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As anticipated, Chairman Powell maintained a rather hawkish tone Friday afternoon, citing unexpected economic strength in the third quarter as reason to stay vigilant on inflation. “We are attentive to signs that the economy may not be cooling as expected.” Powell said. The Fed, Powell said, is “prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”
JPMorgan Asset Management’s chief global strategist David Kelly said Powell wants to keep expectations open as they approach the September meeting. Kelly, however, says from his point of view the bigger risk for the Fed at this point is hiking again, as we don’t yet know the full, lagged effects of the Fed’s aggressive rate rises yet, and there is every reason to believe, Kelly argues, inflation is on its way down, citing recent global PMI numbers, new car prices falling this year, and rents stabilizing. JPMorgan expects we will be in the low 3s by the end of this year and 2% by end of next year. Kelly also said he believes it is nearly impossible to go into recession with 9.5 million job openings, a lingering effect of the pandemic that is helping to keep inflation lower.
Morgan Stanley’s Global Head of Corporate Credit Research Andrew Sheets said much the same on inflation: “Two key measures of underlying inflation, core PCE and core CPI, slowed sharply in the most recent reading.” Sheets said. He says car prices and rent—big drivers of high inflation last year—are now pointing in the opposite direction. Sheets also sights tightening bank credit and a moderation in job growth as a sign rates are restrictive enough for Morgan Stanley economists to believe the Fed is done this year.
On the bond market, Sheets also noted: “Since 1984, there have been five times where the Fed has ended interest rate hiking cycles after multiple increases. Each time the yield on the U.S. aggregate bond index peaked within a month of this last hike. In short, the Fed being done has been good for the U.S. Agg Bond Index.”
Perhaps in line, 30 year mortgage rates ticked further upward over the 7% level on tight housing supply, as Mortgage Bankers Association (MBA) data indicated mortgage application activity drifted further downward to levels not seen in nearly three decades. Lawrence Yun, chief economist at the National Association of Realtors, said the future path of rates depends on 10-year Treasury yields and on what the Fed does at its Sept. 20 meeting. “We are at this critical juncture,” Yun said. “[Mortgage rates] can either break higher, up to 8 percent, or lower, to 6.5 percent.”
Meanwhile, Auction.com reported more than nine in 10 default servicing industry leaders expect completed foreclosure auction volume to increase this year compared to 2022, with 85 percent of those surveyed expecting home prices to decline in 2023 compared to 2022.
As mortgage rates hit a 22-year high and existing homeowners continue to stay in their homes, new single family home sales hit a 17-month high in July, according to HUD and U.S. Census Bureau data.
Last month’s data recorded a seasonally adjusted annual rate of 714,000 new single-family home sales, up 4.4% from the revised June rate of 684,000 and is 31.5% above the July 2022 estimate of 543,000. The median sales price of new houses sold in July 2023 was $436,700 and the average sales price was $513,000. First-time buyers now make up 50% of all buyers, up from 45% in 2022 and 37% in 2021.
Chief economist at the National Association of Realtors, Lawrence Yun, said he expects rates will begin decreasing by the end of the year, citing the Fed’s slowing of its interest rate increases. The Mortgage Bankers Association, said they expect the average 30-year mortgage rate to decrease to 5% by the fourth quarter of next year.
Meanwhile, Morgan Stanley reiterated concerns for regional banks. Vishy Tirupattur, its Chief Fixed Income Strategist, said the firm does not accept a growing narrative that “the issues in the sector that erupted in March are largely behind us.” “The ratings downgrades by both Moody’s and Standard & Poor’s,” Tirupattur said, “provide a reminder that the headwinds of increasing capital requirements, higher cost of funding and rising loan losses continue to challenge the business models of the regional banking sector.” While acknowledging that comment periods are open and changes could occur, on the heels of proposed rules around capital requirements, the Fed’s proposed capital rule on implementing capital surcharge for the eight U.S. global systemically important banks, and proposed regulations on new long term debt requirements for banks with assets of $100-700 billion, Tirupattur said “suffice to say that the documents envisage significantly higher capital requirement for much of the U.S. banking sector, and extends several large bank requirements to much smaller banks.”
In short, Morgan Stanley argues the result — supported by the latest Senior Loan Officer Opinion survey and a paper by the San Francisco Fed evaluating regulatory impacts on the real economy — is tighter credit going forward. “The bottom line is that more tightening lies ahead for the broader economy,” . …[and] “the evolution of regulatory policy can weigh on credit formation and overall economic growth.”
A report by Newmark in the Commercial Observer said debt origination volumes in the sector fell 52 percent year-over-year in the second quarter. They said there are also 32 percent fewer lenders than a year ago and lenders have grown “more selective in recent months, demanding lower loan-to-value ratios amid the Federal Reserve’s interest rate hikes.”
Additionally, the Washington Post ran a story this week about what is being referred to as the “urban doom loop” affecting midsized cities if commercial real estate headwinds persist. “The fear is that a commercial real estate apocalypse could spiral out and slow commerce, wrecking local tax revenue in the process. Midsize cities have some of the highest rates of office delinquency, where loan payments on buildings are behind schedule, and the lowest rates of office occupancy,” the Post reported. “The average delinquency rate across the 50 largest metro areas in the country is about 5 percent. But in places like Charlotte in North Carolina or Hartford in Connecticut, it is almost 30 percent, according to data from the real estate analytics company Trepp. Likewise, occupancy rates average about 87 percent. But in Oklahoma City, it is just 71 percent, and 76 percent in both Memphis and St. Louis.”
As anticipated, Chairman Powell maintained a rather hawkish tone Friday afternoon, citing unexpected economic strength in the third quarter as reason to stay vigilant on inflation. “We are attentive to signs that the economy may not be cooling as expected.” Powell said. The Fed, Powell said, is “prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”
JPMorgan Asset Management’s chief global strategist David Kelly said Powell wants to keep expectations open as they approach the September meeting. Kelly, however, says from his point of view the bigger risk for the Fed at this point is hiking again, as we don’t yet know the full, lagged effects of the Fed’s aggressive rate rises yet, and there is every reason to believe, Kelly argues, inflation is on its way down, citing recent global PMI numbers, new car prices falling this year, and rents stabilizing. JPMorgan expects we will be in the low 3s by the end of this year and 2% by end of next year. Kelly also said he believes it is nearly impossible to go into recession with 9.5 million job openings, a lingering effect of the pandemic that is helping to keep inflation lower.
Morgan Stanley’s Global Head of Corporate Credit Research Andrew Sheets said much the same on inflation: “Two key measures of underlying inflation, core PCE and core CPI, slowed sharply in the most recent reading.” Sheets said. He says car prices and rent—big drivers of high inflation last year—are now pointing in the opposite direction. Sheets also sights tightening bank credit and a moderation in job growth as a sign rates are restrictive enough for Morgan Stanley economists to believe the Fed is done this year.
On the bond market, Sheets also noted: “Since 1984, there have been five times where the Fed has ended interest rate hiking cycles after multiple increases. Each time the yield on the U.S. aggregate bond index peaked within a month of this last hike. In short, the Fed being done has been good for the U.S. Agg Bond Index.”
Perhaps in line, 30 year mortgage rates ticked further upward over the 7% level on tight housing supply, as Mortgage Bankers Association (MBA) data indicated mortgage application activity drifted further downward to levels not seen in nearly three decades. Lawrence Yun, chief economist at the National Association of Realtors, said the future path of rates depends on 10-year Treasury yields and on what the Fed does at its Sept. 20 meeting. “We are at this critical juncture,” Yun said. “[Mortgage rates] can either break higher, up to 8 percent, or lower, to 6.5 percent.”
Meanwhile, Auction.com reported more than nine in 10 default servicing industry leaders expect completed foreclosure auction volume to increase this year compared to 2022, with 85 percent of those surveyed expecting home prices to decline in 2023 compared to 2022.
In their recent article for Reverse Mortgage Daily, Gate House Founding Partners Brian Montgomery, Keith Becker and Dror Oppenheimer discuss the implications of the first positive capital ratio for the HECM program in six years.
The Gate House team, who worked together at the Federal Housing Administration managing the HECM program, provided their unique perspective and explained that important policy changes, and most certainly strong home price appreciation, have contributed to the substantial improvement in the HECM capital ratio.
Nevertheless, they argued, the results do not “provide a reason for complacency or assurance of future (positive) results” and therefore continued vigilance to ensure the program “is not continuously subsidized by the premiums … in the forward book, will be vital for the HECM program to continue to serve its mission.”
Montgomery is the only person to have served as FHA Commissioner twice under three presidents. Becker served as the Deputy Assistant Secretary and Chief Risk Officer for FHA. Oppenheimer served as a Senior Advisor to the Commissioner of FHA.
Eyes will be on inflation data coming out this week. The news on that front has been trending positive and suggests the Fed is nearing the end of the rate hiking cycle.
As we’ve been discussing here, the second quarter was strong and the third quarter appears to be holding up on the consumer front as well, as the jobs market softens slightly and corporate earnings weaken (as firms lose pricing power with supply chains are repaired). Unemployment remains at 3.5%, good for consumers but possibly also a source of wage pressure that keeps the Fed inclined to hold rates higher for longer. Though commodity declines in recent months have also been a boon, a recent pop in oil prices complicates the picture.
Joel Kahn of the Mortgage Bankers Association (MBA) summarizes it well: “The incoming economic data continue to convey conflicting signals about the strength of the economy. Indicators of manufacturing and service sector health remain lackluster, measures of inflation have moved lower, while GDP growth in the second quarter was stronger than expected and consumer spending remains resilient.”
Meanwhile, Morgan Stanley’s Michelle Weaver says no less than 1% of mortgages are in the money for refinance after millions jumped on the opportunity of low rates during the pandemic. The effect [of homeowners remaining in homes with lower rates and reducing existing supply] has made it tough for first time homebuyers who have had to remain renters, and has put upward pressure on rents, Waiver said on the Morgan Stanley podcast “Thoughts on the Market.” Her colleague Jim Egan noted that existing single family housing inventories are at 40 years lows and “We say ’40 year lows’ because that’s just as far back as the data goes, this is the lowest we’ve seen that,” Egan said.
Egan also argued that “while affordability is bad, it’s not getting worse” and is likely to improve, and “while supply is tight, it’s not getting tighter”—he believes we are stuck in a range for a while. Egan said while the Case-Shiller index turned negative this year for the first time since 2012, Morgan Stanley forecasts prices will be unchanged over the coming year. And as JPMorgan’s Michael Cembalest pointed out in his recent “Eye on the Market” podcast, the tight supply of existing homes has made the market more resilient to to rising rates. Consumers, however, are continuing to burn off savings, which might run out in 2024, Cembalest said. JPMorgan sees weakness possible for Q4/Q1, with economic growth down to 1%.
On that consumer front, credit card balances continue to climb, the Fed reported, with total indebtedness rising $45 billion in the April-through-June period, an increase of more than 4% — and taking the total amount owed to over $1 trillion, the highest gross value in Fed data going back to 2003. Total household debt rose $16 billion to $17.06 trillion, also a record. Fed researchers said the rise in balances reflects both inflationary pressures as well as higher levels of consumption. The Fed said its measure of credit card debt 30 or more days late rose to 7.2% in the second quarter, up from 6.5% in Q1, which is the highest rate since the first quarter of 2012 (though close to the long-run average). Total debt delinquency rose slightly 3.18% from 3%.
We’ve talked about commercial office challenges facing the market in the many months ahead. A report in the Wall Street Journal is also sounding an alarm on multifamily apartment owners. While vacancy rates are low and rents are high, some owners saddled themselves with too much debt as rents rose, often borrowing more than 80% of the building value from bond markets, the Journal reported. Though most apartment loans are fixed-rate, long-term mortgages, more investors took shorter-term, floating-rate loans during the pandemic. The surge in debt costs last year “threatens multifamily owners across the country,” the Journal said.
CoStar said apartment-building values fell 14% for the year ended in June after rising 25% the previous year, roughly the same as the fall in office values. And although mortgage delinquencies in the multifamily category are low, they are increasing, the Journal reports: “Borrowing costs have doubled, rent growth is slowing and building expenses are rising…Outstanding multifamily mortgages more than doubled over the past decade to about $2 trillion, according to the Mortgage Bankers Association. That is nearly twice the amount of office debt, according to Trepp. The data provider adds that $980.7 billion in multifamily debt is set to come due between 2023 and 2027.”
With U.S. 30-year fixed mortgage rates touching an average of 6.81% this week, the highest yet for 2023 according to Freddie Mac’s mortgage market survey, and despite tightening credit and signs consumers are already pulling back, low unemployment is creating the likelihood consumers can and will continue to spend over the next two quarters, keeping the prospect of a soft landing alive. That said, corporate earnings in the coming weeks will give us a better indication of whether that more optimistic narrative will be disrupted by multifaceted pressures and risks presented by persistent core inflation, higher interest rates, smaller bank liquidity concerns, and commercial office space contraction.
Citing the low unemployment figures and relatively strong job openings, UBS says they believe the US consumer can continue to spend through 2023, citing household DTI at 40 year lows, many households with debt fixed at low rate mortgages, and household wealth doubling in last decade, creating $10 trillion in wealth. With home prices up 40% from pre-Covid levels, UBS said even though savings is down recently it will likely remain positive through 2023 and into 2024, assisted by real wage growth (though also trending down) and the fact that lower income wages have been growing faster than higher income — all complicating the Fed’s job but nevertheless offering a less painful storyline for the rest of the year.
MBA Chief Economist Mike Fratantoni still forecasts a slowing economy over the next two quarters with a recovery in early 2024, nevertheless he expects the Fed will tighten again later this month: “The June employment report reinforces that forecast,” Fratantoni said. “While job growth and wage growth are trending down, both are still well above the pace that would be consistent with the Federal Reserve’s inflation target. We now expect that the FOMC will raise the federal funds target another 25 basis points at its July meeting.”
Goldman Sachs’ chief US economist believes the rebalancing of the labor market, with declining job openings and increased labor supply (closing a large gap that has existed between demand for labor and diminished workforce participation) without increasing unemployment is healthy for the economy and means less inflationary wage pressure.
Although core inflation has remained stubbornly high, near term inflation expectations and business inflation expectations have both moderated. Alleviation of the worst of pandemic supply chain shortages is also helping to bring down inflation, and relief in commodity prices are not believed to have passed through yet, Goldman Sachs said. An increased supply of rental units in housing, notably, has also not worked its way into inflation numbers either. Shelter is the largest category in inflation by weighting, and the Goldman Sachs team believes it will soon take an estimated 2-2.5% off the CPI, forecasting inflation to be down to the high 3s by end of year, the low to mid 2s next year, before achieving the Fed target 2% by 2025.
We are awaiting the Fed Board’s decision on interest rates Wednesday afternoon, when they are expected to pause, albeit with a hawkish tone, signaling they may not be done with rate hikes this year, and in fact lean toward keeping rates higher for longer to quell lingering inflation, before deciding to go lower late in the year.
As we’ve discussed here, the backdrop has been an economic dichotomy — a strong first quarter, followed with what appears to be even stronger second quarter amidst signals (credit tightening, profit margins tightening, consumers tightening, hiring slowing notwithstanding the strong May) the economy will slow later this year. We may not have seen the last of the bank failures either — while the Fed’s lending facility has calmed the outflow of deposits from smaller and regional banks, the longer these rates stay higher, the more pressure we will see.
Adding to those signals was a report from Attom indicating increased foreclosure activity in May, resuming what it said is “a slow climb back toward levels seen prior to the pandemic.” Meanwhile, Redfin reported 33.4% of home purchases in April were all-cash, reflecting tight supply and reduced affordability for mortgage borrowers, almost the highest share in nine years and up from 30.7% in April 2022. Median down payments were down in April, with the typical down payment of $52,500, down 18% year-over-year, the second-biggest drop since May 2020. Down payments have been falling year-over-year since November.
Redfin said FHA loans “were up as a percentage of purchases, at about 16.4% in April. That’s a notable increase from 10.4% a year earlier. They’ve become more common as high mortgage rates have cooled the market–FHA loans were losing out to buyers with all-cash or conventional loans during the stretch of highest competition.”
The Mortgage Bankers Association reported that mortgage credit availability declined in May, the third consecutive month and the lowest reading since January 2013 “as the industry continued to see more consolidation and reduced capacity as a result of the tougher market.”
Activity at the Fed’s discount window and the Bank Term Lending Program rose in the past week, with banks borrowing $73 billion from the window and $82 billion from the program, up slightly and continuing to stay at high levels. With the seizure of First Republic Bank over the weekend and JPMorgan picking it up early Monday, pressure continues on banks that are similarly exposed to interest rate risk and risk of deposit flight. The Federal Home Loan Banks said advances rose 28% at the end of the first quarter from the close of 2022, reaching a record $1 trillion during the March banking crisis, slowing toward the end of the month.
Following the First Republic deal, shares of a few other banks — Comerica, PacWest Bancorp, Western Alliance Bank and Zions Bank — all sank in Tuesday trading. Eyes and ears will be on whether these potential failures cause dissenting votes Wednesday within the FOMC.
First Republic was the 14th largest bank at the end of 2022 and is now the second largest bank failure in history after Washington Mutual in 2008, which JPMorgan also acquired. Of note here is that JPMorgan will share a loss with the FDIC on loans, with the FDIC reportedly taking 80%. Commercial real estate loans were reportedly a relatively small portion (6%) of First Republic’s loan base. The residential mortgage loans are believed to be low interest, low LTV loans to good credit borrowers. Nearly 60 percent of First Republic’s loans were single-family mortgages, according to their most recent annual report.
The Wall Street Journal reports that home builders are enjoying stronger-than-expected business this spring, capitalizing on the recent fall in mortgage rates and the shortage of existing homes for sale. Active listings in March stood at roughly half of where they were four years earlier, according to realtor.com, in part because higher mortgage rates made many homeowners reluctant to sell and give up their current low rates, the Journal said. WSJ said newly built homes made up “about one-third of single-family homes for sale in March, according to data from the Commerce Department and the National Association of Realtors. The proportion of newly built homes reached nearly 35% in December, a record in data going back to mid-1982 and up from a historical norm of 10% to 20%.”