Morning Report: Jerome Powell testifies in front of the Senate

Vital Statistics:

	Last	Change
S&P Futures	2604.8	3.0
Eurostoxx Index	386.4	1.5
Oil (WTI)	57.6	-0.5
US dollar index	86.5	0.0
10 Year Govt Bond Yield	2.32%
Current Coupon Fannie Mae TBA	102.938
Current Coupon Ginnie Mae TBA	103.75
30 Year Fixed Rate Mortgage	3.89

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

Jerome Powell will testify in front of the Senate today. Here are his prepared remarks. With respect to monetary policy, he had this to say: "If confirmed, I would strive, along with my colleagues, to support the economy's continued progress toward full recovery. Our aim is to sustain a strong jobs market with inflation moving gradually up toward our target. We expect interest rates to rise somewhat further and the size of our balance sheet to gradually shrink." He discusses the dual mandate, and his interpretation of that: "maximum employment, meaning people who want to work either have a job or are likely to find one fairly quickly; and price stability, meaning inflation is low and stable enough that it need not figure into households' and businesses' economic decisions."

In other words, he is pretty much going to vote to continue the same path of Janet Yellen and Ben Bernanke. He thinks inflation is too low, and we are not yet at full employment. However, we are closer to our goals and therefore it is time to remove some of the emergency measures we took during the crisis. Monetary policy is not going to become more hawkish in any meaningful way. 

On the regulatory front, he had this to say: "As a regulator and supervisor of banking institutions, in collaboration with other federal and state agencies, we must help ensure that our financial system remains both stable and efficient. Our financial system is without doubt far stronger and more resilient than it was a decade ago. Our banks have much higher levels of capital and liquid assets, are more aware of the risks they run, and are better able to manage those risks. Even as we have worked to implement improvements, we also have sought to tailor regulation and supervision to the size and risk profile of banks, particularly community institutions. We will continue to consider appropriate ways to ease regulatory burdens while preserving core reforms--strong levels of capital and liquidity, stress testing, and resolution planning--so that banks can provide the credit to families and businesses necessary to sustain a prosperous economy. In doing so, we must be clear and transparent about the principles that are driving our decisions and about the expectations we have for the institutions we regulate."

On this issue, he is probably very close to Yellen, however he is presenting a more business-friendly face. He wants to ease regulatory burdens where appropriate, and to give (hopefully) brighter lines about what the regulators want than previously. 

The issue of regulatory transparency falls along two schools of thought. First, the attitude of the Obama administration (and many regulators on the left) is that regulators should disseminate general principles and not specific guidance (bright lines). Their logic is that the financial sector will figure out a way to game the system, so the easiest way to prevent that is to make the lines so blurry that bankers will not approach them. It definitely makes the system safer, however the downside is that compliance officers end up running the banking system. Most bankers refer to compliance as "the business discouragement unit" because the incentives for compliance offers are to focus solely on the downside. It makes banks risk averse and therefore restricts credit. 

The attitude of those on the right is that there are diminishing returns to that framework in terms of safety at the expense of credit expansion (and overall economic growth). So their view is to give the banks brighter lines so that the lawyers (who are risk averse) are no longer making the capital allocation decisions. The plus side is higher growth, however the downside is that banks game the system and take too much risk. 

I suspect both Yellen and Powell are pretty similar in their regulatory approach, but Powell will probably be a touch more banker-friendly. Of course for the banking sector, the Fed is just one regulator, and they have all the state regulators, plus the CFPB to consider so any change will probably be minor if recognizable at all. So punch line: don't expect to even notice the difference between Powell and Yellen. 

In other news, home prices continued to rise in September, with the FHFA house price index up 0.3% MOM / 6.3% YOY and the Case-Shiller index up 0.5% MOM and 6.2% YOY. While the Pacific and Mountain states continue to experience strong growth, we are seeing a pickup in New England and the Middle Atlantic states. These are the judicial states which still have been still working through their foreclosure inventory. 

Inventories fell at both the retail and wholesale level in October, which means Q4 GDP will start off with an inventory drag. Note we will get the second revision to Q3 GDP tomorrow morning. 

The Senate continues to work with tax reform. Here are the 8 Senators who can make or break tax reform and what they are looking for. In one group are the deficit hawks. The CBO estimate is that this will add $1.4 trillion to the national debt, before taking into account any improvement in growth. Some are looking for some sort of trigger that will bump tax rates back up if the revenue is not there. Others worry about the effect tax rate uncertainty will have on corporate behavior. Another group worries that tax reform will benefit large multinational corporations at the expense of small business. And finally, there are the ones that don't support eliminating the individual mandate in Obamacare to fund tax cuts (Collins and McCain). The inability to repeal and replace Obamacare is making tax reform so much more difficult. We'll see what happens, but I suspect we can't thread the needle here. 

Morgan Stanley is advising clients to bet on a yield curve flattening via the 2 year and 10 year spread. Right now the 10 year is trading at 2.32% and the 2 year is at 1.74%. They are forecasting that the difference in yields (currently 58 basis points) will go to 0 next year. Continued demand from global central banks will support demand for government debt to begin with, and if growth comes in stronger than expected, short rates will increase faster. If growth comes in lower than expected, then demand for duration will keep the 10 year yield low. Note this strategist at Morgan Stanley is a huge bond bull, and was calling for a 1% 10 year bond in 2016 before the surprise election of Donald Trump destroyed that forecast. 

Morning Report: Are we hitting price exhaustion at the high end of the market?

Vital Statistics:

	Last	Change
S&P Futures	2432.3	4.3
Eurostoxx Index	374.4	1.6
Oil (WTI)	47.4	0.0
US dollar index	86.2	0.3
10 Year Govt Bond Yield	2.21%
Current Coupon Fannie Mae TBA	103.09
Current Coupon Ginnie Mae TBA	103.97
30 Year Fixed Rate Mortgage	3.89

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

House prices rose 1.6% in the second quarter and are up 6.6% YOY, according to the FHFA House Price Index. The fastest growth was out West, with Washington up 12.4%. The weakest areas were in the Northeast and Mid-Atlantic, particularly CT. 

Morgan Stanley is warning that stocks and corporate bonds could be vulnerable once the Fed begins to let its portfolio of Treasuries and MBS run off. A committee of investors and banks hypothesized that corporate credit spreads could widen as much as 135 basis points. Will that have the same effect on mortgage backed securities spreads? Quantitative easing itself didn't move in spreads all that much, so I cannot imagine something that will amount to a tiny fraction of that having much impact either. The Fed's balance sheet is now about $4.5 trillion. Pre-crisis it was under $1 trillion. Many market observers think the Fed may never be able to get its balance sheet back down to where it was pre-crisis. 

Tensions with North Korea and fears of a debt ceiling standoff have pushed down the market's assessment of future Fed Funds hikes. The December Fed Funds futures are now predicting a 62% chance of no hike versus a coin toss about a week ago. 

The government plans to try and get some sort of tax reform done this year, however it will be difficult. We are much more likely to see some sort of "tax reform light" which probably won't have a massive impact on the economy in the near term. The first order of business is to fund the government and to get an increase in the debt ceiling. Meanwhile, Bridgewater CEO Ray Dalio is taking off risk due to political polarization and buying gold. 

The DOJ ended the Obama Administration's Operation Choke Point, which was sold as an attempt to prevent banks from funding fraudulent actors, but in reality was just an attempt to prevent banks from doing business with payday lenders, which the Administration opposed on ideological grounds. The idea was to hopefully drive payday lenders out of business by making them unable to find banks to service them. 

Luxury homebuilder Toll Brothers reported earnings this morning, and the stock is down a touch pre-market. Average selling prices fell due to a change in product mix. ASPs for signed contracts were flat and contracts were up 25%. Could we be seeing exhaustion, pricing-wise- at the high end of the market? Perhaps, but Robert Toll, Chairman of the Board said: “We believe our industry has room to run. Single-family housing starts, at 811,000, are still well below the 50-year industry average of 1.02 million units. The home ownership rate is on the rise but also still below historic norms. Interest rates remain low, unemployment is low, and more and more buyers are entering the upscale market. Based on these trends, we believe Toll Brothers is well positioned for future growth.”

Despite the lousy housing starts numbers, homebuilder stocks have been on a tear, rising 31% this year. Part of this was due to corporate tax reform - since homebuilders generally have little to no international exposure, a drop in the statutory rate would boost their earnings the most, compared to someone like Apple who has international entities all over the world. Builders have been struggling with their own issues however, especially a shortage of skilled labor. Many of the skilled laborers who worked in homebuilding during the boom either retired or went to work in different industries. Second, construction materials (aka sticks and bricks) are rising as well, and any sort of trade war with Canada will affect framing lumber prices. One thing to remember about homebuilding is that it is a very cyclical business, and during booms, multiples compress. The average homebuilder P/E is about 11 right now, and during the go-go years, it got down to 8.5. In other words, you could be right on earnings increasing, but wrong on the stock price as it goes nowhere while earnings grow. The other side of that argument is that there is so much pent-up demand for housing right now that a slowdown is simply not on the horizon. 

A new lending firm claims it can cut the closing process down to 8 days, and the borrower never has to speak to a loan officer. The industry average is 43 days. 

Morning Report: FOMC week

Vital Statistics:

	Last	Change	Percent
S&P Futures	2019.9	31.1	1.56%
Eurostoxx Index	3097.4	23.6	0.77%
Oil (WTI)	37.46	-1.0	-2.70%
LIBOR	0.634	0.002	0.24%
US Dollar Index (DXY)	96.4	0.228	0.24%
10 Year Govt Bond Yield	1.96%	-0.03%
Current Coupon Ginnie Mae TBA	105
Current Coupon Fannie Mae TBA	104.1
BankRate 30 Year Fixed Rate Mortgage	3.68

Stocks are lower this morning as oil gets roughed up. Bonds and MBS are up.

There is no economic data this morning, however the rest of the week looks pretty active, with retail sales, inflation data, housing starts, and industrial production. Of course we have the FOMC meeting Tuesday and Wednesday as well. 

Mohammed El-Arian lays out his prediction for the FOMC meeting this week. Bottom line: No move in rates, and an emphasis on data-dependency. They will mention overseas weakness, but won't make the statement that it will affect the US economy all that much. They will be sanguine on overall US data without becoming too hawkish on wages and inflation. So, generally a dovish take on things. 

It is hard to come up with a good reason to take away the punch bowl when investor sentiment is hitting 2 year lows. Of course the ultimate poll is the market, and not some survey. Where are investors doing well these days? Rental properties. 

Note that the recent increase in US rates was driven at least partially by increases in Euro rates. That move seems to be unwinding (in other words, Euro rates are heading back down). This will probably help guide US rates lower as well, especially if we get a dovish statement on Wednesday. 

Morgan Stanley is out with a call saying yields are going lower. Their forecast: 1.45% 10 year by the end of September. While the US economy is doing ok, the rest of the world is not. They think the next rate hike will be in December. 

Why is the first time homebuyer sitting out? Freddie Mac attributes at least some of the reason to misconceptions about buying, specifically credit scores and down payments. Many young borrowers still believe you need 20% down and perfect credit to qualify for a mortgage. Freddie has launched their Real Estate Professionals Resource Center to give pros the lowdown on products that can get a young borrower into a home.