Morning Report: More Yellen testimony today

Vital Statistics:

	Last	Change
S&P Futures	2443.0	3.0
Eurostoxx Index	386.4	1.5
Oil (WTI)	45.5	0.0
US dollar index	87.9	-0.1
10 Year Govt Bond Yield	2.33%
Current Coupon Fannie Mae TBA	102.625
Current Coupon Ginnie Mae TBA	103.59
30 Year Fixed Rate Mortgage	4.03

Stocks are flattish as Janet Yellen begins her second day of testimony in front of Congress. Bonds and MBS are flat.

Initial Jobless Claims fell to 247k last week, showing that employers are hanging on to employees.

Inflation still remains in check at the wholesale level, as the producer price index rose only 0.1% in June. Ex-food and energy it rose 1.9% YOY, which is below the Fed's target. Services increased 0.3%, which could indicate wage growth is beginning to happen.

The markets rallied yesterday on Janet Yellen's dovish comments. Fed-Watcher Tim Duy believes the markets have it wrong. His view is that Yellen has spent enough time at the Fed to understand that the longer the Fed waits to address inflation, the more aggressive they will need to be, which increases the risk of a recession. He basically lays out four scenarios:

• Inflation rebounds while unemployment remains steady, which is the base case Fed scenario
• Inflation remains low while unemployment holds steady. This is the market's bet. 
• Inflation rebounds while unemployment goes lower: This would mean a more aggressive Fed in 2018
• Inflation remains low while unemployment goes lower: Difficult for the Fed.

His view is that we see one of the latter two scenarios. FWIW, I think the unemployment rate is a bit of a red herring given that the employment to population ratio is still pretty low. Granted, some of that is demographic (older Boomers retiring) and some of it is discouraged workers, but a 4.5% unemployment rate today doesn't really mean the same thing it meant, say, 20 years ago. I think the mistake people make is that they fail to recognize that recoveries after burst residential real estate bubbles are fundamentally different animals, characterized by low inflation, weak demand, and risk aversion in business. Weak demand and risk aversion are not recipes for inflation. I suspect the second or the fourth scenario is the most likely. IMO, we won't see inflation until we see wage growth, and that has been slow to materialize. 

Angel Oak Advisors priced a $210 million deal of non-prime residential mortgages recently, and it looks like the second quarter may break $1 billion in non-prime RMBS. This is a record since the financial crisis, but is still a shadow of its former self. At one point during the boom, 1/3 of all mortgages were alt-A or subprime. Even if we hit a record for the rest of the year, we probably won't even sniff 5%. In fact, many of the loans being put in these securitizations wouldn't have even been considered non-prime during the bubble years. These loans are non-QM, and mainly consist of two types of  borrowers: self-employed who don't have enough W2 income and borrowers with a credit event in the past who have large down payments. The borrowers in Angel Oak's portfolio are paying between 5% and 9%. 

Why do appraisals sometimes come in low?  Typically, the problem is in apples-to-oranges comps (i.e. not in the neighborhood, or comps that had an issue like asbestos, mold, etc). The other big issue surrounds things that have value, but tend to get short shrift with appraisers: things like a nice finished basement, a good view, nice appliances, etc. Raised ranch homes are often problematic, as the lower level gets completely excluded from the square footage, basically cutting your square footage in half.