All Things in Moderation

Vital Statistics:

Stocks are lower this morning as we begin an important week for data. Bonds and MBS are up.

Ordinarily, the week after the jobs report is data-light. This week that is not the case. This week kicks off earnings season, with a lot of the big banks reporting. Second, we will get the Consumer Price Index on Wednesday, which is now one of the most important economic reports out there. Finally, we will have the University of Michigan Consumer Sentiment Survey. Historically, these consumer sentiment surveys have generally been non-events as far as markets go, but the Fed is focusing on the inflationary expectations embedded in the report. In fact, that report loomed large in the Fed’s decision to move from 50 basis points to 75.

The stock market is down pretty big from its heights of earlier this year. Do we bottom here? IMO the stock market’s behavior is the classic bear market before a recession playbook. Going forward, earnings season will matter a lot. While I don’t generally talk too much about currencies (they generally aren’t relevant to mortgage banking) the US dollar has been quite strong this year.

This is factoring into earnings for companies with big overseas operations. As a general rule, as the dollar rises, corporate earnings fall. So this increase in USD will be a big factor this earnings season. Microsoft has already warned that the US dollar will take a bite out of profits. Chip shortages and currencies will definitely affect the automakers. The fear in stock market investors is that earnings estimates are still too high and need to drop further.

The profit outlook for banks will be dented by mortgage banking. Wells indicated at a conference that Q2 mortgage banking profits will be down about 50% from Q1. Companies are aggressively cutting staff, and it looks like there probably will be more to come: “Over the next month or two we’ll see the bulk of layoffs,” said Doug Duncan, chief economist at Fannie Mae, which, along with Freddie Mac, backs many U.S. mortgages. “There is usually about a six-month lag between a turn in the market and layoffs.” While Wells and JPM are struggling in mortgage banking, apparently Bank of America has not cut staff. They saw mortgage banking revenue increase in Q1, unlike most of their compatriots.

Filed under: Economy | 33 Comments »

Vital Statistics:

Stocks are lower this morning after the employment report came in stronger than expected. Bonds and MBS are down.

The economy added 372,000 jobs in June, which was well above the Street estimate of 270k. The unemployment rate remained at 3.6%, and average hourly earnings rose 0.3% MOM and 5.3% YOY. There are 5.7 million long-term unemployed who want a job but were unable to find one, which is still higher than the 5 million pre-pandemic.

Leisure and hospitality, health care and professional / business services added the most jobs. Overall, this report will give the Fed the leeway to raise interest rates 75 basis points at the end of the month as expected.

The demise of First Guaranty and Sprout has people asking if this is the harbinger for another 2008. Given that real estate prices have risen so dramatically over the past two years it is hard to deny the similarities are there. That said, there are big differences. The most important difference is that the products that don’t fit the Fannie / Freddie credit box are still high quality loans. We don’t have the negative amortization (i.e. pick-a-pay) loans that were given to anyone who could fog a mirror. The non-QM loans are often based on rental income, which has been rising at a rapid clip.

Second, the home supply situation is much different today than it was in 2006. In 2006 we were coming off years of overbuilding. For the 10 years prior to the 2006 peak, the US built about 16.8 million units. Over the past 10 years, we have built about 10.5 million. The supply overhang doesn’t exist this time around, homeowners have much more equity and the mortgages that were done since the crisis have been much higher quality than during the bubble years.

Others have pointed out that perhaps the non-QM issue is something more reminiscent of the Russian debt crisis of the late 90s, which blew up hedge fund Long-Term Capital Management. FWIW, I don’t see it – the non-QM market simply isn’t that big. Non-QM issuance is around $20 billion per year, give or take. To put that number in perspective, $20 billion is about half the average daily traded volume of US corporate debt. Year-to-date, corporate bond issuance is about $836 billion. A blow up in the non-QM market won’t even register outside of the mortgage banking space.

My guess is that these firms got stuck with inventory that was depreciating in value as rates rose so rapidly over the past few months. Most of these places hold loans on a sort of warehouse line, and they were being hit with curtailments they couldn’t pay. Don’t forget, there are no products which can hedge the interest rates risk on non-QM. Selling TBAs against non-QM paper is subject to basis risk, which means TBAs and non-QM don’t really correlate all that well. In other words, non-QM paper is basically unhedgeable. This is probably not an issue for lenders who simply buy non-QM for their portfolio, but it is an issue for those who rely on securitization as an exit. Note that this issue doesn’t affect the underlying credit quality at all – NQM securities were falling price due to interest rates, not defaults. This is a huge difference from 2006.

The punch line here is that the non-QM issue is something that isn’t big enough to cause any sort of crisis in the overall economy.

Filed under: Economy | 12 Comments »

Vital Statistics:

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

The FOMC minutes were released yesterday at noon. The takeaway is that the Fed is worried most about inflationary expectations becoming entrenched in the economy and is willing to cause a recession to defeat inflation. The time period between the May and June meeting had two big data points: the consumer price index which showed headline inflation at 8.7% and the University of Michigan Consumer Sentiment Index which showed inflationary expectations rising.

Inflationary expectations are critical because they have a self-fulfilling aspect to them. Vendors begin to build them into contracts, employees (especially those that are represented by collective bargaining) negotiate raises into contracts, and consumers / businesses begin to hoard materials in anticipation of future price increases.

The Fed has two vehicles to measure inflationary expectations. The first is consumer sentiment surveys like the University of Michigan and the second is the differential between Treasury Inflation Protected Securities (TIPS) and Treasuries. These market-based measures of inflation so far are still behaving, which gives the Fed some comfort. That said, the University of Michigan report along with the super-tight labor market gives the Fed the leeway to act aggressively. The self-reinforcing aspect of inflationary expectations means that the cost of bringing down inflation now (in terms of growth) are much lower than it will be when these expectations become entrenched. Don’t forget the 1981-1982 recession was the worst since the Great Depression and the Fed took up the Fed Funds rate into the mid-teens to defeat inflation. This is what the Fed is trying to avoid.

In terms of rate hikes, the view that 75 basis points was necessary was almost unanimous, with one participant wanting to hike 50 at this meeting and then 75 in July.

Sprout Mortgage is shutting down, the latest casualty in the mortgage business. So far, the company hasn’t publicly commented, but this was apparently announced on a conference call. There is no word on what Sprout will do with loans in the pipeline and the company isn’t responding to media requests for comment. Separately, Wells announced more layoffs. It will be interesting to hear from the banks next week when they announce earnings. Wells had telegraphed that origination income will be down 50% compared to Q1.

In other economic data, initial jobless claims rose to 235k last week. Meanwhile, outplacement firm Challenger Gray and Christmas reported that announced job cuts rose to 32,517 from 20,712 during the same month last year. The automotive sector bore the brunt of most of the changes, as shortages and high prices are depressing business. Health care / products is also laying off workers as the COVID-19 pandemic hiring spree reverses.

So far the labor market remains tight, but cracks are beginning to show in the foundation. I keep saying this, but it bears repeating: the rate hikes from earlier this year won’t begin to impact the economy until late this year.

Finally, there is no ADP report this month as they are retooling their methodology. There has been too much of a difference between the ADP report and the BLS’s Employment Situation Report so they are reworking their models.

Filed under: Economy | 53 Comments »

Vital Statistics:

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

The yield curve inverted yesterday afternoon and remains so this morning, with the 2s-10s spread at -2 basis points. An inverted yield curve is usually an early warning sign for a recession. Given the Fed’s aggressive path for rates, we are probably headed for one. The big question lies around the labor market. So far we aren’t seeing any major uptick in initial jobless claims. If that holds, then we might manage to avoid one.

As I discussed yesterday, the unofficial definition of a recession – two consecutive quarters of negative GDP growth – is not used by the government. The NBER basically has discretion to declare one is occurring. Since the labor market is so strong, they probably will avoid declaring one.

Note that the German Bund yielded 1.52% at the end of June and is now trading at 1.1%. This is a big decline in just a week as investors are fearing a recession in Europe. The Euro – dollar spot rate is almost back to parity, something we haven’t seen in over 20 years. Not all sovereign yields are down – the Japanese government bond yield is up to 25 basis points, however British Gilts are down about 30 bps over the past week. While the economies of Europe, the US and Japan are in different phases, sovereign debt markets do generally correlate. This is part of what is pushing down yields in the US.

The Fed Funds futures are becoming a touch less hawkish. Compared to a week ago, the central tendency for the end of the year has decreased by 25 basis points to a range of 3.25% – 3.5%. This is still much higher than a month ago, when the central tendency was 2.75% – 3.0%.

The current handicapping is another 75 basis points at the end of July meeting, 50 basis points in September, then 25 in November and December. That is still a lot of tightening to go, and since the Fed Funds rate tends to impact the economy with a 9 month lag or so we haven’t even begun to feel the impact of the rate hikes we have already seen.

Mortgage applications fell by 5.4% last week as purchases fell 4% and refis fell 8%. There was an adjustment for the early close on July 1, so that is probably affecting the numbers somewhat. The refi index is down 78% from a year ago, and the share of refis has fallen below 30%.

“Mortgage rates decreased for the second week in a row, as growing concerns over an economic slowdown and increased recessionary risks kept Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Mortgage rates have increased sharply thus far in 2022 but have fallen 24 basis points over the past two weeks, with the 30-year fixed rate at 5.74 percent. Rates are still significantly higher than they were a year ago, which is why applications for home purchases and refinances remain depressed. Purchase activity is hamstrung by ongoing affordability challenges and low inventory, and homeowners still have reduced incentive to apply for a refinance.”

The service economy rose in June, according to the ISM Services Index. This reading was above expectations, but lower than May’s numbers. It looks like the prices index fell for the second straight month, which is welcome news on inflation. Here is what one retailer had to say: “Consumers are shifting purchases away from our discretionary products to essentials. Inflation is definitely taking a bite from our sales, and mall traffic is far below the norm, potentially due to inflation, a need for more disposable income on essentials and less willingness to drive to malls. E-commerce sales will be going up again.” [Retail Trade]

Another indication the economy is slowing: job openings are decreasing. Job opening fell by 427k to 11.3 million. The quits rate inched down to 2.8% from 2.9%. The quits rate tends to be a leading indicator for wage gains.

Filed under: Economy | 5 Comments »

Vital Statistics:

Stocks are lower this morning as investors fret about growth going forward. Bonds and MBS are up again.

The big event this week will be the jobs report on Friday. The Street is looking for 270,000 jobs and for unemployment to remain at 3.6%. We will also get the ISM Services Report which will be a bellwether for the state of the economy.

The data last week has pushed the Atlanta Fed’s GDP Now forecast to -2.1%. This would mean negative GDP growth for the first half of 2022.

This would typically mean we are in a recession. That said, the government and the chattering classes are pushing back against that definition. The government changed the definition of a recession from 2 consecutive quarters of negative GDP growth to something more subjective: “In general usage, the word recession connotes a marked slippage in economic activity. While gross domestic product (GDP) is the broadest measure of economic activity, the often-cited identification of a recession with two consecutive quarters of negative GDP growth is not an official designation. The designation of a recession is the province of a committee of experts at the National Bureau of Economic Research (NBER), a private non-profit research organization that focuses on understanding the U.S. economy.” 

What this means is that even if we get a negative GDP print in the second quarter, the government and the business press will insist we are not in a recession. They will use the low unemployment rate as the reason. That said, the National Bureau of Economic Research generally gets around to calling something a recession after it is over.

Regardless of whether the government determines we are in a recession or not, the yield curve is definitely giving clues that we are headed towards one. The slope of the yield curve (i.e. the difference between short term rates and long term rates) is often a pretty solid indicator of an impending recession. Here is a chart of 2s-10s going back to the 1970s:

The shaded lines indicate an official NBER recession. You could make the argument that this indicator has lost value in a QE world, and you would be 100% correct. That said, the indicator is flashing a warning sign for growth.

The problem for the Fed is that interest rates are still highly negative on an inflation-adjusted basis. The Consumer Price index is running over 8% and the PCE Index is running at a 4.7% rate ex-food and energy. So, even though the Fed is being aggressive in hiking rates, overall monetary policy remains highly accommodative.

Filed under: Economy | 18 Comments »

We lasted another year. I can’t say the prospects look good for the long term, but I am marginally more optimistic than I was last year, so let’s celebrate while we still can. Hope you all have a good 4th!

Filed under: Economy | 17 Comments »

Vital Statistics:

Stocks are lower this morning as we kick off the third quarter. Bonds and MBS are up. The first half of the year was the worst for the S&P 500 since 1970.

The bond market closes early today at 2:00 pm. Liquidity should be lousy as most of the street will be on the LIE by noon.

The Fed Funds futures are beginning to handicap some chance of a 50 basis point hike at the Fed meeting this month. The current futures contracts imply a 28% chance of 50 bps and a 72% chance of 75.

The manufacturing economy decelerated in June according to the ISM Manufacturing Index. This is the lowest ISM reading since June 2020. New Orders and Employment contracted, which indicates that the economy is slowing down.

“The U.S. manufacturing sector continues to be powered — though less so in June — by demand while held back by supply chain constraints. Despite the Employment Index contracting in May and June, companies improved their progress on addressing moderate-term labor shortages at all tiers of the supply chain, according to Business Survey Committee respondents’ comments. Panelists reported lower rates of quits compared to May. Prices expansion slightly eased for a third straight month in June, but instability in global energy markets continues. Sentiment remained optimistic regarding demand, with three positive growth comments for every cautious comment. Panelists continue to note supply chain and pricing issues as their biggest concerns.”

Construction spending fell 0.1% MOM in May but is still up 9.7% on a YOY basis. Residential construction rose 0.2% MOM and is up 18.7% on a YOY basis.

Overall, it looks like the economy is beginning to slow down and we should start seeing more confirmation in indicators like the jobs report next week. The big question for the stock market will be earnings season which kicks off in a couple of weeks with the big banks. If Q2 earnings are better than expected maybe we could start to put in a base under the stock market.

Filed under: Economy | 18 Comments »

Vital Statistics:

Stocks are lower as we end a hideous quarter for the markets. Bonds and MBS are up.

FGMC has filed for bankruptcy. It won’t affect closed loans and the company obtained DIP financing. “While we have made considerable efforts to address our ongoing financial challenges related to the state of the mortgage market, we ultimately must do what is best for our borrowers and consumers,” said Aaron Samples, chief executive officer of FGMC. “After careful review and consideration, the Company determined that pursuing the protections of chapter 11 is the right and responsible path at this time. As part of this process, the Company retained a portion of its workforce to manage the day-to-day business. We are requesting that the court approve a variety of motions that will promote a smooth transition for all pertinent parties while also preserving value for the benefit of the Company’s stakeholders.”

Personal incomes rose 0.5% MOM, according to the Bureau of Economic Analysis. This number was in line with expectations. Personal consumption expenditures came in light, rising only 0.2%, when the Street was looking for a 0.5% increase. If you adjust for inflation, spending fell 0.4%.

The inflation indices were at least somewhat encouraging. PCE Inflation rose 0.6% MOM, which was an increase however the YOY change was flat at 6.3%. Ex-food and energy PCE inflation rose 0.3% MOM and fell to 4.7% YOY.

Overall, the spending number is discouraging, and indicates that second quarter GDP might be weaker than people are thinking.

Jerome Powell said yesterday that he was more concerned about the risk of inflation than the risk of recession. Is there a risk we would go too far? Certainly there’s a risk,” Mr. Powell said Wednesday. “The bigger mistake to make—let’s put it that way—would be to fail to restore price stability.” He was speaking at the European Central Bank’s annual economic conference.

The risk is that the economy transitions into a higher-inflationary regime where higher inflationary expectations get baked into the economy. This happened in the 1970s, and the Fed found itself with a economy where growth stagnated and inflation kept ratcheting higher. The state of affairs was eventually described via the misery index, which was the sum of inflation, unemployment and interest rates.

Inflationary expectations tend to have reinforcing effects. People tend to accelerate purchases in order to buy before prices rise. This exacerbates shortages. Workers expect annual cost-of-living increases which further increases the prices of finished goods. This psychological phenomenon is what the Fed is trying to ward off.

Filed under: Economy | 62 Comments »

Vital Statistics:

Stocks are flattish this morning after yesterday’s tech rout. Bonds and MBS are flat.

The final revision of first quarter GDP came in at -1.6%, a downward revision from the previous -1.5%. The PCE Price Index (basically inflation) was revised upward to 7.1%. Ex-food and energy it rose 5.2%. Consumption was revised downward to 1.8% from 3.1%.

The latest GDP Now estimate from the Atlanta Fed has growth increasing at 0.3% in the second quarter. If that is how it plays out, we will have managed to avoid a technical recession, however growth is anemic and the recent increases in the Fed Funds rate won’t begin to impact the economy until later this year.

Mortgage applications rose 0.7% last week as purchases rose 0.1% and refis increased 2%. The numbers were affected by the Juneteenth holiday.

“Mortgage rates continue to experience large swings,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. He noted the 30-year fixed rate declined 14 basis points last week to 5.84 percent after increasing 65 basis points during the past three weeks. Rates are still significantly higher than they were a year ago, when the 30-year fixed rate was at 3.2 percent.

“The decline in mortgage rates led to a slight increase in refinancing, driven by an uptick in conventional loans,” Kan said. “However, refinances are still 80 percent lower than a year ago and more than 60 percent below the historical average. Overall purchase activity has weakened in recent months due to the quick jump in mortgage rates, high home prices, and growing economic uncertainty.”

The abrupt shutdown of First Guaranty has left a lot of lenders with uncertain pipelines. The company laid off almost 80% of its staff on Friday, and basically left a skeleton crew to wind things down. “FGMC has experienced significant operating losses and cash flow challenges due to unforeseen historical adverse market conditions for the mortgage lending industry, including unanticipated market volatility,” Cassie Vacante, senior vice-president of Human Resources, wrote in a WARN notice.

I have heard rumors that liquidity is beginning to dry up in the non-QM space. I have to imagine the fallout from FGMC is related to it. Last week there were rumors that FGMC was hit by margin calls, which might be indicative of weakening buy-side demand for private label securities. While these are rumors only, it seems to fit.

Home Prices rose 21% in May, according to the Clear Capital Home Data Index. In the Southern region, prices rose 23%, led by a slew of Florida locations. The Northeast is beginning to experience home price appreciation at long last. Note this index is a month ahead of the FHFA and Case Shiller indices so it reflects more recent data. The rise in mortgage rates has yet to affect home price appreciation.

Filed under: Economy | 38 Comments »

Vital Statistics:

Stocks are higher this morning as China eases lockdown restrictions. Bonds and MBS are down.

House prices rose 1.6% MOM and 18.8% YOY according to the FHFA House Price Index. “House price appreciation continues to remain elevated in April,” said Will Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “The inventory of homes on the market remains low, which has continued to keep upward pressure on sales prices. Increasing mortgage rates have yet to offset demand enough to deter the strong price gains happening across the country.”

Separately the Case-Shiller Home Price Index rose 1.8% MOM and 21.2% YOY. These appreciation numbers go back to April, so this is before the Fed really started pushing up rates. That said, I think the supply and demand situation is not really conducive to any sort of meaningful / widespread home price depreciation.

Consumer confidence fell again in June, according to the Conference Board. “Consumer confidence fell for a second consecutive month in June,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “While the Present Situation Index was relatively unchanged, the Expectations Index continued its recent downward trajectory—falling to its lowest point in nearly a decade. Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by yearend.”

The one bright spot is that the present situation (which is how things actually are) is holding up. The other bright spot is that consumers are more pessimistic about the overall economy than they are about their personal financial situations.

Times are still good for landlords as the CoreLogic Single Family Rent Index rose 14% YOY in April. Some numbers are absolutely staggering: Miami was up 41% on a YOY basis. Orlando was up 26%. The downside is that these numbers will almost certainly add to inflationary pressures going forward.

Filed under: Economy | 38 Comments »