All Things in Moderation

Vital Statistics:

Stocks are higher as markets continue to rebound. Bonds and MBS are down.

We are heading into a pretty big week for data, although the jobs report will slip into next week. We will get home prices and consumer confidence tomorrow, the final revision to Q1 GDP on Wednesday, personal incomes and outlays on Thursday, and ISM data on Friday. Markets will have an early close on Friday ahead of the 4th of July weekend.

First Guaranty mortgage laid off almost all of their staff on Friday. It sounds like they were short on cash and unable to strike a deal to raise more. Instead of ponying up more cash, main backer PIMCO decided to pull the plug instead.

Durable Goods orders increased in May, according to the Census Bureau. Orders were up 0.7% while shipments increased 1.3%. The report shows that demand remains strong, and some of the supply side numbers show that supply chain issues may be easing a touch, which is good news for the inflation numbers and the economy overall.

Pending Home Sales rose 0.7% in May, according to NAR. The Northeast saw the biggest gain, with home sales rising 15.4%. “Despite the small gain in pending sales from the prior month, the housing market is clearly undergoing a transition,” said NAR Chief Economist Lawrence Yun. “Contract signings are down sizably from a year ago because of much higher mortgage rates. Trying to balance the housing market by choking off demand via higher mortgage rates is damaging to consumers and the economy,” Yun added. “The better way to balance the market is through increased supply, which also helps the broader economy.”

His point about housing construction being the answer to soaring home prices is spot-on. Historically housing has led the economy out of a recession. It wasn’t unusual to see housing starts spike above a 2 million annualized pace coming out of recessions in the past. This was almost par for the course in the 1970s and 1980s.

The 2008 financial crisis never witnessed a rebound in home construction as we did have an overhang of foreclosures and excess new construction. That overhang was probably balanced out by the mid teens, and now we have an abject shortage of housing. The government would love to see new home construction, however the constraints are on the supply side – materials and especially labor.

I suspect the recovery from the current / imminent recession will finally be the one that ushers in a wave of new home construction. The big question will be whether we have the workers to do it.

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

The S&P Flash Composite Purchasing Managers Index showed the economy slowed pretty dramatically in June. PMI Indices are based on questionnaires given to business executives, so they are a little more timely than some of the government statistics.

Service industries fared a little better than manufacturers, which is starting to see evidence of demand destruction. New orders contracted for the first time since July of 2020. Pricing pressures show no sign of abating however. Business confidence numbers fell to the lowest in over a decade.

It is possible that we are on the cusp of “bad news is good news” as far as market sentiment – where economic weakness is interpreted as good news for stocks and bonds because it means the Fed may ease up on the brakes. We aren’t there quite yet, but it feels like we are close.

Regardless of the PMI data, the Fed Funds futures are still a lock for 75 basis points in hikes at the next meeting.

New Home Sales rose 10.7% MOM to a seasonally adjusted annual pace of 696,000 units. This is still down over 5% on a YOY basis. The Street was looking for 587k, so this is an upside surprise. Note that April’s number was exceptionally low, so perhaps some sales got pushed to May. Regardless, housing still remains a bit of a drag on the economy.

The University of Michigan Consumer Sentiment index slipped in June to 50. This is a big decline from May, and it confirms the lousy initial reading. This is the lowest reading on record for the index. It is down an astounding 41% on a YOY basis.

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Stocks are higher this morning as Jerome Powell heads to the Hill to testify in front of the House. Bonds and MBS are up.

Jerome Powell reiterated his commitment to reducing inflation and said a recession is a possibility. “At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so,” the Fed chief said in remarks for the Senate Banking Committee. “We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2%,” Powell said. “We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy.”

Despite the increase in interest rates, the employment market remains resilient. Initial Jobless Claims ticked down slightly to 229,000 last week, which is still historically very low.

The CFPB is reviewing the Non-QM rule. The CFPB’s Qualified Mortgage Rules to explore ways to spur streamlined modification and refinancing in the mortgage market, as well as assessing aspects of the “seasoning” provisions. The other thing probably worth exploring is the APOR / HPML issue and how it is applied in a period of rapidly rising interest rates.

The number of mortgages in forbearance fell last week to 0.85% from 0.94%. So far we are seeing scant evidence that the increase in interest rates and the weakening economy is having an effect on loan performance. “Servicers are whittling away at the remaining loans in forbearance, even as the pace of monthly forbearance exits slowed in May to a new survey low,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “Most borrowers exiting forbearance are moving into either a loan modification, payment deferral or a combination of the two workout options.”

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Stocks are lower this morning as investors get more bearish about the economy. Bonds and MBS are up.

Jerome Powell heads to the Hill for his Humphrey Hawkins testimony. The meat of the message is this quote from the prepared remarks:

Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing rate increases will be appropriate; the pace of those changes will continue to depend on the incoming data and the evolving outlook for the economy. We will make our decisions meeting by meeting, and we will continue to communicate our thinking as clearly as possible. Our overarching focus is using our tools to bring inflation back down to our 2 percent goal and to keep longer-term inflation expectations well anchored.

The Fed Funds futures still anticipate a 89% chance of a 75 basis point hike in July and a 11% chance of a 50 basis point hike. The central tendency for December is a Fed Funds futures rate of 3.5%, which means another 200 basis points are anticipated.

Citigroup sees a 50% chance of a global recession this year. Chief Global Economist Nathan Sheets said: “The global economy continues to be afflicted by severe supply shocks, which are pushing up inflation and driving down growth. But more recently, two further factors have burst onto the scene: Central banks are hiking policy rates with increasing vigor in their fight against inflation, and the global consumer’s demand for goods looks to be softening. We conclude that central banks face a daunting challenge as they seek to wrestle inflation down,” Sheets added. “The experience of history indicates that disinflation often carries meaningful costs for growth, and we see the aggregate probability of recession as now approaching 50%. Central banks may yet engineer the soft—or ‘softish’—landings embedded in their forecasts (and in ours), but this will require supply shocks to ebb and demand to remain resilient.”

Mortgage applications rose 4.2% last week as purchases rose 8% and refis fell 3%. “Mortgage rates continued to surge last week, with the 30-year fixed mortgage rate jumping 33 basis points to 5.98 percent – the highest since November 2008 and the largest single-week increase since 2009,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “All other loan types also increased by at least 20 basis points, influenced by the Federal Reserve’s 75-basis-point rate hike and commentary that more are coming to slow inflation. Mortgage rates are now almost double what they were a year ago, leading to a 77 percent drop in refinance volume over the past 12 months.”

Existing Home Sales fell 3.4% MOM and 8.6% YOY in May, while the median home price reached $400,000. “Home sales have essentially returned to the levels seen in 2019 – prior to the pandemic – after two years of gangbuster performance,” said NAR Chief Economist Lawrence Yun. “Also, the market movements of single-family and condominium sales are nearly equal, possibly implying that the preference towards suburban living over city life that had been present over the past two years is fading with a return to pre-pandemic conditions.”

Inventory remains an issue, although it is improving. Unsold homes sat at a 2.6 month supply at the end of May. A balanced market is more like 6%. Lawrence Yun is bearish on sales going forward: “Further sales declines should be expected in the upcoming months given housing affordability challenges from the sharp rise in mortgage rates this year,” Yun added. “Nonetheless, homes priced appropriately are selling quickly and inventory levels still need to rise substantially – almost doubling – to cool home price appreciation and provide more options for home buyers.”

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Vital Statistics:

Stocks are higher to begin this shortened week after a horrendous two weeks. Bonds and MBS are down.

There isn’t a lot of market-moving data this week, however Jerome Powell will head to the Hill for his semiannual Humphrey-Hawkins testimony. Aside from a lot of Fed-Speak, new home sales on Friday will be important.

The Fed Funds futures are predicting another 75 basis point hike at the July Fed meeting. This would imply about 150 basis points of tightening in the context of six weeks. This amounts to one of the biggest moves ever from the Fed, and the last time the Fed moved like this the overall interest rate environment was much higher. Going from 9.25% to 10.75% in the 80s probably has less of an impact than going from 0.5% to 2.25%.

With the Atlanta Fed’s GDP Now index predicting flat growth in Q2, the new home sales number will probably take on more significance than normal. Given the lousy housing starts number last week, I expect new home sales to come in weak as well, which will probably seal the deal for a negative Q2. That will make us officially in a recession.

So far, it doesn’t appear that there are any systemic issues in the financial markets. No blow-ups that spew counterparty risk all over the place. Corporate balance sheets are generally unleveraged, and most of the debt issuance during the pandemic was about refinancing existing debt and locking in low rates.

Growth decelerated in May, according to the Chicago Fed National Activity Index. This index is comprised of various economic indicators and is intended to be sort of a meta-index for the economy. The index fell to 0.1%, which is barely above trend. Sales and employment trends added to the index, while production, consumption and housing were weak spots.

New Residential is changing its name to Rithm Capital. It will now be an internally-managed REIT versus an externally managed one. “We are taking this opportunity to rebrand to Rithm Capital and demonstrate the growth of our Company,” said Mr. Nierenberg. “We have changed dramatically since our inception, from an owner of MSR assets to a company with complementary operating companies and a unique portfolio of investments. The new name and brand help distinguish us from our operating companies, including Newrez, and reflect our culture, team and ambitions for growth beyond residential mortgages.”

I have absolutely no idea what Rithm is supposed to mean. Is it an acronym? But this is definitely one of the stranger name changes since Nationstar rebranded as Mr. Cooper.

The company also declared its normal $0.25 dividend. This gives the stock a double-digit dividend yield. So far the anticipated dividend cuts in the mortgage space have yet to materialize.

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Stocks are rebounding this morning after yesterday’s blood bath. Bonds and MBS are down.

Biden said that a recession isn’t inevitable in an interview with AP. On the subject of what voters should take away from the fact that economists suggesting a recession is possible next year, he said:

“They shouldn’t believe a warning. They should just say: “Let’s see. Let’s see, which is correct.” And from my perspective, you talked about a recession. First of all, it’s not inevitable. Secondly, we’re in a stronger position than any nation in the world to overcome this inflation. It’s bad. Isn’t it kind of interesting? If it’s my fault, why is it the case in every other major industrial country in the world that inflation is higher? You ask yourself that? I’m not being a wise guy. Someone should ask themself that question. Why? Why is it? If it’s a consequence of our spending, we’ve reduced the deficit. We’ve increased employment, increased pay. There was a survey done uh, uh, by the, uh, I forget which one it was, which one it was now, about three months ago. You had more people had lower debt (inaudible) credit cards, more savings in their savings account, higher pay in the job they had, more satisfaction in the job they had and they were in good shape financially.”

The Conference Board’s Index of Leading Economic Indicators fell 0.4% in May. “The US LEI fell again in May, fueled by tumbling stock prices, a slowdown in housing construction, and gloomier consumer expectations,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The index is still near a historic high, but the US LEI suggests weaker economic activity is likely in the near term—and tighter monetary policy is poised to dampen economic growth even further.”

Given the abrupt rise in interest rates, I suspect the LEI hasn’t caught up to the new reality yet. Even the MBA forecast from earlier this month has a Q2 and end of year forecast for the 30 year fixed rate mortgage around 5%. It is currently 6%. Last week’s CPI report was a game changer.

Industrial production rose 0.2% in May, which was a touch below consensus. Manufacturing production fell 0.1%. Capacity Utilization inched up to 79%. Capacity Utilization is much lower than it was in the 1970s, and is at least one positive statistic on the inflation front. Of course the economy is much different today – we are no longer a manufacturing-focused economy but this is at least one positive development.

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Stocks are lower this morning as markets digest the Fed’s move yesterday. Bonds and MBS are down.

The Fed raised the Fed Funds rate 75 basis points yesterday. This was the biggest increase since 1994. We got a new set of projections as well, with the Fed raising its inflation and unemployment forecasts and cutting GDP growth forecasts. The dot plot moved upward pretty dramatically. You can see the June versus March plots below:

The central tendency in March was for a Fed Funds rate between 1.75% and 2% by the end of the year. That forecast is now 3.25% – 3.5%. The forecast for 2022 GDP was lowered from 2.8% to 1.7%, while the forecast for unemployment was moved up from 3.5% to 3.7% and the forecast for inflation was increased to 5.2% from 4.3%. The core inflation forecast (ex-food and energy) was bumped up slightly from 4,1% to 4.3%.

Jerome Powell said the central bank focused a lot on the University of Michigan sentiment index, especially the part about inflationary expectations. The median expectation for inflation was 5.4%, but the mean was 7.4%. That is a big concern for the Fed. The fear is that we get a wage-price spiral, where prices rise, workers demand higher compensation, which increases prices and drives further inflation. The big question concerns whether the Fed is chasing oil prices. Since the Fed has no control over commodity prices, it really should focus on core inflation. That said, its mandate is to manage headline inflation, so it may be forced to overreact to rising food and energy prices.

With the Atlanta Fed predicting 0% GDP growth this quarter, and the lousy retail sales print yesterday, we might already be in a recession. And if we are, we might be getting to the point where bad economic news is considered good news since investors will assume economic weakness will take the top off inflation and allow the Fed to take a breather on rate hikes. The minutes to the June meeting will be interesting to read.

So far, the yield curve has steepened in response to the meeting, with 2s / 10s trading at 14 basis points. Corporate credit spreads are behaving as well, so we aren’t seeing indications that economic weakness is spilling over into the financial sector, at least not yet.

Housing starts disappointed again, as rising home prices, mortgage rates, and materials prices make new houses expensive. Starts fell 14% MOM and 4% YOY to a seasonally-adjusted annualized pace of 1.55 million. Building Permits came in flat YOY at 1.7 million.

The NAHB / Wells Fargo Housing Market Index (which measures builder sentiment) fell to the lowest level since June of 2020. This is the sixth consecutive monthly decline. Building materials costs are up 19% YOY, except for lumber.

Housing remains a weak part of the economy, however it usually leads the economy out of a recession. If we get some relief on inflation and rising interest rates, perhaps the housing sector will get some legs later this year or next.

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Stocks are higher this morning as we await the FOMC decision at 2:00 pm. Bonds and MBS are up.

The FOMC decision will be released at 2:00 pm today. The market is predicting a 75 basis point increase in the Fed Funds rate. One week ago, the market was certain that the Fed would hike 50 basis points, so we have had a pretty sizeable jump in expectations in a short period of time. We will also get a fresh set of economic projections as well as a new dot plot.

Volatility in global bond markets has made predicting the reaction to the Fed decision pretty much a fool’s errand. I suspect the dot plot will be the main thing traders focus on, with an eye to predicting whether the Fed moves 50 or 75 in June. Note that European sovereign yields are down hard this morning as the ECB has called an emergency meeting to discuss volatility.

Retail sales fell 0.3% in May, according to the Census Bureau. This was below consensus. April’s numbers were revised downward as well. Ex-vehicles and gas, retail sales rose 0.1%. Motor vehicles were a big drag on the numbers. That said, it looks like consumers are beginning to pull in their horns, which can be a either a blessing or a curse for the Fed. If the drop in spending cools off inflation, then we have a better chance for a soft landing. If not, then we are looking at stagflation all over again.

Mortgage applications rose 6.6% last week as purchases rose 8% and refis rose 4%. This was the first increase in apps in 5 weeks. “Mortgage rates followed Treasury yields up in response to higher-than-expected inflation and anticipation that the Federal Reserve will need to raise rates at a faster pace,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Despite the increase in rates, application activity rebounded following the Memorial Day holiday week but remained 0.29 percent below pre-holiday levels. With mortgage rates well above 5 percent, refinance activity continues to run more than 70 percent lower than last year.”

Separately, Wells Fargo’s CFO said at a conference yesterday that he expected Q2 mortgage banking income to be down about 50% from Q1.

The increase in mortgage rates this year has been the biggest since 1981. Between the increase in home prices and the rise in rates, the typical principal and interest portion of a mortgage is up big as well. This is cooling down the housing market, and Moody’s is predicting that home price appreciation will be flat over the next year, and some markets might see a drop in prices.

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

Yesterday’s market sell-off took the S&P 500 into bear market territory, which is defined as 20% from the peak. What caused the stock market to sell off so dramatically? The answer is that the markets reassessed their forecast for this week’s FOMC meeting. The Fed Funds futures went from forecasting a 50 basis point tomorrow to a 75 basis point hike. Take a look at the Fed Funds futures chart below:

Last week, the Fed Funds futures were predicting a 96% chance for a 50 basis point hike. They are now predicting a 94% chance of a 75 basis point hike. This is all in reaction to the overly-hot CPI number on Friday.

One other market observation is this reassessment of Fed policy has flattened the yield curve. The yield curve is basically a plot of the interest rate at different maturities. Typically, the yield curve slopes upwards, which means that investors require a higher interest rate for longer maturities than shorter ones. That is no longer the case in any meaningful way. The 2 year bond yield is 3.33%, while the 10 year is 3.35%. The difference is a mere 2 basis points. A year ago, that difference was 2% or 200 basis points. The black line in the chart below is what the curve looked like a year ago. The blue line is what it looks like today.

If long term rates fall below short term rates (in other words, a yield curve inversion), that often forecasts a recession. Note that the shape of the yield curve means a lot less in a QE world, but historically that has been a decent economic signal. That is what stocks are reacting to.

Inflation at the wholesale level rose 0.8% MOM in May, according to BLS. On an annual basis, prices rose 10.8%. Ex-food and energy, prices rose 0.5% MOM and 6.8% YOY. These numbers were a tough below Street expectations, but probably won’t make a difference as far as Fed policy is concerned.

Small business optimism is under pressure, according to the NFIB small Business Optimism Survey. Expectations about the future are downright awful, and the expectations index is at a record low. This is being driven by inflation, a tight labor market, and continued supply chain issues. The thick line in the chart below shows whether businesses think this is a good time to expand. The thin line shows expectations for the future.

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Stocks are lower this morning as rates continue to rise in the aftermath of Friday’s CPI report. Bonds and MBS are down. With the stock market hovering just above 3,800 we are officially in a bear market. Having fun yet?

The Fed is almost assuredly going to increase the Fed Funds rate by 50 basis points at its meeting this week. Traders will parse the language for the degree of hawkishness, but I think markets are pretty much factoring in 50 basis points in June, July, and September. That is a lot of tightening in the face of a weak economy. The Atlanta Fed’s GDP Now index has Q2 growth coming in at 0.9%. Don’t forget Q1 was highly negative, so if Q2 ends up being negative, we will officially be in a recession.

Since the unemployment rate is so low, an official recession might not make a difference to the Fed. Their dual mandate is for unemployment and inflation, not growth and inflation.

In other data this week, we will get the producer price index tomorrow, housing starts, retail sales and leading indicators. So a pretty busy week, but the Fed will dominate the data.

About the only good news these days is that house prices are rising and making homeowners wealthier. In the first quarter, home equity rose 32.2%, according to Corelogic. Patrick Dodd, CEO of Corelogic said: “Price growth is the key ingredient for the creation of home equity wealth. Home prices were up by 20% in March compared to one year earlier in CoreLogic’s national Home Price Index. This has led to the largest one-year gain in average home equity wealth for owners and is expected to spur a record amount of home-improvement spending this year.” Over the past year, the average home gained $64k in home equity.

Got credit card debt? Debt-consolidation cash-out refis are a good way to lower your rate.

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