Morning Report: US home value more than 1.5x GDP

Vital Statistics:

	Last	Change
S&P Futures	2694.8	9.0
Eurostoxx Index	389.7	0.2
Oil (WTI)	60.1	0.2
US dollar index	86.0	-0.3
10 Year Govt Bond Yield	2.43%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	103.25
30 Year Fixed Rate Mortgage	3.97

Stocks are up on the last trading day of the year. Bonds and MBS are flat.

Yet another slow news day. 

Should be a dull day for bonds as the market closes at 2:00 pm EST. There is no economic data or Fed-speak either. 

Oil has topped $60 a barrel, which is higher than it has been for the past 3 years, but is pretty low in the grand scheme of things. It is something to watch, however as oil prices are a drag on the economy when they get too high. The US has so much capacity however that whenever prices rise, additional supply can come on line in a hurry. The US is pretty much insulated from OPEC any more. 

What is the value of all US homes in the US? Almost $32 trillion, or more than 1.5x US GDP.  Over the past year, they have increased in value by almost $2 trillion. This increase is more than 3x the rate of inflation. 

As inflation rises, we should expect to see US bond yields rise. That said, global sovereign bond markets do influence each other, and the spread between US Treasuries and German Bunds has risen to more than 2%. Relative value trading (i.e. investors swapping out of more expensive German bonds into cheaper US Treasuries) should act as a bit of a drag on US interest rates. The bigger question will be whether global growth pulls up Euro yields or whether the US yield curve continues to flatten. 

See you all in the new year!

Morning Report: Chicago PMI strong

Vital Statistics:

	Last	Change
S&P Futures	2687.5	2.0
Eurostoxx Index	390.3	-0.2
Oil (WTI)	59.7	0.0
US dollar index	86.3	-0.3
10 Year Govt Bond Yield	2.43%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	103.25
30 Year Fixed Rate Mortgage	3.97

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

Very slow news day. 

The Chicago PMI came in at a very strong 67.6 as production and new orders hit multi-year highs. Employment was disappointing however as businesses struggle to find qualified employees. 

Initial Jobless Claims came in at 245k last week ahead of the Christmas holiday. Surprised it is that high.

Some the biggest fixed income managers lay out their trades for 2018. Blackrock says to move up in credit quality. Note that they are neutral on everything. U.S. municipal bonds, U.S. credit, emerging markets and Asian fixed income, and an underweight position on Treasuries, European sovereign debt and European corporate bonds. They don't like anything, really. Fidelity says global growth is going to become inflationary, so buy TIPS (Treasury inflation protected securities) and emerging market debt. Goldman is betting against the crowd, favoring yield curve steepeners as opposed to the biggest trade on the Street, which is betting on a flatter yield curve. The theme seems to be inflation will return, and that means higher rates next year. The elephant in the room is the Fed, and the fear that increasing short term rates will torpedo the recovery. 

Easy come, easy go. Bitcoin continues to give back gains after it hit a record last week. It is down 28% from its highs on fears that South Korea might close one of its exchanges. Here is the fundamental issue with Bitcoin: governments despise it, and while they might not be able to kill it directly, they can attack everything that supports it. While there are a few retailers that accept Bitcoin, understand that they don't hold it. They immediately exchange it into dollars.  

Tax reform has some people in high tax jurisdictions rushing to pre-pay their property taxes ahead of the change in 2018. Note the IRS will only allow this if they are assessed and paid in 2017. So if your local government can't get the assessments out in time, it doesn't matter if you prepay. 

Morning Report: House prices continue to rise on inventory tightness

Vital Statistics:

	Last	Change
S&P Futures	2689.8	2.8
Eurostoxx Index	390.1	-0.1
Oil (WTI)	59.5	-0.4
US dollar index	86.6	-0.2
10 Year Govt Bond Yield	2.46%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	103.25
30 Year Fixed Rate Mortgage	3.97

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

Home prices rose 0.7% MOM in October and are up 6.4% YOY, according to the Case-Shiller Home Price Index. Seattle, Las Vegas, and San Diego led the charge with 12.7%, 10.2%, and 8.1% gains respectively. Inventory fell to 3.4 month's worth of supply, although some of that is probably seasonal. With home prices accelerating so fast out West, renting could be more attractive than buying in some MSAs. 

Manufacturing continued to be strong in in December according to the Richmond and Dallas Fed.

Pending home sales rebounded in November, according to NAR.  This is the first YOY gain since June, and is being driven by a strong economy. There might have been some hurricane elements at play however. 

What trade worked in 2017 (aside from Bitcoin and the stock market?) Credit risk transfer securities issued by Fannie and Fred. These are meant to offload some of the credit risk that the GSEs hold on their balance sheets. They take the first losses when borrowers default. The subordinate tranches of these securities made over 11% last year. outstripping high yield bonds and MBS by a wide margin. If there is more of an appetite for these securities, it will go a long way in helping establish the framework for competition to Fannie and Fred. 

The current state of affairs over who runs the CFPB: Mick Mulvaney (appointed by Trump) or Leandra English (appointed by outgoing director Richard Cordray). 

Tax reform will probably cause more migration from the high-cost states like NY, NJ, CT, IL, and CA to cheaper states like NC and TX. These states are hit with the double-whammy of high housing costs and high state taxes. The difference probably isn't going to be enough to cause a massive migration, however it could nudge those who are on the fence. 

Bond funds have been seeing outflows since tax reform has passed and investors are making changes to their asset allocations. Bond funds saw a withdrawal of $3.3 billion in the week ending Dec 20, which may account for the big increase in the 10 year's yield that week. It isn't just US Treasuries - the German Bund yield is up big this year as well. As investors become more constructive on the economy, they are shifting to emerging market sovereign bonds, which pay more and are more levered to global economic growth and out of Treasuries and Bunds, which are largely looked at as safe haven assets. Developed market stock funds also saw outflows as investors rang the register after a great year. 

Morning Report: Incomes and spending rise

Vital Statistics:

	Last	Change
S&P Futures	2689.8	2.0
Eurostoxx Index	390.0	-0.7
Oil (WTI)	58.0	-0.4
US dollar index	86.8	0.0
10 Year Govt Bond Yield	2.49%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.375
30 Year Fixed Rate Mortgage	3.88

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

This should be a relatively quiet day as bonds close early heading into the long holiday weekend. 

Durable Goods orders increase 1.3% MOM / 8.2% YOY in November, coming in below analyst estimates. A surge in aircraft orders drove the increase. Core capital goods orders (a good proxy for business capital expenditures) rose 8.1% YOY. 

Personal incomes rose 0.3% in October, slightly below the Street estimate of 0.4%. Consumer spending was better than expected, rising smartly at 0.6%. Inflation remains nowhere to be found, with the core PCE up 0.1% MOM and 1.5% YOY. The low inflation numbers certainly give the Fed some breathing room, although tax reform will probably push them to be more aggressive. Especially since 9 companies so far have announced wage increases based on tax reform. 

The Fed Funds futures are currently handicapping a 5% probability of no hikes in 2018, a 21% probability of a single 25 basis point hike, a 35% chance of 50, a 27% chance of 75, and a 10% chance of 100. 

Bitcoin is crashing right now, down 25% from yesterday. I was asked how Bitcoin would affect the real estate market.  My view was that Bitcoin is simply so volatile that I cannot imagine both a buyer and seller being comfortable quoting a house in bitcoin. I just don't see someone trying to sell their house for 25 bitcoin. Second, the financing has to be in dollars as no banks lend in bitcoin yet, and I cannot imagine what the interest rate for a bitcoin loan would be. So no, it may be accepted by your local store, however it is more of a novelty at this point. Will that change? Who knows? Will Bitcoin be dominant cryptocurrency or will it be like Classmates.com or MySpace - early adopters that got crushed later on by Facebook? 

Bloomberg takes a look at the state of housing entering 2018. Tight inventory, builder confidence, and a growing economy point to a strong housing market next year. On the other side of the coin, the drop in the mortgage interest deduction could hurt homes at the top end, while the larger standard deduction may lower the incentive to buy versus rent for many at the lower end of the income scale. IMO, the negatives are marginal compared to the positives. 

Don't forget, housing's contribution to GDP is way, way below historical levels. If 2018 is the year homebuilding finally breaks out, it will have an ousized effect on GDP growth. Labor shortages might be the bottleneck, but as wages rise, they attract new workers so that state of affairs doesn't last long. Swinging a hammer pays a lot more than slinging burgers.

90 day delinquencies spiked in November, according to Black Knight Financial Services. 85% of the spike is attributed to the hurricanes, so it doesn't really tell us anything about the state of the economy.

Finally, happy holidays to all!

Morning Report: House prices rise 6.6% YOY

Vital Statistics:

	Last	Change
S&P Futures	2687.0	5.5
Eurostoxx Index	388.8	0.4
Oil (WTI)	57.5	0.3
US dollar index	86.8	0.0
10 Year Govt Bond Yield	2.49%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.375
30 Year Fixed Rate Mortgage	3.88

Stocks are up this morning after tax reform is passed. Bonds and MBS are flat.

Hot on the heels of tax reform is legislation to keep the lights on. The House is set to vote on a stopgap measure to keep the government open for another month. This will prevent the Senate from attaching too many things to the bill. It also gives the government some breathing room after the new year to hash out a longer-term funding deal. 

In response to the tax cuts, 5 big corporations (Comcast, AT&T, Boeing, Fifth Third, and Wells Fargo) all announced they were either raising pay or paying bonuses to workers. Could this be the start of broader wage growth? 

House prices rose 0.5% in October, according to the FHFA House Price Index. September's 0.3% increase was revised upward to 0.5%. On a YOY basis, prices rose 6.6% nationally. The East South Central region (TN, KY, MI, and AL) rose 8.2%, which was a particular strong showing. As usual, the West and Mountain states led the charge, while the Upper Midwest and the East Coast brought up the rear.

The final revision for third quarter GDP came in at 3.2%. The prior estimate was 3.3% as consumer spending was revised down a tenth of a percent to 2.2%. The GDP price deflator was unchanged at 2.1%. 

In other economic data, Initial Jobless Claims rose to 245k last week, while the Philly Fed Manufacturing Index rose. The Chicago Fed National Activity Index gave back some of October's hurricane-related gains. The Index of Leading Economic Indicators rose 0.3%. Overall, all of these reports were strong readings and show the economy with some momentum heading into 2018. 

The chickens are coming home to roost for subprime auto lending. Some big private equity firms got into the business, hoping to generate huge returns from auto loans paying in the high single digits. Unfortunately, the default rates have soared for these loans, and auto sales have cooled off and they can't exit the business. No, it isn't a canary in the coal mine for the US economy as a whole. 

Realtor.com weighs in on the hottest and coldest real estate markets of 2017. In the top 20, the hottest are unsurprising - the Bay Area. However there are a few surprises, like Detroit, Fort Wayne, and Stockton.

This reminds me of the late 90s, when companies discovered you could get a multiple by adding .com to your corporate moniker. Long Island Iced Tea company jumps fivefold after renaming itself Long Blockchain and committing to looking for a way to make money in blockchain and fintech. Not that they have any business in it, or expertise, but they will look into the idea. 

Morning Report: Is the Trump Reflation Trade returning?

Vital Statistics:

	Last	Change
S&P Futures	2693.3	-0.3
Eurostoxx Index	390.5	-0.5
Oil (WTI)	57.5	0.3
US dollar index	86.8	0.0
10 Year Govt Bond Yield	2.49%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.375
30 Year Fixed Rate Mortgage	3.88

Stocks are higher this morning as tax reform looks set to pass. Bonds and MBS are down. 

The Senate passed tax reform, and it looks like we'll need a second vote in the House because of the name. Stocks like it, and bonds are selling off. That said, bonds are selling off worldwide, so it isn't just the US. 

Hot on the heels of tax reform comes funding the government, as normal funding runs out on Friday.  Mitch McConnell has vowed there will be no government shutdown, and he is probably correct, as the continuing resolution will be larded up with all sorts of unrelated measures to garner the necessary votes. The big threat is if Democrats demand some sort of immigration deal or if conservatives balk at stabilizing Obamacare or re-authorizing CHIP. Politicians talk about "Christmas Tree" bills, where everyone gets an ornament (or a priority satisfied). Given the silence in the media and the absence of leaks, it appears that is exactly what is going on. Just in time for the season, I guess.  

The 10 year broke through support yesterday, which caused a sell-off driven by stop-loss selling on the part of technical traders.  Don't forget, one of the biggest trades on the Street right now is the yield curve flattening trade, where investors are long the 10 year and short the 2 year (or some variation of that). Yesterday, people got carried out on that trade as the losses on the 10 year side of the trade were not offset by gains on the 2 year. My point on this is that the movement in the 10 year over the past couple of days has a lot of noise in it, caused by temporary technical trading. It might just be a blip. 

Does the passage of tax reform bring the Trump Reflation Trade back into play? The Trump Reflation Trade refers to the rally in stocks and the sell-off in bonds that we saw a year ago based on policy expectations in Washington. The markets were expecting a tax cut and an infrastructure spending plan which would goose the economy and drive investors out of safe assets like Treasuries into riskier assets like stocks and corporate bonds. That trade petered out, at least on the bond side of the ledger as getting anything passed in Washington looked almost impossible. We had a nice rally in bonds in Spring and have been stuck in a narrow range since. With tax reform now done, and talks of infrastructure spending next year, we could see a repeat, where bonds test the early 2017 levels around 2.6%. That said, I would be extremely surprised to see a deal on infrastructure, as 2018 will be all about midterm elections and posturing ahead of them. 

The tax bill made some changes that are positive for housing and the mortgage industry. The biggest one for many smaller independent originators concerns mortgage servicing rights and the recognition of income for tax purposes. The original bill would have required originators to pay the tax up front for the MSR portion of the gain on sale. Since MSRs are not cash, it would have hurt the cash flows of many smaller originators and perhaps driven them out of servicing. The tax treatment for MSRs remains unchanged. Second, affordable housing advocates were worried about two provisions that would have possibly discouraged affordable housing construction - the removal of the Low Income Housing Tax Credit and Private Activity Bonds. Those provisions remain unchanged. 

Mortgage Applications fell 4.9% last week as purchases fell 6% and refis fell 3% despite a drop in rates. 

Existing Home Sales rose 5.6% to a seasonally adjusted annualized value of 5.81 million, which is the highest since 2006. The median home price rose 5.8% to $248,000. There are 1.67 million homes for sale, which represents about 3.4 month's worth. The first time homebuyer was 29% of sales, and we saw cash-only sales (think investors) increase to 22%. The new tax bill will make it somewhat more attractive to be a landlord, so we could see some effect here, especially at the lower price points. 

Morning Report: Housing starts solid

Vital Statistics:

	Last	Change
S&P Futures	2697.3	2.8
Eurostoxx Index	392.4	-0.3
Oil (WTI)	57.4	0.2
US dollar index	86.9	0.3
10 Year Govt Bond Yield	2.43%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.375
30 Year Fixed Rate Mortgage	3.88

Stocks are higher as Congress begins the voting for tax reform. Bonds and MBS are down. 

The House is expected to vote on tax reform this afternoon around 1:30. Depending on the procedural machinations, the Senate will vote either tonight or tomorrow. Bob Corker and Susan Collins are supposedly on board, so this should be done. 

Housing starts increased to 1.3 million in November, according to Census. This is up 3.3% MOM and 13% YOY. Building Permits came in at 1.3 million as well. The increase in starts was driven by single-family, not multi, and hit a 10 year high. Note that tax reform's pass-through treatment will be good news for landlords and could encourage more multi-fam construction. We didn't see any jump in multi-fam permits last month, so maybe the change is too recent to influence behavior yet. 

Minneapolis Fed Head Neel Kashkari argues that we should not be raising interest rates yet. Neel was one of 2 dissenters at the last FOMC meeting, preferring to maintain the current level of rates.  His argument is that inflation remains below the Fed's target rate of 2% and there is still slack in the labor market. He also is worried about what the flattening yield curve is saying. IMO he has a point - we want the labor market to keep bringing back the long-term unemployed, however we are hardly going to a tightening posture. On a scale of 1 - 10, where 1 is easy and 10 is tight, we are going from a 1 to a 2. Real interest rates are still negative, and the Fed is still buying Treasuries and MBS albeit at a reduced pace. What would a 10 on that scale look like? The early 1980s, when Paul Volcker tightened to quell inflation and took the Fed Funds rate from 9% to 19%. We are in a different economic scenario than the late 70s, but some historical perspective is helpful. 

New mortgage loan credit risk increased in the third quarter, according to CoreLogic's Housing Credit Index. The increase in risk was driven by an increase in the share of condo / multi-fam loans. Credit scores improved, while DTIs fell. We are back in the pre-bubble range of credit risk. 

Morning Report: Don't fear the flattening curve

Vital Statistics:

	Last	Change
S&P Futures	2692.5	10.5
Eurostoxx Index	392.1	3.9
Oil (WTI)	57.5	0.2
US dollar index	86.9	-0.2
10 Year Govt Bond Yield	2.37%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.591
30 Year Fixed Rate Mortgage	3.88

Stocks are up this morning on optimism over tax reform. Bonds and MBS are down small. 

This should be a quiet week as people prepare for the holidays, however we will get a lot of economic data. The biggest one will be personal incomes and outlays on Friday. 

Homebuilders are more optimistic now than they were during the bubble years, according to the NAHB Homebuilder Sentiment Index. 

Congress worked on making smallish changes to the tax bill over the weekend. Marco Rubio held out for an increased child tax credit. The state and local tax deduction was supposedly widened to $10k. Another change involves tax breaks for real estate pass-throughs, which caught one wavering Republican Senator - Bob Corker - by surprise. Since it looks like John McCain will not be voting on the plan this week, Republicans need Corker's vote. It is a fluid situation, to say the least. 

The New York Fed took up its estimate for Q4 GDP to 4%. We will get the final revision to third quarter GDP on Thursday. 

One of the biggest trades on the Street right now is the yield curve flattening trade, where investors bet the difference between long-term rates and short-term rates will decrease. There are many reasons to put on the trade, but the most common one is that the yield curve tends to do this during tightening cycles, and people are making the bet that history will repeat itself. The side effect of this trade is a whole lot of articles claiming that the changes in the yield curve are predicting a recession going forward. Given that the NY Fed just took up its Q4 GDP estimate up to 4%, a recession doesn't seem to be on the horizon. But here is the bigger issue: What information is the yield curve transmitting when it is being influenced by global central banks? Yes, before the Fed was buying (and holding) 4.5 trillion worth of bonds, the yield curve was probably providing useful information. But now? I would argue that all of this central bank buying is distorting the signals the curve might be sending. And therefore I would caution against reading too much into it. 

Freddie Mac weighs in on the housing market and makes its predictions for 2018. Big picture: the economy is getting better, Millennials are beginning to buy, and increased homebuilding should alleviate the big inventory problem. That said, cuts in the mortgage interest deduction and increasing supply should dampen home price appreciation. Basically the current housing market is great and that should continue, albeit at a somewhat slower level. FWIW, I suspect the demand for housing is only going to get bigger, and will dwarf whatever homebuilding is being done. 

Morning Report: The Fed bumps up its forecast for 2018 GDP

Vital Statistics:

	Last	Change
S&P Futures	2671.0	2.0
Eurostoxx Index	389.3	-1.4
Oil (WTI)	56.3	-0.4
US dollar index	86.9	0.1
10 Year Govt Bond Yield	2.37%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.591
30 Year Fixed Rate Mortgage	3.88

Stocks are higher after a relatively dovish FOMC statement. Bonds and MBS are down small after rallying hard after the announcement yesterday. 

As expected, the Fed raised rates a quarter of a percent yesterday and released their economic forecasts. This was Janet Yellen's last hurrah. The vote was 7-2 with two dissenters: Evans and Kashkari, who both wanted to maintain the current Fed Funds rate. Bonds rallied on the FOMC decision, largely due to the dot plot, which showed virtually no change from September, despite a big upward revision in the Fed's 2018 GDP forecast, which went from 2.1% to 2.5%. Their forecast for unemployment was revised downward from 4.1% to 3.9%, while their forecast for core inflation remained unchanged at 1.9%. It was a Goldilocks report for the markets. You can see the dot plot comparison below, with the central tendency right around 2%.

Note that the Fed Funds futures are currently predicting 1-2 hikes next year through November (we don't have December 2018 Fed Funds futures yet). So, the market is somewhat more dovish than the FOMC is, but they are pretty close. Note that one of the big trades on the Street right now is a bet that the Fed will blink and only raise rates 1-2 times next year. The other big trade that is happening right now: yield curve flattening trades, where traders bet that the difference in yield between the 2 year and the 10 year will decrease. 

Initial Jobless Claims fell to 225k last week. This is just off the post-crisis low of 223k, and you would have to go back to the early 1970s to find similar readings. The job market is pretty strong, provided you are employed. The long-term jobless still are with us, although it remains to be seen how many will (or even want to) re-enter the workforce. That untapped reservoir is probably one big reason why wage inflation continues to be muted. 

Retail Sales came in way stronger than expected, pointing to a strong holiday shopping season. The headline number was up 0.8%, as was the control group, which was a big jump from October, and above the highest point in the consensus range. The S&P SPDR Retailer ETF (XRT) is up about .63% in an otherwise flattish market early. 

The ECB maintained interest rates at current levels and cut their QE buying in half. Central bank demand for sovereign debt is being cut back globally. FWIW, we aren't really seeing that much of an impact in yields (Probably as people pile into curve flatteners, as described above). The German Bund is down with Treasuries. 

The NAR points out that the median age of renters is rising - it rose to 40 from 38 a year before. Given that the relative attractiveness of buying compared to renting is about as big as it ever has been, what gives? It is mainly empty-nest Boomers who are choosing to go with rentals, which means no more home maintenance. 

Bill Gross warns that the Fed really has to stop hiking rates once the Fed Funds rate gets around 2 - 2.25% or else it runs the risk of hurting the housing market. "A lot [of mortgages] are variable, floating-rate mortgages. And to the extent that the Fed has already raised interest rates by 75 to 100 basis points and is expect to raise by another 50 to 100 that affects the average monthly payments." He is correct on the ARM part of it, and with the Fed raising short term rates, while long-term rates stay in place, it is the time to refinance out of an ARM and into a 30 year fixed rate mortgage. While he does draw upon 2005 - 2006 as a comparison, we were in a bubble then. It really isn't similar to today, where inventory is so tight we probably won't see any price decreases. If anything, we are seeing bidding wars. 

Morning Report: Awaiting the Fed

Vital Statistics:

	Last	Change
S&P Futures	2667.8	0.0
Eurostoxx Index	391.3	-0.4
Oil (WTI)	57.7	0.5
US dollar index	87.3	0.0
10 Year Govt Bond Yield	2.42%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.591
30 Year Fixed Rate Mortgage	3.88

Stocks are flat as we await the FOMC decision today at 2:00 pm. Bonds and MBS are up on a weaker-than-expected CPI number.

The FOMC decision is set to be released around 2:00 pm EST. The Fed is almost certainly going to hike by 25 basis points, but the economic forecasts and the fed funds forecasts (the dot plot) will be the focus. The language of the statement will come into play as well, but the dot plot will be the first thing traders will look at. Loan officers, be careful locking around then. 

Mortgage applications fell 2.3% last week as purchases fell 1% and refis fell 3%. The 10 year bond yield inched up and mortgage rates hit their highest levels since March. 

Prices at the consumer level rose 0.4% in November and are up 2.2% YOY. Ex-food and energy, they rose 0.1% MOM and 1.7% YOY. The Fed prefers to focus on the personal consumption expenditure index, not CPI. Energy prices rose smartly in November, and accounted for about 3/4 of the increase in the index. The core rate was a touch below expectations. 

The House and Senate continue to work on reconciling their tax bills. It looks like the final compromise will result in a corporate tax rate of 21%, a mortgage interest cap of $750k, lowering the top rate to 37%, and setting the pass-through rate at 23%. Congress hopes to vote on a bill early next week, before Democrat Doug Jones, who won in Alabama last night, takes his seat. 

If the mortgage interest deduction cap falls to $750,000 it probably shouldn't make that big of a difference for home prices, and certainly not at the lower price points. Remember, the median house price in the US is about 1/3 of that number. But the bedroom communities of some of the bigger cities could see a softening, especially at the top end. 

The lack of affordable housing is a critical problem in this country, and many advocates are worried about tax reform. Affordable housing is largely driven by tax benefits, and those benefits are a function of tax rates. Lower tax rates, and the value of the tax benefits fall. A second issue is that commodity prices are rising, which increases construction costs. Lumber is up almost 15% from the beginning of the year, and OSB products are up 30%. 

Homeowners' equity increased by 1.3 trillion over the past year ending in September, as the value of the housing assets rose to $24.2 trillion and outstanding mortgage debt rose to $10 trillion. Homeowner's equity as a percentage of home value is pretty much back to pre-crisis levels. It has been mainly driven by home price appreciation, not decreasing mortgage debt, however. 

Morning Report: Stirrings of inflation at the wholesale level

Vital Statistics:

	Last	Change
S&P Futures	2666.3	1.8
Eurostoxx Index	390.4	1.4
Oil (WTI)	58.4	0.5
US dollar index	87.3	-0.1
10 Year Govt Bond Yield	2.39%
Current Coupon Fannie Mae TBA	102.531
Current Coupon Ginnie Mae TBA	103.591
30 Year Fixed Rate Mortgage	3.88

Stocks are up this morning as we begin the FOMC meeting. Bonds and MBS are flat. 

Inflation at the wholesale level came in slightly above forecast according to the Producer Price Index. The headline number was 0.4% MOM and 3.1% YOY. Ex-food and energy, it rose 0.3% / 2.4% and ex-food, energy, and trade services it was up 0.4% / 2.4%. This report confirms building inflationary pressures in the system. It won't have an effect on this Fed meeting, but it is something to watch.

Speaking of inflation, one of the bigger complications for the Fed is the effect of Amazon on price discovery. Amazon (and the Internet in general) allow consumers to compare prices easily, something that was not possible a generation ago. Goldman tried to estimate the effect of the internet on core CPI, and they found it to be about 0.1%. All of the Fed's inflation models were conceived pre-internet. While price comparison on the web is not the only reason why inflation is low, it is a new factor. Deflation is generally experienced in the wake of asset bubbles - Japan has experienced it for a generation, the US had low inflation from the Depression that lasted until the 60s, and we have had persistently low inflation since the residential real estate bubble burst. Low productivity hasn't helped either, as productivity growth drives wage inflation. 

Small business optimism hit the highest level in 34 years on tax reform according to the NFIB. “We haven’t seen this kind of optimism in 34 years, and we’ve seen it only once in the 44 years that NFIB has been conducting this research,” said NFIB President and CEO Juanita Duggan. “Small business owners are exuberant about the economy, and they are ready to lead the U.S. economy in a period of robust growth.” While small business didn't add any workers last month, hiring plans increased, and difficulties in finding workers remains a big problem. 

CoreLogic reported that delinquency rates in July were the lowest in a decade. The foreclosure inventory rate was 0.7%, down from 0.9% a year ago and is the lowest level since 2007. Delinquency rates are the lowest in the West, while New York has the highest. The Northeast judicial states like New York, New Jersey, and Connecticut still have a foreclosure inventory to work through. Lower oil prices were beginning to push up DQ rates in places like Alaska and Louisiana. 

Congress hopes to pass tax reform by Christmas. The bill is in committee right now, where the House and Senate are trying to reconcile their differences. 

Bitcoin mania: People are taking out mortgages to buy bitcoin. This will not end well. That said, can bitcoin double from here? Of course. Can it go to zero? Of course. 

Morning Report: Job openings at 6 million

Vital Statistics:

	Last	Change
S&P Futures	2651.8	0.8
Eurostoxx Index	389.0	-0.2
Oil (WTI)	57.5	0.2
US dollar index	87.2	-0.1
10 Year Govt Bond Yield	2.37%
Current Coupon Fannie Mae TBA	102.625
Current Coupon Ginnie Mae TBA	103.625
30 Year Fixed Rate Mortgage	3.92

Stocks are flat this morning after a bomb went off in New York City's Penn Station. Bonds and MBS are up small. 

This week will be dominated by the FOMC meeting on Tuesday and Wednesday. The markets are forecasting a 25 basis point hike in the Fed Funds rate, but the economic forecasts will be the focus, as well as the dot plot. It will be interesting to see the 2018 GDP forecast. The Fed was consistently high in their GDP estimates during the Obama administration, however their 2.1% forecast for 2017 looks to have been way light, given that the NY Fed just upped its Q4 GDP estimate to 3.92%. That would put 2017 GDP growth just shy of 3% for the year. 

Job openings were largely unchanged at 6 million in October, according to the JOLTS survey. The hires rate increased to 5.6 million. The quits rate was unchanged at 2.2%. The quits rate is the most important number in this release, as increases in the rate usually correspond to increases in wage growth. 

So far, the Fed's tightening has had almost no effect on the market. In the old days, a couple Fed Funds hikes and you would start to see a slowdown. If anything, the economy is accelerating, not decelerating. JP Morgan believes that we won't see a meaningful effect on the economy until we get to a real 1% Fed Funds rate, where "real" means inflation-adjusted. Currently, the Fed Funds real rate is negative (inflation is higher than the Fed Funds rate). Once the Fed Funds rate is 1.5% higher (or around 2.5%, we should see an impact, which makes that a 2019 event, not a 2018 event.

35% of new home sales in October were for homes that hadn't even begun construction, the highest number since 2005. Shortages of skilled labor, along with increasing commodity prices are preventing new home sales and housing starts from being high enough to meet demand. Housing will almost certainly be the engine to propel US economic growth over the next few years. 

Last week, a news story suggested that the Trump CFPB would back off the banks, referring mainly to Wells Fargo. He then tweeted that the story is false, and if anything, he would increase penalties on the banks for bad behavior. 

Morning Report: Movement on housing reform

Vital Statistics:

	Last	Change
S&P Futures	2647.0	7.8
Eurostoxx Index	389.5	3.1
Oil (WTI)	57.6	0.9
US dollar index	87.3	0.0
10 Year Govt Bond Yield	2.38%
Current Coupon Fannie Mae TBA	102.625
Current Coupon Ginnie Mae TBA	103.625
30 Year Fixed Rate Mortgage	3.92

Stocks are higher after a strong jobs report. Bonds and MBS are down small. 

Jobs report data dump:

• Payrolls up 228,000
• Two month revision up 38,000
• Unemployment rate 4.1%
• Labor Force participation rate 62.7%
• Average hourly earnings up 2.5% YOY

Overall a strong report, and probably good for the markets. The modest wage inflation will keep the Fed cautious, while slack continues to be taken up. That said, a rate hike is more or less a certainty next week. We probably won't see any big pickup in wage inflation until the labor force participation rate gets back up to the 65% - 66% level. 

In other labor news, job cuts increased slightly according to outplacement firm Challenger, Gray and Christmas, while initial jobless claims fell to 236,000. 

Consumer sentiment edged up slightly in November, according to the University of Michigan survey. 

Congress came up with a deal to keep the lights on for two weeks. The debt ceiling will have to be raised at some point, although the government can use cash on hand and other extraordinary measures to get through until Spring. Expect to see some conservative Republicans to balk at additional spending, which makes bringing aboard some Democrats a necessity. A deal with Democrats will involve an equal hike in defense and non-defense spending as well as some sort of immigration deal. A shutdown doesn't seem to be in the cards, at least not yet. 

With all the commotion going in Washington right now, it is easy to forget about housing reform, but Bob Corker and Mark Warner are beginning to come to a consensus over what the future of housing finance should look like. Fannie and Fred will remain, but the government will make it easier for new competitors to enter the market. Jeb Hensarling of Texas has moderated his stance on government guarantees of mortgages, which helped move things along. The goal is to keep the mortgage market more or less as-is for borrowers, while increasing competition in the secondary market and bolstering taxpayer protection. In one wrinkle, the Fannie Mae preferred shareholder might get some sort of recovery. The prefs were up 24% on the news, while the common fell slightly. 

The FHA will no longer insure mortgages for properties that include Property Assessed Clean Energy (PACE) assessments."FHA can no longer tolerate putting taxpayers at risk by allowing obligations like these to be placed ahead of the mortgage itself in the event of a default," said U.S. Department of Housing & Urban Development (HUD) Secretary Dr. Ben Carson. "Assessments such as these are potentially dangerous for our Mutual Mortgage Insurance Fund and may have serious consequences on a consumer's ability to repay, or when they attempt to refinance their mortgage or sell their home." Dave Stevens of the MBA also welcomed the decision.

Ginnie Mae is tightening requirements on securitizations in order to combat the high prepayment speeds that the securities have been experiencing. They targeted VA IRRRLs last year by making IRRRLs that refinanced a loan less than 6 months old ineligible for standard securitizations. Ginnie is now including cash-out refis and FHA streamlines as well. Some MBS strategists have predicted that this will weaken demand for the higher coupon Ginnie Mae securities, which would mean that borrowers get less and less of a pickup in points for going higher in rate.

Morning Report: Productivity increases in the third quarter

Vital Statistics:

	Last	Change
S&P Futures	2625.0	-3.3
Eurostoxx Index	384.5	-2.3
Oil (WTI)	56.9	-0.8
US dollar index	86.8	0.0
10 Year Govt Bond Yield	2.32%
Current Coupon Fannie Mae TBA	102.625
Current Coupon Ginnie Mae TBA	103.625
30 Year Fixed Rate Mortgage	3.88

There is a slight risk-off feel to the market today as stocks are lower and bonds rally.

Mortgage Applications rose 5% last week as purchases rose 2% and refis rose 9%. The average 30 year fixed rate mortgage dropped a basis point to 4.19%.

The economy added 190,000 jobs last month according to the ADP Employment Survey. The Street is looking for 204,000 jobs in this Friday's payroll report. This ADP number is more or less close to the average for the past year. Moody's Chief Economist Mark Zandi is warning that the job market could overheat next year, as he sees the unemployment rate going below 4%. Will that cause the Fed to start hiking rates more aggressively? Perhaps, but until we start seeing broad-based wage inflation and begin to see it flow through to prices the Fed will probably be content to gradually normalize policy and not push the economy into a recession.

Productivity rose 3% in the third quarter, according to BLS, as output increased 4.1% and hours worked increased 1.1%. Generally speaking productivity increases drive wage increases, although that relationship has broken down somewhat over the past 15 years or so. Unit labor costs declined 0.2% as the increase in productivity offset the 2.7% increase in wages. At a recent CEO roundtable, labor costs have taken over regulation as the top concern of Corporate America. Tax reform will probably encourage more capital investment to make workers more productive, and that should translate into wage inflation, although not necessarily into a larger number of workers.

As tax reform gets resolved, the next issue will be funding the government. It won't take many conservatives to balk at funding the government to make Democrats necessary to keep the lights on. Democrats want some sort of immigration deal to go along with voting for a continuing resolution, which will be a non-starter for many Republicans. Don't forget the last time we had a government shutdown, you couldn't get 4506-Ts from the IRS, loan officers, plan accordingly.

Ray Dalio of Bridgewater warns that tax reform will cause an exodus from high tax states like California, New York, New Jersey, and Connecticut. Many big names in the hedge fund business have already relocated to Florida, where there are no state income taxes. Connecticut will be especially vulnerable, as it gets most of its revenue from one county. Meanwhile, NAR and Trulia warn that tax reform will hit property values in these high tax states, and will exacerbate the inventory shortage as it will discourage sellers. As I have said before, it may affect the higher end of the market in these areas, but the sub $750,000 sector should be fine. If anything, it might encourage those that are thinking of buying a million dollar home to lower their price point, which would increase demand in that sector. As a general rule, the multi-million sector in the Northeast has been moribund to begin with, and the multi-million sector in the West has been driven by foreign money and stock market appreciation.

Affordable Housing Advocates are also staunchly opposed to the new tax bill. Many for simple ideological reasons, however tax reform will affect the value of the tax write-offs that act as the incentive to build affordable housing. It will make affordable housing construction less attractive (and may turn it into a money-losing enterprise). Some groups claim that the home price appreciation has been so fast (especially in California) that it is creating a homelessness problem. A lack of affordable housing has been an issue for a long time, and tax reform certainly won't make it less of one.

The hurricanes accounted for 10% of the country's mortgage delinquencies. This is going to be a huge headache for lenders with servicing portfolios in Texas and Florida.

The emergence of fraud and swindles usually signals the top of bubbles. Liar loans and CDO squareds were the bell ringing at the top of the US residential real estate market. It looks like we are getting to see some of this in China as well, which has a residential real estate market of epic proportions. When China's residential real estate bubble finally bursts, it will be a massive battle of wills between Mr. Market and Mr. Big Government. When Japan's bubble burst, the government used all sorts of ham-handed methods to prevent a crash, and I wouldn't be surprised to see China try some of the same things. Once China's bubble bursts, they will export deflation to the world, which will keep inflation in check in the US, however it will also sap global growth. Luckily Japan seems to be picking up at long last (almost 30 years).

Morning Report: Toll Brothers misses

Vital Statistics:

	Last	Change
S&P Futures	2642.0	3.8
Eurostoxx Index	386.6	-0.9
Oil (WTI)	57.3	-0.2
US dollar index	86.7	0.1
10 Year Govt Bond Yield	2.39%
Current Coupon Fannie Mae TBA	102.625
Current Coupon Ginnie Mae TBA	103.625
30 Year Fixed Rate Mortgage	3.88

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

Toll Brothers announced earnings this morning that missed analyst expectations. The sector has been on a tear this year, so weak earnings are expected to be punished by the markets. Revenues increased 9% and earnings increased 68%. The company used a lot of its cash to repurchase stock and bonds, which isn't a great sign for future growth. Generally when companies are seeing great opportunities, they re-invest in the business. When they don't, they buy back stock. The street didn't like the guidance, and the stock is down about 6% pre-market. 

Toll is in the luxury end of the housing market, covering McMansions in urban areas out West and luxury apartments in the East. The change in the mortgage interest deduction is probably going to impact demand. Note that the builders that focus on entry-level building are doing much better. For the past 10 years, the luxury end of the market was the only part that was working. Now the market is shifting to the first time homebuyer. 

Speaking of the luxury end of the market, the New York Times frets about the effect tax reform will have on New York City. It turns out that 40,000 residents in New York City account for half the city's revenue. If they leave, it will have a huge impact on the city's finances. The people most affected will be those making over $200,000, and in a high cost area like New York City and the suburbs, that is not rich by any stretch of the imagination. 

Factory orders fell 0.1% in October, ending a generally good month for manufacturing. Capital Goods orders were strong however, and that points to a stronger Q4 and 2018. Capital Goods orders are generally associated with business expansion, capacity increases, and modernization. 

The services economy decelerated in November from a record in October, according to the ISM Non-Manufacturing Survey. 

Tax reform heads to committee to resolve the differences between the House and Senate versions. Here are the biggest sticking points. The committee starts work on Monday, with an eye to have a final vote in Mid-December. 

Home prices rose 0.9% MOM and are up 7% YOY, according to CoreLogic. The fastest growth continues to be in the West and Mountain states. Much of the Midwest remains undervalued while we are seeing overvaluation in places like Florida, Texas, and the West Coast. Note that fears about climate change are not evident in Florida real estate. 

First time homebuyers are still relatively uninformed about mortgages. According to a recent survey, 20% of Americans think it is impossible to get a mortgage with less than 5% down, despite the fact that FHA goes down to 3%, VA allows nothing, and the GSEs have 3% down products. Most people get their information on the Internet, and surprisingly almost nobody gets their mortgage information from the CFPB. 

How did HAMP and HARP help struggling homeowners? It turns out, not much. In fact, borrowers who had a principal reduction had pretty much the same default rates as borrowers without a principal reduction. These reductions were big: 32% or about $112,000 on average. These results pour cold water on the strategic default theory, which says that borrowers will choose to toss the keys to the bank once the home value is less than their outstanding mortgage. FWIW, I think the defaults in 2006 were strategic defaults, as the economy had yet to roll over and professionals were playing the greater fool game. Note that modifying a mortgage payment to a percentage of income didn't really help either. The punch line is that many defaults were caused by a short term blip in a borrower's financial situation - often an unexpected expense like a medical bill - and servicers should work on creating a solution to help the borrower over that hump and then re-evaluate.