All Things in Moderation

Vital Statistics:

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

GDP growth in the first quarter was revised downward from -1.4% to -1.5%, according to BEA. The PCE price index, which measures inflation was steady at 7%. Ex-food and energy, the PCE index was revised downward from 5.2% to 5.1%. Inventory and exports were the reason for the decline in GDP growth.

The FOMC minutes didn’t have much effect on the markets yesterday. Inflation remains too strong for the Fed’s liking and the Street is looking for 50 basis point hikes in June and July.

They discussed the negative GDP print in Q1 specifically.

Participants commented that after its rapid growth in the last quarter of 2021, real GDP had declined in the first quarter of this year, with net exports and inventory investment making large negative contributions to growth. They noted, however, that these volatile components tended to contain little signal about subsequent growth and that household spending and business fixed investment had remained strong in the first quarter. These advances and the further tightening of labor market conditions were judged consistent with significant underlying momentum in the domestic economy.

The Fed thinks that GDP growth remains solid, and that fiscal policy will act as a natural drag on the economy while the supply chain issues will get worked out. In addition, a few members thought there were signs that the pandemic-related restrictions on labor supply were easing. I take this to mean that many workers who were staying out of the labor market due to health fears are now re-entering the labor force. Of course inflation could have something to do with that as well.

The characterization of GDP growth as “solid” is somewhat contradicted by the latest GDP Now estimate out of the Atlanta Fed, which just revised its estimate downward from 2.4% to 1.8%. I suspect the putrid new home sales number had something to do with it.

Speaking of new home sales, pending home sales fell 3.9% in April, according to NAR. Year-over-year pending home sales are down 9.1%.”Pending contracts are telling, as they better reflect the timelier impact from higher mortgage rates than do closings,” said Lawrence Yun, NAR’s chief economist. “The latest contract signings mark six consecutive months of declines and are at the slowest pace in nearly a decade. The escalating mortgage rates have bumped up the cost of purchasing a home by more than 25% from a year ago, while steeper home prices are adding another 15% to that figure. The vast majority of homeowners are enjoying huge wealth gains and are not under financial stress with their home as a result of having locked into historically low interest rates, or because they are not carrying a mortgage,” Yun explained. “However – in this present market – potential homebuyers are challenged and thus may attempt to mitigate the rising cost of ownership by opting for a 5-year adjustable-rate mortgage or by widening their geographic search area to more affordable regions.”

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Vital Statistics:

Stocks are flattish this morning on no real news. Bonds and MBS are flat as well.

Rates have been falling the past few days, which seems to be a return to the “risk off” mentality where investors sell stocks to buy bonds. Regardless of the reason, mortgage rates are beginning to come down which is good news for borrowers. This might be a good time to wake up some borrowers. The latest economic data has been somewhat subdued, which helps the situation. We are nowhere near recessionary territory for this year, but if growth is slowing that takes some pressure off the Fed.

The FOMC minutes will be released today at 2:00 pm. The minutes are usually not market-moving but with the bond market so skittish they might take on more importance.

Mortgage applications fell 1.2% last week as purchases increased by 0.2% and refis fell by 4%. “The 30-year fixed rate declined for the second straight week to 5.46 percent but remains well above what borrowers were used to over the past two years,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Most refinance borrowers continue to remain on the sidelines as a result, and refinance applications have fallen in nine of the past 10 weeks. Compared to January 2022, refinance activity is down 66 percent.” You can see we are at the lows of early 2018 on the refi index.

Durable Goods orders rose 0.4% in April, which was a deceleration from March. Ex-transportation (which tends to be volatile) they rose 0.3%. This is further evidence that the Fed’s actions to slow the economy have working.

You don’t have to look at the charts of the major mortgage bankers (Mr. Cooper notwithstanding) to know that profits fell in the first quarter. The MBA Mortgage Bankers Performance Report showed that average pretax profit was only 5 basis points, which is well below the 55 basis point average since 2008. Rising costs were the big driver.

“It was a challenging mortgage market environment in the first quarter of 2022, with rising mortgage rates and low housing inventory resulting in lower production volume,” said Marina Walsh, CMB, MBA Vice President of Industry Analysis. “In addition to cost increases, productivity slipped for both sales and fulfillment staff “Furthermore, pull-through rates of closings to applications declined by 5 percentage points in the first quarter, affecting both revenue and cost. With the record-setting refinance volume of the past two years in the rearview mirror, the mortgage industry is clearly in a period of transition and many companies will need to make tough decisions.”

Average production volume fell 29% compared to the fourth quarter, while production revenue was more or less flat at 350 basis points. Servicing income rose to $242 per loan from $71 in the fourth quarter.

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Vital Statistics:

Stocks are lower this morning after Snap reported lower-than-expected earnings / guidance. Bonds and MBS are up.

Jerome Powell will be speaking at 12:20 today. I don’t see any prepared remarks, but markets are a on a hair trigger these days, so just be aware.

New Home Sales fell to a seasonally-adjusted annual rate of 591,000 in April, which was way below consensus estimates. This is down 17% MOM and 27% compared to a year ago. The report doesn’t give much color on the reasons for the decline, and these reports often have a pretty large sampling error. This reading is typical for what we saw in the 70s and 80s.

The expansion slowed in May, according to the Markit PMI Composite Flash index. The index hit a 4 month low, with manufacturing and services both declining. New orders increased, albeit at the slowest pace since August 2020. Rising input prices hit a series high going back to 2009. “The early survey data for May indicate that the recent economic growth spurt has lost further momentum. Growth has slowed since peaking in March, most notably in the service sector, as pent up demand following the reopening of the economy after the Omicron wave shows signs of waning. Companies report that demand is
coming under pressure from concerns over the cost of living, higher interest rates and a broader economic slowdown.”

Note this puts the Fed in a bit of a bind, as demand is starting to wane early in the tightening cycle. Inflation remains too high for them to pull back on the increases quite yet.

Americans’ financial well-being improved in 2021, according to a Fed study on the subject.

Despite persistent concerns that people expressed about the national economy, the survey highlights the positive effects of the recovery on the individual financial circumstances of U.S. families. In 2021, perceptions about the national economy declined slightly. Yet self-reported financial well-being increased to the highest rate since the survey began in 2013. The share of prime-age adults not working because they could not find work had returned to pre-pandemic levels. More adults were able to pay all their monthly bills in full than in either 2019 or 2020. Additionally, the share of adults who would cover a $400 emergency expense completely using cash or its equivalent increased, reaching a new high since the survey began in 2013.

The report also looks at the emerging use of buy-now-pay-later credit, which allows people to finance purchases using simple interest and making a small number of equal payments. The people who use this often skew towards lower income and education.

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Vital Statistics:

Stocks are higher this morning after the Biden Administration floated the idea of eliminating some tariffs on overseas goods. Bonds and MBS are up small.

The upcoming week will be relatively data-light, however we will get new home sales and personal incomes / outlays. The personal incomes / outlays number will be watched closely because it contains the inflation number. Markets will be watching closely to see if we are getting some relief in the month-over-month numbers. The year-over-year inflation numbers will be bad, of course but markets are looking for an indication that inflation is on the decline.

Economic growth is accelerating, according to the Chicago Fed National Activity Index. This is a meta index of 85 individual economic numbers. It indicates whether the economy is growing above or below trend. The Atlanta Fed’s GDP Now index has been moving up during May, and is looking at something like 2.3% growth in the second quarter.

The latest concern in the business press is the possibility of a recession. This is due to the fact that the Fed has often overshot to slow the economy. This was particularly true in the 1970s (a similar environment to today). St. Louis Fed President James Bullard doesn’t see a recession this year or next, unless there is a “really large shock” to the economy. “Recessions would have to come because there’s some really large shock and I can’t rule out that there would be some really big shock. Maybe there would be, but I am not seeing it near-term.” Bullard said during an exclusive interview with FOX Business’ Edward Lawrence on “Cavuto: Coast to Coast” on Friday. 

With rising interest rates, adjustable-rate mortgages aka ARMS are making a comeback. The share of ARMS came in at 10% last week, which was a tripling of the previous rate. ARMs allow borrowers to take a lower initial rate, however the rate can move upwards or downwards after a fixed period of time. Note that in the past most ARM loans had 1 year resets i.e. 5/1, 7/1 etc. Now most are based on SOFR, and they are resetting every 6 months. So you’ll hear 5/6, 7/6 etc. You can see in the chart below that ARMs are increasing but they are nowhere near where they were in the early 2000s.

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Vital Statistics:

Stocks are higher this morning after China cut interest rates overnight. Bonds and MBS are flat.

The Chinese economic situation will be something to watch as that will probably stick a fork in a lot of the commodity inflation we have been seeing. China has a real estate bubble comparable to the one the US experienced in the 1920s and Japan experience in the 1980s. I suspect that countries which experience decades of supernormal growth often create real estate bubbles, which cause epic slowdowns – the Great Depression in the US, the lost decade in Japan.

Risks for a US recession in late 2022 and early 2023 are building, and we are starting to see some strategists become more pessimistic on the economy. “Recession risks are high — uncomfortably high — and rising,” said Mark Zandi, chief economist at Moody’s Analytics. “For the economy to navigate through without suffering a downturn, we need some very deft policymaking from the Fed and a bit of luck.” Senior executives from Wells Fargo and Goldman Sachs have echoed this sentiment.

Further evidence is coming from retailer earnings. “While we anticipated a post-stimulus slowdown in these categories … we didn’t anticipate the magnitude of that shift,” Brian Cornell,Target’s chief executive, said in a Wednesday earnings call. “When we talk to our guests, they often express their concerns about a host of rapidly changing conditions, ranging from geopolitics to the high and persistent inflation they’ve been experiencing.”

Recessionary risks will put a ceiling on interest rates, which is why we may have seen the peaks of interest rates already in this tightening cycle. That said, the Fed Funds futures have yet to reflect this changing sentiment.

Lower-credit borrowers are beginning to fall behind in auto loans and credit cards. Delinquencies are rising in these sectors, which should at some point filter through to FHA loans, I suspect. We are still in a historically strong credit environment (stimulus checks plus a healthy labor market) but if we do see a recession credit quality will deteriorate. 30 day mortgage delinquency rates are at 2.8%, which is down 40% from last year.

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Vital Statistics:

Stocks are lower this morning, continuing off of yesterday’s bloodbath. Bonds and MBS are up.

The sell-off in the stock market has been pretty brutal. The VIX, which is an indicator of market pain is spiking, but is not overly elevated. The bottom of a sell-0ff is usually indicated with a dramatic spike. The chart below shows the VIX going back to 2000. You can see that the bursting of the tech bubble in 2000 didn’t really cause much of a spike, but the big spikes around 9/11, the 2008 financial crisis, Brexit, and COVID stand out. At least according to this indicator, we aren’t at maximum fear yet.

Despite the market sell-off, the index of leading economic indicators is still pretty strong. “The US LEI declined in April largely due to weak consumer expectations and a drop in residential building permits,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Overall, the US LEI was essentially flat in recent months which is in line with a moderate growth outlook in the near-term. A range of downside risks—including inflation, rising interest rates, supply chain disruptions, and pandemic-related shutdowns, particularly in China—continue to weigh on the outlook. Nevertheless, we project the US economy should resume expanding in Q2 following Q1’s contraction in real GDP. Despite downgrades to previous forecasts, The Conference Board still projects 2.3 percent year-over-year US GDP growth in 2022.”

Existing Home sales fell 2.4% in April, according to NAR. The median home price rose 14.8% to $391,200. It looks like home price appreciation is moderating a little. “Higher home prices and sharply higher mortgage rates have reduced buyer activity,” said Lawrence Yun, NAR’s chief economist. “It looks like more declines are imminent in the upcoming months, and we’ll likely return to the pre-pandemic home sales activity after the remarkable surge over the past two years.” Inventory is still extremely low, but is up marginally from a few months ago.

Mortgage applications fell 11% last week as purchases fell 12% and refinances fell 10%. Refinances are 76% lower than this time last year. “Mortgage rates – despite declining last week – remained over two percentage points higher than a year ago and close to the highest levels since 2009,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “For borrowers looking to refinance, the current level of rates continues to be a significant disincentive. Furthermore, general uncertainty about the near-term economic outlook, as well as recent stock market volatility, may be causing some households to delay their home search,” he said. These results were consistent with MBA’s May forecast released earlier this week, which now calls for fewer home sales and mortgage originations in 2022 compared to a year ago.”

Mortgage builder applications fell 14% in March, according to the MBA. “The spike in mortgage rates cooled demand and homebuilders continued to grapple with rising costs, supply-chain issues and extended completion timelines,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “With the supply of existing homes on the market still at extremely low levels, the new home market is an important source of housing supply. However, the pace of construction has slowed in recent months.”

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Vital Statistics:

Stocks are lower this morning after lousy retailer earnings. Bonds and MBS are down.

I just got back from the Secondary conference in NYC. Seemed much more sparsely attended than previous years. The talk is all about cost-cutting and getting every last basis point you can out of a loan. Non-QM was a big subject, especially the part about that market drying up a couple months ago when rates spiked. Credit spreads for NQM are in from the wides of a couple months ago, but are still nowhere near where they were at the end of last year.

Retail sales rose 0.9% in April, which was a touch below expectation. These numbers are nominal, which means inflation isn’t taken into account. Ex-vehicles they rose 0.6% and ex-vehicles and gas they increased 1%. FWIW, we have seen some poor numbers out of the retailers – Target announced earnings this morning and is down 25% compared to yesterday’s close. Margins are decreasing an costs (especially distribution costs) are up. WalMart was beaten up pretty badly yesterday as well.

Do these numbers raise concerns about consumption, which is 70% of the US economy? Not yet, is the short answer. During the COVID lockdowns, people spent more on goods and less on services. Now that the pandemic is largely behind us, that is reversing. People are taking trips and vacations instead of spending on a new TV. Note that rising gas prices are having an effect as well. Rising gas and food prices crowd out other discretionary spending. Falling consumption will help alleviate price pressures, which is something that the Fed would like to see.

Jerome Powell said that no one should doubt the Fed’s resolve to fight inflation, even if that means unemployment will increase. “Restoring price stability is an unconditional need. It is something we have to do,” Mr. Powell said in an interview Tuesday during The Wall Street Journal’s Future of Everything Festival. “There could be some pain involved.” The Fed has painted itself into a corner, as the economy is weakening and the Fed needs to tighten to bring inflation under control. In a lot of ways, this was the story of the 1970s.

Housing starts disappointed again, coming in at 1.72 million in April. This is down MOM, but up significantly year-over-year. Building Permits rose to 1.82 million, in line with expectations.

The NAHB Housing Market Index – a measure of homebuilder sentiment – fell pretty dramatically from 77 to 69. This is a two year low on the index. “The housing market is facing growing challenges,” said NAHB chief economist Robert Dietz. “Building material costs are up 19% from a year ago; in less than three months mortgage rates have surged to a 12-year high, and based on current affordability conditions, less than 50% of new and existing home sales are affordable for a typical family.”

The MBA revised its forecasts for 2022 and 2023. Total originations for 2022 have been lowered from $2.5 trillion to $2.6 trillion. 2023 and 2024 are expected to contract further to $2.3 trillion and $2.5 trillion respectively.

Interestingly, they think rates have peaked here. They see the 30 year fixed rate mortgage settling out at 5.2%, and then gradually declining to 5% by the end of the year and then falling to 4.8% in 2023. The 10-year Treasury is expected to find a level at 2.9%. GDP growth is expected to stay below 2% for the next couple of years. Inflation is forecasted to peak around 8%, and fall to 5.4% by the end of the year.

Needless to say, the underlying assumption here is that the Fed can stick the landing and cool off inflation without causing a recession. In other words, this is probably a best-case scenario economically. Historically, an aggressive tightening schedule has caused recessions. The difference is that we have a super-tight labor market going into a tightening cycle. On the other hand, globalization and technology have papered over a lot of monetary sins over the past 40 years and that phenomenon is largely played out.

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A traditional NR conservative, Matthew Continetti, has written a new book on the last hundred years of American conservatism. YMMV, but after watching the video, your commentary is invited.

https://www.pbs.org/newshour/show/why-the-gop-has-a-history-of-attracting-populist-views

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Vital Statistics:

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

Jerome Powell sounded hawkish yesterday when discussing inflation.

“We fully understand and appreciate how painful inflation is,” Powell said in an interview with the Marketplace national radio program, repeating his expectation that the Fed will raise interest rates by half a percentage point at each of its next two policy meetings while pledging that if data turn the wrong way “we’re prepared to do more. Nothing in the economy works, the economy doesn’t work for anybody without price stability…We went through periods in our history where inflation was quite high … The process of getting inflation down to 2% will also include some pain, but ultimately the most painful thing would be if we were to fail to deal with it and inflation were to get entrenched in the economy at high levels, and we know what that’s like. And that’s just people losing the value of their paycheck.”

Import prices were flat in April after rising steadily for months. The US dollar has been rallying on higher interest rates in the US, which is helping offset rising inflation overseas. On a year-over-year basis they were up 7.2%.

Consumer sentiment fell in May, according to the University of Michigan Consumer Sentiment Survey. As you can see from the chart below, consumer sentiment is associated with lows that are generally associated with deep recessions (especially 2008 – 2010 and 1980 – 1982). Inflation is the driving force here.

Consumers’ assessment of their current financial situation relative to a year ago is at its lowest reading since 2013, with 36% of consumers attributing their negative assessment to inflation. Buying conditions for durables reached its lowest reading since the question began appearing on the monthly surveys in 1978, again primarily due to high prices. The median expected year-ahead inflation rate was 5.4%

Surveys of Consumers Director Joanne Hsu

The one bright spot in the report is that consumers believe longer-term inflation will drop to 3% or so, which is still above the Fed’s long-term rate but probably not high enough to materially change consumer behavior.

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Vital Statistics:

Stocks are lower again on Fed fears. Bonds and MBS are up.

It looks like the “risk off” trade is beginning to positively affect bonds. Bonds are rallying, however MBS are lagging (as usual). The S&P 500 is within spitting distance of official bear market territory, which would be 20% off the high set in January. The Nasdaq entered that territory long ago.

Inflation at the wholesale level rose 0.5% in April, according to the Producer Price Index. This is a deceleration from the 1.5% we saw in March and 1.1% we saw in February. On a year-over-year basis, the PPI is up 11%. The core rate rose 0.6%, which was a deceleration from February and March. It is up 6.9% on a year-over-year basis. While the deceleration in month-over-month increases is welcome, the Fed is probably going to stick to is schedule and hike rates another 50 basis points at the June meeting.

Wages are rising, however they are not keeping up with inflation. Real (inflation-adjusted) wages fell 0.1% month-over-month in April, according to BLS. On a year-over-year basis, real wages fell 2.6%. Separately, initial jobless claims rose 203,000 last week. Overall the labor market is exceptionally strong, although the big question comes out to where inflation plateaus. That will determine whether we get the dreaded wage-price spiral that the Fed is trying to prevent. The low unemployment rate gives the Fed some breathing room to raise rates more aggressively.

With rising rates, ARMs are making a comeback. Last week the 30 year fixed rate mortgage was 5.53%, while 5/1 ARMS were 4.47%. “Despite a slow start to this year’s spring home buying season, prospective buyers are showing some resiliency to higher rates. Purchase activity has now increased for two straight weeks,” said Joel Kan, an MBA economist, in a release. “More borrowers continue to utilize ARMs to combat higher rates. The share of ARMs increased to 11% of overall loans and to 19% by dollar volume.”

ATTOM reported that 45% of mortgaged residential properties were considered equity rich, compared to 32% a year ago. “Homeowners continue to benefit from rising home prices,” said Rick Sharga, executive vice president of market intelligence for ATTOM. “Record levels of home equity provide financial security for millions of families, and minimize the chance of another housing market crash like the one we saw in 2008. But these higher home prices and rising interest rates make it extremely challenging for first time buyers to enter the market.”

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