Morning Report: Percentage of young adults living at home highest since 1940

Vital Statistics:

	Last	Change
S&P Futures	2266.3	-0.3
Eurostoxx Index	360.2	-1.1
Oil (WTI)	52.2	0.1
US dollar index	93.0	-0.4
10 Year Govt Bond Yield	2.55%
Current Coupon Fannie Mae TBA	103
Current Coupon Ginnie Mae TBA	104
30 Year Fixed Rate Mortgage	4.29

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

Mortgage Applications rose 2.5% last week as purchases rose 3% and refis rose 3%. Not sure how that is possible, but there it is. 

Existing home sales rose 0.7% in November to an annualized pace of 5.6 million. They are up 15.4% from a year ago and are the highest level since February 2007. The Northeast led the charge, with an 8% increase. The median home price was $234,900 which is up almost 7% YOY. Total housing inventory fell for the 18th straight month to 1.85 million, which represents a 4 month supply. The first time homebuyer accounted for 32% of sales. Historically that number has been closer to 40%. The combination of rising rates and prices continue to be a headwind for the first time homebuyer, however an improvement in the economy (and subsequent wage growth) will help offset that. 

The rapid home price appreciation we have seen in some markets mean that people who have been foreclosed upon may find themselves with a profit at the end. This has historically been an extremely rare event, and even today it only happens in the hottest housing markets like Seattle and Denver. 

Investor confidence continues to grow, as the Wells Fargo sentiment index rose for the third straight quarter and is at a 9 year high. Optimism over the 12 month economic outlook drove the increase, and 37% cite the election for that improvement. If Trump can get through some sort of corporate tax relief, then the forward earnings estimates on the S&P 500 are too low, compared to where they were before the election. That is part of what has been driving the markets. You take corporate tax rates from 35% to 20% or 25%, and the forward P/E multiple on the S&P drops even if pre-tax earnings don't improve.  

Talk about pent-up demand for housing: 40% of young adults (ages 18-34) were living with their parents in 2015, which is a 75 year high. "The number of adults under age 30 has increased by 5 million over the last decade, but the number of households for that age group grew by just 200,000 over the same period, according to the Harvard Joint Center for Housing Studies." Housing starts have basically kept pace with household formation, but are unprepared if these people suddenly decide to move out. You can see the relationship between housing starts and household formation below: That 5 million equates to almost 4 years of housing starts based on our current run rate. That will be the catalyst to take growth from 2% to 3% plus.

Morning Report: Vastly different forecasts for the 10-year

Vital Statistics:

	Last	Change
S&P Futures	2164.0	-3.0
Eurostoxx Index	339.4	2.0
Oil (WTI)	44.4	-0.2
US dollar index	88.0	0.2
10 Year Govt Bond Yield	1.57%
Current Coupon Fannie Mae TBA	103.3
Current Coupon Ginnie Mae TBA	104.2
30 Year Fixed Rate Mortgage	3.52

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

Mortgage Applications fell 1.3% last week as purchases fell 2% and refis fell 1%. Considering that the 10 year bond yield picked up 17 basis points last week, those are surprisingly good numbers, however there could be comparison issues with the 4th of July week. 

Brexit has created some winners and losers in the real estate business. Winners: those in the mortgage origination business and borrowers who benefit from lower mortgage rates. Losers: high-end developers who rely on foreign money and the private label securitization market, which needs higher yields to attract interest in non-guaranteed paper. 

Strategist Komal Sri-Kumar, who has been right as rain about the rally in Treasuries this year (when everyone else was predicting higher yields) has an eye-popping forecast for the 10 year: 90 basis points. He sees global growth slowing and believes inflation will be nowhere to be found. 

On the other side of the trade, SocGen believes fair value in the 10 year is 1.95%, and sees a 1% chance of the 10 year hitting 1.1% this year. Their original model was looking for high 2%. In fact, most strategists were looking for 2.75% of so on the 10 year by the end of the year. No one can make heads or tails of the bond market right now. 

We obviously have a bubble in sovereign debt, and the world is assuming inflation and growth are never, ever coming back. In other words, it is just another "its different this time" argument. IDTT are the 4 deadliest words in investing. Will it end with a cataclysmic top like we had in stocks in 2000 and residential real estate in 2006? Who knows? The last time we had interest rates this low was the 1930s under the gold standard. Today, we have negative rates under the PhD standard. This is uncharted territory and isn't in the economics textbooks. 

What will be the catalyst to get growth and inflation growing again? It should be housing. Household formation was depressed during the Great Recession and has been coming back. Housing starts are still lagging, however. Throw in obsolescence and you have a housing shortage, which is driving up prices. That pent-up demand is going to get released as the Millennials age, and that is going to push housing starts up to where they should be, around 2 million units a year. Compare housing starts to household formation over the past few years. 

Tim Duy, a very smart Fed-watcher suggests the Fed doesn't have the room to raise rates given that the yield curve is flattening. A flat yield curve (where long-term rates are close to short term rates) is generally bad for the economy, especially the banking system.  He suggests that the process of normalization start with shrinking the Fed's balance sheet. Since the Fed cut rates to zero first, and then instituted quantitative easing, the Fed should undo quantitative easing first and then raise rates. In fact they are doing the opposite. The first step would be to stop re-investing maturing proceeds and let the debt run off. Ideally, the Fed should be hitting bids in the Treasury market, selling overpriced paper, but they have to figure out how to offset the contractionary effect it will have on the money supply. 

Morning Report - Negative Q4 GDP?

Vital Statistics:

	Last	Change	Percent
S&P Futures	1502.2	-2.9	-0.19%
Eurostoxx Index	2741.1	-8.1	-0.30%
Oil (WTI)	97.63	0.1	0.06%
LIBOR	0.299	-0.002	-0.67%
US Dollar Index (DXY)	79.42	-0.142	-0.18%
10 Year Govt Bond Yield	1.99%	0.00%
RPX Composite Real Estate Index	193.1	-0.3

Markets are lower on a surprisingly weak 4Q GDP number, which showed the economy contracted by .1%.    The ADP employment change report showed the economy added 192k jobs in January.  Mortgage Applications fell 8% last week.  Later today, we will get the FOMC rate decision. The 10 year, which was above 2% earlier is back down below.  MBS are up small.

The Q4 GDP number was surprisingly weak (the Street was at + 1.1%) and will undoubtedly be revised upward as it does not jive with the other data points out there.  Certainly the earnings reports we are seeing out of Corporate America do not indicate a recession.  This is the "advance" report (the first of three) and is based on incomplete data.  The next estimate will be released at the end of Feb.

NAR has a good piece on the home ownership rate and household formation. The latest homeownership rate of 65.3% is the lowest since 1996.  Renters have been increasing.  They estimate that household formation broke out of its doldrums in 2012 and will be close to normalcy - around 1.1 million.  Note that this represents pent-up demand for housing as the Great Recession drove the low numbers, not demographics.  Of course some of these new households will go to rentals, but many will start purchasing starter homes, and they are the key to get transactions flowing again. This would also help ease the burden on the sandwich generation.

Chart:  Household Formation:

Looks like the sequester is going to happen, though the recent GDP report may give lawmakers a push to do something about it.

When the FOMC statement is released, people will be focusing on the end of QE. Aside from the effect on interest rates, there is also the question about the size of the Fed's balance sheet.  A recent paper projects the Fed's balance sheet to start contracting in 2015, with a return to a more normal size in early 2018.  The Fed has been highly profitable during QE, since its own buying influences prices and makes its holdings of MBS and Treasuries more valuable. But what happens when they begin to sell?  The Fed may in fact lose money over the next few years, which will undoubtedly bring a political angle into the future role of the Fed.  Whoever succeeds Ben Bernake will, like Paul Volcker, preside over a Fed that will be unpopular, to say the least.