Former Fed Chief Yellen Says Rates Could Next Move Up or Down (Implied Rate Forecast Is Down, US Treasury Curve Downward Sloping From 1-3 Years)

My favorite Bloomberg headline of all time is: “Former Fed Chief Yellen Says Rates Could Next Move Up or Down.” Wow, how insightful. But of course, she was refering to The Fed Funds Target rate which she kept at 25 basis points seemingly forever. However, current Fed Chair Jerome Powell could either raise, lower of keep rates constant, depending on the state of economy.

But then again, both the ECB and Bank of Japan are currently at zero (ECB) and below zero (BOJ). The US Fed is headed in a direction that differs from other central banks.

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While Powell has been increasing The Fed Funds Target rate AND shrinking The Fed’s balance sheet, Europe is drowning in negative target rates (Eurozone, Switzerland, Sweden, Denmark) as is Japan.

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But in terms of central bank balance sheets, only the US is shrinking their balance sheet.

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There are currently around $9 trillion of bonds trading at negative interest rates.

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As we stand today, the US Treasury yield curve is downward sloping at tenors 1-3 years.

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The current implied policy curve for The Fed is declining (meaning Fed Fund rate cuts are implied in 1-3 years.

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So, former Fed Chair Janet Yellen thinks rates could go up or down.

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The Average Adjustable-rate Mortgage Is Nearly $700,000! (Misleading Because Mortgage Refis Are Essentially Dead)

MarketWatch has the tantalizing headline of “The Average Adjustable-rate Mortgage Is Nearly $700,000.”

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True, the average loan size for ARMs (adjustable-rate mortgages) is substantially higher than for FRMs (fixed-rate mortgages).

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But here is a catch. Mortgage refinancing applications are virutally dead.

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Mortgage purchase applications are relatively sedate but rising following the financial crisis with new rules governing bank lending such as QM (Qualified Mortgage) and other Consumer Financial Protection Bureau (CFPB) rules.

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A more relevant chart that the one posted by MarketWatch is a comparison of average loan size by purchase applications and refi applications. Note that following the financial crisis, average loan size for purchases is higher than for refi applications.

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For the week ending 02/01/19, mortgage purchase applications SA declined 4.58% while mortgage refis were up 2.6% from the preceding week.

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The bottom line is that the MarketWatch piece, while tantalizing, is fundamentally misleading. Mortgage refi applications are nearly dead and mortgage purchase applications are rising again, but are no where near the 2000-2007 levels.

So, who killed mortgage refinancing applications?

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These guys! (Paul Volker can be excluded from the blame list).

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“Bond King” Gross Retires, Dudley “Amazed and Baffled” About Fed’s Balance Sheet Unwind And World’s Largest Pension Fund Suffers Catastrophic Quarter (Boogie In The Dark?)

I feel like investors are doing the “Boogie In The Dark” when it comes to understanding this broken market.

What’s going on?

First, bond king Bill Gross (formerly of PIMCO then Janus-Henderson) has thrown in the towel after 50 years.  His success at PIMCO was in the greatest bond bull run in modern history. But his Janus fund started near the peak of The Fed’s QE3 balance sheet expansion. Then his fund underperformed when The Fed started unwinding their balance sheet (and raising their target rate). Translation: The Fed got bond king Gross dizzy … and he retired.

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And that brings me to the former New York Fed President William Dudley.

(Bloomberg) — Former Federal Reserve Bank of New York President William Dudley said he’s “amazed and baffled” at the attention the wind-down of the U.S. central bank’s balance sheet has been receiving from investors, pointing to other culprits as the likely cause of recent volatility in financial markets.

Amazed and baffled? Just ask Bill Gross about the importance of Fed’s wind-down.

Then we have the world’s largest pension fund, Japan’s Government Pension Investment Fund that lost 9.1 percent, or 14.8 trillion yen ($136 billion), in the three months ended Dec. 31. The decline in value and the rate of loss were the steepest based on comparable data back to April 2008. Domestic stocks were the fund’s worst performing investment, followed by foreign equities. Assets fell to 150.7 trillion yen at the end of December from a record 165.6 trillion yen in September.

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But who helped break the market by distorting asset prices and returns? The Federal Reserve and other global central banks.

With so many uncertainties in global market (Brexit, trade wars, Venezuela’s meltdown, The Fed’s uncertain policy path, Italian debt crisis. etc., …

(Bloomberg) — Italy is preparing to sell as much as 1.8 billion euros ($2.1 billion) of state-owned real estate as it seeks to rein in soaring debt, people with knowledge of the plan said.

investors should hedge their risk exposure across markets … or move to cash or short-term Treasuries. In other words, take out some insurance.

Lastly, down in Virginia, we are suffering through yet another embarrassing governor (Northam) after McAuliffe and his electric call debacle.

Bye, bye Bill Gross. I can’t stand to see you go.

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Fed Tightens Agency MBS Holdings Day After Powell Hinted At Stopping QT (Oops, They Did It Again!)

Oops, they did it again. 

After hinting on January 30th that The Fed is considering halting shrinking of its balance sheet (better known as Quantitative Tightening), The New York Fed reported yesterday that their agency mortgage-backed securities holdings had been reduced by $7 billion. Aparently, The Fed is sticking to autopilot in terms of shrinking their balance sheet, at least for the moment.

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Again, only Agency MBS was reduced in the amount of just over $7 billion. All other holdings remained the same from the previous week.

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In other words, despite the talk, talk, The Fed is continuing to drain the punchbowl.

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US Pending Home Sales Fall 9.5% YoY In December To Lowest Level Since 2014 As Fed Unwinds

As The Federal Reserve continues to unwind its balance sheet, pending home sales YoY declined 9.5% YoY, the worst since 2014.

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Pending home sales got a big boost from The Fed’s third round of asset purchases (QE3), but PHS are feeling the pain of The Fed’s unwind.

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I wonder if “The Savior,” Ben Bernanke, saw this coming. Doctor, doctor (Bernanke), we’ve got a bad case of declining pending home sales.

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Simply Unaffordable! The Fed And Why Apartment Rents Are So High And The 1-Unit Housing Bubble of 2006 Market Distortion

The infamous home price bubble and financial crisis of 2008 is easily blamed on 1) subprime borrowers, 2) Collateralized Debt Obligations (CDOs), 3) financial derivatives, 4) tricked-up ARMs (adjustabe rate mortgages) like pay-option ARMs, 4) lack of regulatory oversight (The Fed claimed that is wasn’t their job!), etc.

But what generally overlooked is the supply response by developers and homebuilders to the sudden decline in interest rates (following the Fed Funds target rate).  A construction boom occured in the early to mid-2000s until The Fed decided to raise rates rapidly again in 2004 that helped result in a crash of 1-unit housing starts that never really recovered. True, subprime borrrowers disappeared (or shifted to FHA-insured loans), and tricked-up ARMs have been discouraged by the Elizabeth Warren brainchild The Consumer Financial Protection Bureau (CFPB). So, now we have increasing 1-unit housing starts at a lower level (fewer borrowers relative to the 2000s) and an over-supply of houses that the US is still trying to work through.

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Multifamily (5+ unit) starts collapsed in 2008 following the foreclosure wave that put thousands of homes on the market, generally at reduced prices. But as wage growth slowed following The Great Recession, the demand for apartments increased (generally more affordable) and the rental vacancy rate is near the lowest level since 2000. Low vacancy rates, rising apartment rates = affordability crisis.

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Why don’t developers and homebuilders (apartments) put up more supply? If some areas, like Northern Virginia, they have responded. But rents in Washington DC and NOVA remain high. (Check out Rent Cafe). But national rents continue to rise as well.

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Another compounding factor is tight land use controls in most major cities, preventing a supply response. This essentially forced some households to the suburbs for more affordable housing (some DC workers actually commute from West Virginia to DC or Virginia cities like Front Royal (great apple cider doughnuts at the Apple House in nearby Linden VA).

So housing in the US remains “simply unaffordable.” And with tight local housing regulations. the US housing market is addicted to gov(ernment).

 

 

 

Fed Balance Sheet Fracas Highlights Confusion Over Market Impact (Dazed And Confused? Or Communications Breakdown?)

Are financial markets “dazed and confused” by The Fed’s activities? Or is there a “communications breakdown?” Or are we “over, under, sideways, down” in terms of The Fed and asset bubbles?

(Bloomberg) — Wall Street has become obsessed with the Federal Reserve’s balance-sheet runoff, as investors debate why it’s suddenly roiling markets more than a year after it began.

There’s been no shortage of industry veterans sounding the balance-sheet alarm in recent weeks. . Billionaire Stanley Druckenmiller has called it a “double-barreled blitz” that coDoubleLine Capital Chief Executive Officer Jeffrey Gundlach says the unwind, interest-rate policy and guidance on where the two are headed have resulted in the equivalent of 15 implied tightenings. Billionaire Stanley Druckenmiller has called it a “double-barreled blitz” that could lead to a major policy error. And Guggenheim Partners Chief Investment Officer Scott Minerd has expressed concerns that liquidity constraints could give way to systemic risk.

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Others say not so fast. Strategist at Barclays, Royal Bank of Canada and Wrightson ICAP have suggested the unwind’s link to stocks is weak, at best. Still, the S&P 500 Index plunged more than 3 percent in the hours following last month’s Fed meeting after Chairman Jerome Powell said the rundown was on “automatic pilot,” forcing policy makers to re-craft their message on the fly. And U.S. stocks spiked higher Friday amid reports that the Fed is weighing ending the reductions sooner than previously expected.

The extent to which officials are ready to change tack should become clearer Wednesday following the Federal Open Market Committee’s first meeting of the year. A survey of economists ahead of this week’s decision indicates that most don’t expect the central bank to slow or stop the balance sheet run-off this year, while the median forecast for interest-rate hikes is two in 2019. Regardless of what officials signal, though, Wall Street is likely to remain on edge as it comes to terms with what the balance-sheet unwind actually means for markets.

How did we get here?
The Fed’s unprecedented quantitative-easing programs in the aftermath of the financial crisis pumped trillions of dollars into the banking system. It bought bonds from banks and paid for them by crediting their reserves. Now, with the economy on firmer ground, the Fed wants to siphon off that extraordinary liquidity to contain the potential inflationary effects, prevent asset-price bubbles, and replenish its ammunition to fight the next downturn. The central bank has been letting Treasuries and mortgage bonds on its balance sheet roll off, or mature rather than replacing them, since October 2017. The unwind has gradually accelerated to its current pace of a maximum $50 billion a month.

By contrast, the market frenzy over the balance sheet erupted just weeks ago — a disconnect that raises some eyebrows, particularly among fixed-income practitioners. Wrightson ICAP economist Lou Crandall wrote that “the Fed’s portfolio runoff is a sideshow” for equities, and RBC’s Michael Cloherty has described the impact as “wildly exaggerated.” That said, most agree that more clarity on the process surrounding the Fed’s unprecedented policy maneuver could help.

“The Fed has never done a two-variable experiment at the same time as they’re tightening policy,” said Lisa Hornby, a U.S. fixed-income portfolio manager at Schroder Investment Management. “The market has been scared by the fact that it’s a reversal of the policies that have been happening for years that have helped all risk assets.”

Where is the unwind being most directly felt?
Money markets. The Fed’s crisis-era bond investments created vast excess bank reserves. Post-crisis rules enacted to curb risk-taking have prompted banks to use much of those reserves to meet the more stringent requirements. As the balance-sheet unwind slowly drains liquidity from the financial system, some in the market are suggesting bank reserves are once again poised to become scarce, forcing banks to tap additional funding. Combined with a surge in Treasury-bill issuance — in and of itself partly driven by the government’s need to replace the Fed as a regular buyer — that’s helped push key money-market rates higher, especially in the market for repurchase agreements.

“Even though the Fed might be holding rates at 2.40 percent, the clearing rate for repo is much higher than that and I think that’s a result of this quantitative tightening and balance-sheet unwind,” said Bret Barker, a fixed-income portfolio manager at TCW Group in Los Angeles.

What about the impact on riskier assets?
That’s more complicated. The Fed’s purchases suppressed yields on Treasuries and agency mortgage-backed securities, driving investors into higher-yielding assets such as equities and corporate debt. Narrowing credit spreads enabled a record amount of corporate borrowing, which was used in part to buy back shares. Now, as the Fed normalizes policy, some of the tailwinds are reversing. Yields on Treasury bills from one- to six-months have risen to roughly 2.3 to 2.5 percent, more than the 2.1 percent dividend yield on the S&P 500 Index. Some say the additional tightening impact of the balance-sheet unwind may make credit conditions too restrictive, particularly for over-levered companies, and push the economy into recession.

“A lot of it is sentiment more than the fundamentals,” said Sebastien Page, head of global multi-asset strategy at T. Rowe Price in Baltimore. The markets have “gone through massive liquidity injections and the building up of those balance sheets. So what investors are worried about is the change in direction, so you go from rates going down and liquidity going up, to rates going up and liquidity going down.”

Where does the balance sheet unwind go from here?
It’s fair to say no one — not even the Fed chairman — can say with certainty what the balance sheet will look like in a year’s time. The most recent New York Fed survey shows primary dealers expect it to stabilize at about $3.5 trillion, which at the current rundown rate implies an end to the unwind in early 2020, according to analysis from ABN Amro Bank. Just three weeks ago, Powell said the future balance sheet “will be substantially smaller than it is now,’’ and encountered yet another wobble in stocks. More recent public statements from central-bank officials suggest policy makers are considering stopping the runoff sooner rather than later.

Another point of contention is whether the portfolio will still include mortgage-backed bonds. Nomura’s head of Americas fixed-income strategy George Goncalves expects a “full roll-off of the legacy MBS book but also a shift to a short U.S. Treasury duration portfolio.”

Amid all this uncertainty, a couple of things about the balance sheet are clear. Markets will have to accept that — at least for the remainder of this economic cycle — the days of maximum policy accommodation are over. In the meantime, will have to be wary of drawing attention to the autopilot and take full control of the market narrative.(Updates to add result of economists survey.

Here is Fed Chair Jerome Powell demonstrating his toxic masculinity by singing “I’m a man.’

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US Economy Growing Above Long-run Trend Without Sustained Inflation (As Gov’t Measures Inflation)

The good news? The US economy is growing above the long-run trend. But without sustained inflation.

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At the last reading Core Personal Consumption Expenditure (PCE) growth was only 1.88%. Compare that to home prices growing at 4.7% YoY (CS) and FHFA’s Purchase Only YoY at 5.76%.

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Zillow’s rent index for all homes YoY is only 0.485, well below The Fed Funds Target rate and Core PCE growth. And The Fed Funds Target rate is above Core PCE growth.

Here is a closer look at the past year. Rising Fed Funds Target rate, stable inflation (Core PCE YoY), decling house price growth and continued balance sheet undwinding.

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Home Prices in U.S. Cities Rise by Lowest Rate in Almost Four Years As Fed Unwinds Its Balance Sheet (Vegas Fastest Growing, DC Slowest)

Yes, US home price growth continues to slow as The Federal Reserve continues to unwind its bloated balance sheet.862767_cshomeprice-release-0129

(Bloomberg) — Home prices in 20 U.S. cities rose in November at the slowest pace since early 2015, decelerating for an eighth straight month as buyers balk at the ever-receding affordability of properties.

The S&P CoreLogic Case-Shiller index of property values increased 4.7 percent from a year earlier, down from 5 percent in the prior month, and below the median estimate of economists, data showed Tuesday. Nationally, home-price gains slowed to a 5.2 percent pace.

Sure enough, US housing has gotten quite expensive (although not Singapore, Hong Kong or London expensive). But the interesting story is … look at house price growth when The Fed enacted QE3, their third round of asset purchases. Then look at house price growth when The Fed began unwinding its bloated balance sheet.

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Let’s see what happens if The Fed continues its unwind.

On a metro level, Las Vegas (still recovering from the horrid collapse in house prices in the late 2000s) was the YoY leader … again. Followed by Phoenix, rising from the housing ashes of the housing bubble of the 2000s.

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The slowest growing metro areas? Once again, Washington DC has the slowest growth rate followed by Chicago. And then New Yawk (or New York).

 

Dust Their Brooms: Should Lehman Bros Have Been “Surprised” By Their Sudden Illiquidity? (Bear Stearns Then Fannie Mae And Freddie Mac’s Stock Price Already Plunged)

Movies like “Margin Call” and “The Big Short” make the financial crisis look like a total surprise … to them. Well, it wasn’t a surprise to GSEs Fannie Mae and Freddie Mac. Their common stock prices (green line) began plummeting in December 2007. Lehman Bros stock price didn’t start plummeting until February 2008.

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Why? National home prices had peaked in 2006 and had slowly begun to retreat. But as of December 2007, the Case-Shiller national home price index had fallen 17.4% from the peak in 2016. Subprime delinquencies had risen 46.5% over the same period. U-3 unemployment started rising in a big way in 2008.

But as home prices nosedived in 2008, subprime delinquencies skyrocketed. You can see Fannie Mae’s large drop in price in November 2008 (while they didn’t purchase subprime loans in high volume, they did invest in subprime ABS and ALT-A loan deals). While ALT-A turned out to suffer big losses, they performed better than subprime after the intial subprime spike.

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On September 6, 2008, Fannie Mae and Freddie Mac were placed into conservatorship with their regulator, FHFA and remain there ever since. Also in September, Lehman Bros declared bankruptcy … afer Fannie Mae and Freddie Mac were placed into conservatorship.

*There was other lenders that failed or had to be absorbed elsewhere, like Countrywide, and Wachovia.

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But Fannie Mae, Freddie Mac and Lehman Bros demise came AFTER Bear Stearns demise in March 2008, owing to subprime deal failures. In fact, you could see trouble brewing shortly after home prices started to fall. By 2007, both Bear and Lehman were showing distress, but not Fannie Mae. Fannie Mae and Freddie Mac’s regulator, FHFA saw the warning signs with subprime and took action on September 8th (maybe prematurely since they could have continued).

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Congress bailed out the banks and Fannie Mae and Freddie Mac and swept the financial dust away (aka, dust their brooms).

Just look at the above chart. Starting in 2016, risk managment at all financial firms should have been on yellow alert. By Q4 2007, it should have been upgraded to red alert. How is it possible that Lehman Bros or Bear Stearns (or Goldman Sachs) were taken by surprise as Margin Call implied.

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Oh well.