Morning Report - Affordability remains high

Vital Statistics:

	Last	Change	Percent
S&P Futures	1676.7	-0.8	-0.05%
Eurostoxx Index	2667.9	-18.8	-0.70%
Oil (WTI)	106.9	0.6	0.55%
LIBOR	0.266	-0.001	-0.52%
US Dollar Index (DXY)	82.74	-0.299	-0.36%
10 Year Govt Bond Yield	2.54%	0.00%
Current Coupon Ginnie Mae TBA	104.2	-1.3
Current Coupon Fannie Mae TBA	103.6	0.0
RPX Composite Real Estate Index	202.5	-0.5
BankRate 30 Year Fixed Rate Mortgage	4.45

Markets are flattish after the consumer price index came in more or less in line with expectations and Goldman beat earnings estimates. Bonds and MBS are flat as we await the Bearded One tomorrow morning.

Re Bernanke's testimony, the Washington Post is saying the Fed will be delaying debate over unwinding QE amid concerns over how the markets will react. One interesting concern, from Richmond Fed Jeffrey Lacker, is that the Fed will experience capital losses on its holdings of mortgage backed securities, and could find itself in a position where it makes no money (or even experiences losses), which will raise public and Congressional scrutiny. Want a proxy for the Fed's balance sheet?  Take a gander at the chart of Agency Mortgage REIT American Capital (AGNC). They hold a levered portfolio of agency fixed and adjustable rate mortgage backed securities. The stock is down a third since rates started going up in early May.

Mortgage REITs like AGNC or Annaly (NLY)  are unloading mortgage-backed securities as rates increase. This is largely due to margin requirements, although interest rate hedging plays a part. As the value of their holdings drops, which is what is happening as rates increase, the banks that provide them leverage will demand more capital. The REITs can either raise capital in the private markets (which isn't going to happen) or they can raise capital by selling their inventory. The thing to remember is that the margin clerk doesn't care if the mortgage backed securities are overvalued or undervalued. The margin clerk will hit whatever bid is available if the company doesn't sell the merchandise themselves. That is how you get these air pockets like we had on July 5, where the we set record highs on mortgage rates and the 10 year yields. As mortgage REITs de-lever, you can expect rate volatility. Floating in this environment can be a little hairy. 

CoreLogic's latest Market Pulse makes the argument that in spite of the recent rise in house prices and rates, housing affordability is still elevated compared to historical numbers. They dismiss (as do I) the notion that we are back in a bubble or are even close to one. Bubbles are psychological events where everyone gets this idea that an asset price cannot fall. We will not experience another real estate bubble, although our great-grandkids might. Here is Corelogic's chart on affordability:

Based on the weak retail sales numbers yesterday (headline +4% vs expectations of +.8%, ex-autos flat vs expectations of + .5%), a number of sell-side firms took down their 2Q GDP estimates a hair. We will get the preliminary estimate of 2Q GDP in a couple of weeks.

Freddie Mac's mid-year update gives a forecast for the rest of 2013. Punch line: home price appreciation will slow, but remain positive, the labor market will continue the pace of the first half of the year, home sales up 2% and starts up 12% from the first half, and mortgage rates will continue to rise. Will the rise in mortgage rates stall the housing recovery? They anticipate it won't, because affordability still remains high.