business owners including inflation and worker shortages, the outlook for economic policy is not encouraging either as policy talks have shifted to tax increases and more regulations.”

The report is interesting in that it captures the divergence in the economy right now. If you look at things like sales, profits and economic sentiment, the situation is pretty negative. If you look at the employment picture, it is the exact opposite.

That said, the chart for economic optimism is getting pretty dire and approaching Great Recession levels.

The Atlanta Fed GDP Now Index has improved somewhat, but we are looking at negative growth still with the index showing a -1.2% estimate. This would make two consecutive quarters of negative GDP growth, however the media / government is pushing back against calling this a recession. Ultimately, the official recession call is ultimately subjective and the administration / media will be working the refs pretty hard.

Loan Depot is doing a massive restructuring to get its costs in line. Headcount is going to decline 43% between the end of 2021 and 2022. Their outlook is quite dire. We are executing our Vision 2025 plan on a foundation of a strong balance sheet and ample liquidity, with a current cash position of approximately $1 billion. We anticipate continued challenging market conditions, with mortgage originations projected to decline by roughly half in 2022 from 2021, including an accelerated decline in the second half of 2022, followed by a further decline in 2023. We continued to reduce our costs significantly in the second quarter. Over the next two quarters, we expect to accelerate these efforts and aggressively drive down our costs in line with our previously stated goal of exiting this year with a profitable operating run rate. After two years of substantial headcount and expense growth that was necessary to support unprecedented origination volumes we are returning to previous levels of staffing and expense.”

Loan Depot stock has been a disaster this year, falling 70% year-to-date. The current dividend of $0.08 a share clearly ain’t happening – that 19% yield is not real. Surprised they didn’t just rip the band aid off and cut the dividend to $0.02 a quarter.

Mortgage credit availability fell in June, according to the MBA. “Mortgage credit availability decreased slightly in June, as significantly higher mortgage rates compared to a year ago slowed refinance activity and impacted the overall mortgage credit landscape,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “While there was reduced supply of lower credit score, high LTV rate-term refinance programs, the decline was offset by increased offerings for conventional ARM and high balance loans. With higher rates and elevated home prices, more prospective buyers are applying for ARMs, but activity remains below historical averages.”

I am guessing this doesn’t take into account the NQM market, which will be affected by the exit of Sprout and FGMC. Mortgage credit is getting close to the levels seen in the aftermath of the Great Recession.

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