All Things in Moderation

Vital Statistics:

Stocks are lower this morning after the CPI report. Bonds and MBS are down.

Inflation at the consumer level rose 1% month-over-month and 8.6% on an annual basis. This is a 40 year high for the index. Ex-food and energy, the index rose 0.6% on a MOM basis and 6% year-over-year. These numbers were higher than Street expectations.

The worrisome part of the CPI reading is that the month-over-month numbers are not falling. The April reading looks like an outlier, as we had a dip in energy prices that month, but it is hard to argue that price appreciation is peaking.

The food at home index (i.e. supermarket prices) rose 11.9% YOY, which was the largest increase since 1979. Food away from home (restaurant prices) rose 7.4%, however making apples-to-apples comparisons for restaurants is tough since portion sizes are hard to measure.

Ex-food and energy, shelter (i.e. home prices) rose 5.5%, which was the biggest increase since 1991. Rising home prices tend to affect the index with a 12-18 month lag, so these numbers would reflect late 2020 / early 2021 home price appreciation numbers. Since we have been seeing home prices rise in the high teens over the past few quarters, the index will begin to reflect this in the numbers as we move through this year and next.

Overall, this report didn’t show what the market was hoping to see – any indication that inflation is beginning to moderate. The Fed is probably going to hike 50 basis points at the meeting next week, and in July.

Consumers are in a downright awful mood, according to the University of Michigan Consumer Sentiment Index. The index declined 14% compared to May and is down 41% on a year-over-year basis. To put things into perspective, consumer sentiment is at the lows experienced during the 1980-1982 recessions, which at the time was the worst since the Great Depression.

Filed under: Economy | 6 Comments »

Vital Statistics:

Stocks are lower this morning as the ECB prepares to hike rates. Bonds and MBS are down.

The ECB has ended quantitative easing and has paved the way for a 25 basis point hike in rates. Europe has been in a negative rate environment for a long time, so the adjustment will be worth watching. Since global bond yields generally correlate, a rise in European yields will push up US yields as well. That said, the US Treasury is still one of the highest-yielding sovereigns on the planet.

Stocks and bonds sold off on the announcement, with the 10 year ticking towards 3.05%.

Rising rates have decreased mortgage credit, according to the MBA. Interestingly, we are back at post-crisis levels, although much of it is driven by higher rates. “The index remains more than 30 percent below pre-pandemic levels, as credit tightening has occurred in recent months around refinance loan programs,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Last month’s tightening was most notable in the government and jumbo segments of the mortgage market. The decrease in government credit was driven mainly by a reduction in streamline refinance programs, as mortgage rates increased sharply through May, slowing refinance activity. Jumbo credit availability, which was starting to see a more meaningful recovery from 2020’s pullback, declined after three months of expansion.”

2.71 million mortgages were originated in the first quarter, according to data from ATTOM. This is down 18% from the fourth quarter and 32% from a year ago. “The drop-off in Q1 refinancing activity is no surprise with mortgage rates rising as rapidly as they have,” said Rick Sharga, executive vice president of market intelligence at ATTOM. “But many forecasts expected purchase loans to remain strong in 2022, and even increase in both the number of loans originated and the dollar volume of those loans. The weakness in purchase loan activity shows just how much of an impact the combination of escalating home prices and rising interest rates have had on borrower activity this year.”

While the percentage decline is grabbing attention, compared to post-bubble numbers current production is still pretty strong.

Initial Jobless Claims ticked up to 229,000 last week. These are still historically very low numbers, but we are beginning to see some layoffs happen.

Filed under: Economy | 81 Comments »

Vital Statistics:

Stocks are lower this morning after the World Bank cut its global growth outlook. Bonds and MBS are down small.

The World Bank cut its 2022 global growth forecast from 4.1% to 2.9%. This is a pretty sizeable slowdown from the 5.7% we experienced last year. The war in Ukraine, supply chain issues, and lockdowns in China are the big drivers of the downgrade. Stagflation is a risk as the economic environment looks similar to the 1970s, with a combination of supply shocks and a prolonged period of highly loose monetary and fiscal policy. The World Bank expects global growth to slow even further in 2023 to 2.3%.

This slowdown in growth will probably put pressure on the Fed to moderate its path of consecutive 50 basis point hikes in the Fed Funds rate. The Fed will be data-dependent, however the drop in new home sales is worrisome since housing has typically been a big driver of economic performance.

Consumer attitudes are pessimistic, according to a Wall Street Journal / NORC poll. 83% of consumers said that the economy was “poor” or “not so good.” A third said they were not satisfied with their financial situation, while only about a quarter expected to see an increase in their standard of living going forward. That said, the labor market is still strong, with 2/3 of respondents saying they could get a new job with similar salaries and benefits. Overall, these consumer sentiment surveys are often negatively correlated with gas prices. When prices at the pump are high, consumers get discouraged.

Mortgage Applications fell 6.5% last week as purchases fell 7% and refis fell 6%. “While rates were still lower than they were four weeks ago, they remained high enough to still suppress refinance activity,” Kan said. “Only government refinances saw a slight increase last week. The purchase market has suffered from persistently low housing inventory and the jump in mortgage rates over the past two months. These worsening affordability challenges have been particularly hard on prospective first-time buyers.” You can see below that the index eclipsed the lows of 2018. The index itself is at a 22 year low.

Home Prices rose 20.9% in April, according to the CoreLogic Home Price Index. They are expected to rise another 5.6% over the next year. It looks like CoreLogic bumped up their forecast which had been in the low single digits previously. Rising rates have driven buyer urgency this spring, as 70% of homes sold above the asking price.

“The record growth in home prices is a result of a scarcity of for-sale inventory coupled with eager buyers who want to purchase before mortgage rates go higher. Buyers who closed on their home in April had locked in their mortgage rate in February or March, when rates were lower than today. With 30-year fixed mortgage rates much higher now, we expect to see waning buyer activity because of eroding affordability. As a consequence, our forecast projects slowing price growth over the coming year.”

Filed under: Economy | 9 Comments »

Vital Statistics:

Stocks are lower this morning after another profit warning from bellwether retailer Target. Bonds and MBS are down.

Target made a profit warning this morning saying that it will need to discount some inventory in order to move it.

“We’ve had some additional time after earnings to really evaluate the overall operating environment,” said Target Chief Executive Brian Cornell in an interview. That includes watching consumer behavior as they face high rates of inflation, he said, and seeing many other retailers talk about high inventory levels during their earnings presentations. “We have to be decisive and get out in front of this to make sure this doesn’t linger through the back half of the year,” he said.

Consumption is 70% of the economy, so warnings from retailers are a red flag. The Atlanta Fed’s GDP Now model has Q2 GDP coming in at 1.3%, which is pretty lousy given that GDP contracted in the first quarter.

That said, we are starting to see some moderation in inflationary indicators. Shipping rates are down 33% from their peaks in fall of 2021. Fertilizer prices are beginning to drop as well.

Tappable equity (in other words, home equity above 20%) rose $1.2 trillion in the first quarter of 2022 as home price appreciation accelerated. This is a record gain. Total tappable equity sits at $11 trillion, or about $207,000 per mortgaged property. This is more than 2x the amount of tappable equity at the peak of the US residential real estate bubble of the mid ’00s.

This increase in tappable equity creates opportunities for cash-out refinances. That said, the vast majority of this equity is held by high-credit borrowers with very low rates. They don’t have much high-rate credit card debt to refinance and would probably prefer to take out a HELOC if they want to take out any equity.

Filed under: Economy | 23 Comments »

Vital Statistics:

Stocks are higher this morning as China’s COVID crisis seems to be ending. Bonds and MBS are down.

The week after the jobs report is generally data-light, and we will also have no Fed-Speak as this is the quiet period ahead of the June FOMC meeting. The biggest economic report will be the Consumer Price Index on Friday. While the year-over-year numbers will grab the headlines, investors will be focused mainly on the month-over-month numbers, to see if inflation is beginning to moderate.

The Cleveland Fed President Loretta Mester said she hasn’t seen evidence that inflation has peaked. “I think the Fed has shown that we’re in the process of recalibrating our policy to get inflation back down to our 2% goal. That’s the job before us,” Mester said in a live interview on CNBC’s “The Exchange. I don’t want to declare victory on inflation before I see really compelling evidence that our actions are beginning to do the work in bringing down demand in better balance with aggregate supply,” she added.

She also supports the idea of the Fed raising the Fed Funds rate 50 basis points at the next two meetings. He bias is towards hiking another 50 in September, unless economic circumstances change.

“I’m going to come into the September meeting, if I don’t see compelling evidence [that inflation is cooling], I could easily be at 50 basis points in that meeting as well,” she said. “There’s no reason we have to make the decision today. But my starting point will be do we need to do another 50 or not, have I seen compelling evidence that inflation is on the downward trajectory. Then maybe we can go 25. I’m not in that camp that we think we stop in September.”

FWIW, the Fed Funds futures have a 60% chance of another 50 basis points in September

Filed under: Economy | 12 Comments »

Vital Statistics:

Stocks are lower this morning as investors fret about a slowing economy. Bonds and MBS are down.

The economy added 390,000 jobs in May, which was above Street expectations and the 129,000 increase ADP reported yesterday. The unemployment rate was steady at 3.6%. Average hourly earnings rose 5.2% on YOY basis. The usual suspects (leisure / hospitality and health care) increased employment, while retail fell. Retailers have been warning about consumer spending, so the number seems to fit.

Payrolls are close to pre-pandemic levels, but aren’t quite there yet.

The services economy expanded at a slower rate in May, according to the ISM Services Index. This is the lowest reading in the past year. “According to the Services PMI^®, 14 industries reported growth. The composite index indicated growth for the 24th consecutive month after a two-month contraction in April and May 2020. Growth continues — albeit slower — for the services sector, which has expanded for all but two of the last 148 months. The sector’s slowdown was due to a decline in business activity and slowing supplier deliveries. The Employment Index (50.2 percent) returned to expansion territory, and the Backlog of Orders Index grew, though at a slower rate. COVID-19 continues to disrupt the services sector, as well as the war in Ukraine. Labor is still a big issue, and prices continue to increase.”

Home Prices accelerated in May, according to the Clear Capital Home Data Index. Overall prices rose 8.9% quarter-over-quarter and almost 22% YOY. The Sun Belt and Florida are the big winners, with prices in Phoenix rising 38% and Tampa rising 40%. Interestingly, the Northeast had the fastest quarterly rise. The Northeast and Midwest have lagged the rest of the market since the 2008 bust, so maybe there are some signs of life there.

Filed under: Economy | 23 Comments »

Vital Statistics:

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

The economy added 128,000 jobs in May according to the ADP Employment Survey. This was below expectations and is lower than the Street 325k estimate for tomorrow’s jobs report. “Under a backdrop of a tight labor market and elevated inflation, monthly job gains are closer to prepandemic levels,” said Nela Richardson, chief economist, ADP. “The job growth rate of hiring has
tempered across all industries, while small businesses remain a source of concern as they struggle to keep up with larger firms that have been booming as of late.” You can see the the “tempering” of jobs growth in the chart below.

Productivity declined 7.2% in the first quarter, according to BLS. This is the biggest drop in productivity since 1947. Declining productivity is generally an inflationary indicator, as firms are making less with more resources. Unit Labor Costs rose 12.6%, which is a function of declining productivity and rising wages. The chart below shows inflation (red line) versus unit labor costs (blue line). In a lot of ways, the current environment is reminiscent of the late 1960s, where a tight labor market, profligate government spending, and easy money combined to create the 1970s inflation.

The thing to keep in mind is that inflation is a ratchet – the higher prices often do not decrease – they create a new plateau. So if prices increase 6% and wages increase 4%, it will take a while for wages to catch up, and in the meantime people will be worse off.

Job openings decreased to 11.4 million, but are still at close to record levels. Layoffs hit a record low of 1.2 million, while quits edged down slightly to 4.4 million. Separately, 200,000 people filed for initial unemployment benefits last week. The labor market remains strong, and that should bolster the economy going forward.

JP Morgan CEO Jamie Dimon got the market’s attention yesterday when he warned of an economic hurricane. “You know, I said there’s storm clouds but I’m going to change it … it’s a hurricane,” Dimon said Wednesday at a financial conference in New York. While conditions seem “fine” at the moment, nobody knows if the hurricane is “a minor one or Superstorm Sandy,” he added. “You’d better brace yourself,” Dimon told the roomful of analysts and investors. “JPMorgan is bracing ourselves and we’re going to be very conservative with our balance sheet.”

He is primarily worried about the Fed’s quantitative tightening, or the reversal of its bond buying program. He is right that we are in uncharted territory here. The last time the Fed tried quantitative tightening, it caused major disruptions in the money market. That was during an environment of benign inflation, so the Fed was able to reverse its policy easily. That might not be possible this time around.

Filed under: Economy | 7 Comments »

Vital Statistics:

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

Manufacturing expanded in May, according to the ISM Manufacturing Report. This is the second-lowest reading since September, 2020. New Orders and production improved, while prices inflation is moderating. Employment is falling. “The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. Despite the Employment Index contracting in May, 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 slightly lower rates of quits compared to April. May was a second straight month of slight easing of prices expansion, but instability in global energy markets continues. Surcharge increase activity appears to be stabilizing across all industry sectors. Sentiment remained strongly optimistic regarding demand, with five positive growth comments for every cautious comment. Panelists continue to note supply chain and pricing issues as their biggest concerns.

Janet Yellen admitted she was wrong about inflation over the past couple of years. “Well, look, I think I was wrong then about the path that inflation would take,” the Treasury secretary said when asked about her previous comments. “As I mentioned, there have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t — at the time didn’t fully understand. But we recognize that now.”

When discussing inflation, it pays to look at how some inputs affect each other. For example, here is a chart of natural gas:

Natural gas is a big component of electricity generation, and energy-intensive industries will have to pass on that increased costs to consumers.

Know what else is reliant on natural gas? Food. This is because natgas is a big input into fertilizer, which makes growing food more expensive. The US is a net exporter of natural gas, so world markets are not driving this. This is a capacity issue in the US, which ironically is the Saudi Arabia of natural gas. ESG (environmental and social justice funds) have declared war on fracking and made difficult for energy companies to raise funds for exploration and production. Of course as prices rise, we might see some members of the Climate Action 100 break ranks, however this is going to be a constraint on new production. It is the elephant in the room with the business press but realistically there is no lever that Washington can push. Additional drilling permits will do nothing if the energy companies can’t get financing.

Refining capacity has fallen over the past several years, and in order to maintain production of gasoline, diesel fuel refining has taken the hit, driving up diesel (and therefore transportation costs). Of course this gets passed onto consumers in the form of higher prices. Regulations could help here, especially suspending the Jones Act which requires American-flagged ships to transport goods from one US port to another. Shortages of diesel, particularly on the East Coast) could be addressed with supply elsewhere in the US.

Mortgage applications fell 2.3% last week as purchases fell 1% and refis fell 5%. Mortgage applications are at the lowest level since 2018. “Concerns of weaker economic growth and the recent stock market sell-off drove Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The purchase market continues to struggle with supply and affordability challenges. With the 30-year fixed rate at 5.33 percent, the refinance market continues to shrink, led by larger decreases last week for FHA and VA refinance applications. The refinance index was 75 percent below last year’s level, when rates were more than 200 basis points lower.”

Filed under: Economy | 14 Comments »

Vital Statistics:

Stocks are lower this morning as oil continues to climb. Bonds and MBS are down.

The upcoming week is packed with data, with the jobs report on Friday, ISM numbers and productivity. The jobs report will be the most impactful on the markets, however the consensus is that the Fed will hike by 50 basis points at the June meeting and another 50 at the July meeting.

House prices rose 18.7% YOY in the first quarter, according to the FHFA House Price Index. “High appreciation rates continued across housing markets during the first quarter of 2022,” said William Doerner, Ph.D., Supervisory Economist in FHFA’s Division of Research and Statistics. “Strong demand coupled with tight supply have kept prices climbing.  Through the end of March, higher mortgage rates have not yet translated into slower ​​price gains, but new home sales have dropped during the last few months, with a significant falloff in April.”

The fastest growing states were Florida (up 30%), Arizona (up 28%), Utah (up 27%), Tennessee (up 26%) and Idaho (up 26%). The slowest MSA was Washington DC (up 7%). You can see the rapid rise in home prices in the chart below which looks at Q1 appreciation since 2011 when home prices bottomed after the bubble.

Though there is disagreement amongst economists whether money printing causes asset inflation, the above chart certainly correlates with the increase in the money supply.

Mortgage backed securities have been unpopular this year ahead of the Fed’s plan to increase rates and sell some of its portfolio. The additional yield required by MBS investors has risen to 1.2% compared to 0.70% at the beginning of the year. Annaly Capital, a major mortgage REIT has raised capital to start increasing its portfolio of mortgage backed securities. The mREIT stocks have been sold off hard over the past year, but the feared dividend cuts have not materialized. Annaly currently yields over 13%, and AGNC Investment yields 12%

The increase in MBS spreads has also been driven by extreme volatility in the bond market. Since borrowers have the option to prepay the mortgage early, MBS investors are “short” that option. This means that as volatility increases, the value of that option increases, which increases the difference between the yield on Treasuries and mortgage backed securities. The TBA market is trading at extremely wide bid-ask spreads which demonstrates some of the fear in the market.

Bond market volatility seems to be calming down, which will naturally pull MBS yields closer to Treasury yields. In addition, we are seeing relative value investors like the mortgage REITs begin to put in a floor on MBS. If Treasuries stabilize, I would expect to see mortgage rates work lower. We might have already seen the highs of the year in mortgage rates.

Sun Belt cities are the fastest-growing, with 1/3 of them in Arizona. Florida is also seeing a big increase. Where are they coming from? The biggest cities in the US – New York City (which lost 305k people in 2021), Los Angeles, Chicago, San Francisco. 8 of the 10 largest cities in the US lost population in 2021.

Filed under: Economy | 41 Comments »

Vital Statistics:

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

The stock market is open for a full day today, but the bond market closes early at 2:00 pm. Liquidity should be downright lousy in the MBS market as most of the street will be on the LIE by noon.

Personal incomes rose 0.4% MOM in April, according to BEA. Personal consumption expenditures rose 0.9%. Incomes were lower than street expectations, while income were higher.

The PCE price index rose 0.2% MOM and 6.3% YOY. Ex-food and energy it was up 0.3% MOM and 4.9% YOY. The trend in the core rate has been decelerating which is good news as far as the Fed is concerned. The YOY numbers are still bad, but it looks like the worst is over as far as inflation goes.

Regardless of the inflation picture, consumer sentiment remains dour. It is back at the lows of 2008 -2010 and 2012. The drop in sentiment was driven primarily by buying conditions for durable goods and housing. Inflation is the key driver here, although housing inventory has been an issue for over a decade. Still, lower inventory and higher borrowing costs are making things difficult for would-be first time homebuyers. That said, consumers view this situation as temporary, and future expectations are higher.

Filed under: Economy | 22 Comments »