Alarm! Big Short Resurfaces in U.S. Bonds, Wary of ‘Convexity Trigger’

Alarm!

It was great to be a “Master of the Universe” (Treasury and MBS trader) since October 1981 when the US 10Y Treasury yield peaked at 15.84% and mortgage rates peaked at 18.63%. Treasury and mortgage rates have generally fallen ever since. But what happens if Treasury and mortgage rates rise?

Bond investors are piling back into short positions, motivated not only by the specter of inflation but also by the risk that yields are approaching levels that will unleash a wave of new selling by convexity hedgers.

That level is around 1.60% in the U.S. 10-year Treasury yield, less than 10 basis points from its current mark, according to Brean Capital’s head of fixed income strategy, Scott Buchta. It’s the mid-point of “a key threshold” between 1.40% to 1.80%, an area “most critical from a convexity hedging point of view.”

Convexity hedging involves shedding U.S. interest-rate risk to protect the value of mortgage-backed securities as yields rise, slowing expected prepayment rates.

It’s already begun to pick up as yields stretched past the 1.40% level. Another wave is expected at around 1.6% — a point of “maximum negative convexity” in agency MBS, “where 25bp rallies and sell-offs should have an equal effect on convexity-related buying and selling,” Buchta says.

Signs that short positions are accumulating include Societe Generale’s “Trend Indicator.” Among its 10 newest trades are short positions in Japanese 10-year debt, German 5-year debt futures, U.K. 10-year gilts, U.K. short sterling and U.S. 2- and 5-year notes. Meanwhile, CFTC positioning data for U.S. Treasury futures show asset managers flipped to net short in 10-year note contracts in the process of dumping the equivalent of $23 million per basis point of cash Treasuries over the past week. Hedge-fund shorts also remain elevated in the long-end of the curve, as measured by net positions in Bond and Ultra Bond futures.

“Bond-bearish impulses remain in place,” says Citigroup Inc. strategist Bill O’Donnell in a note, citing tactical and medium-term set-ups. Traders should be aware of short-covering rallies in the meantime, however, he says.

“Potentially extreme short-term positioning and sentiment set-ups could easily allow for a counter-trend correction under the right conditions,” he said.

U.S. 10-year yields topped at 1.57% this week, the cheapest level since June, spurring the breakeven inflation rate for 10-year TIPS to 2.51%, the highest since May. Friday’s September jobs report could add fuel to this inflationary fire, rewarding bond shorts.

Here is a chart of the rising 10Y Treasury yield against The Fed’s 5Y forward breakeven rate.

Here is a Fannie Mae 3% coupon MBS. Note the rise in Modified Duration with an increase in interest rates.

Convexity for the FNMA 3% MBS?

There is something on the wing. Some-thing.

Stimulypto! U.S. Rents Are Increasing at ‘Shocking’ Rates of More Than 11.5% (Newly-signed Leases Rose 17%)

So much for the transitory inflation that The Federal Reserve keeps spouting on about.

(Bloomberg) — The pace of rent increases is heating up in the U.S.

Rent data for the past two months show no sign yet of the usual seasonal dip at this time of year, following peaks early in the summer, when many lease renewals come due.

A Zillow Group Inc. index based on the mean of listed rents rose 11.5% in August from a year earlier, with some cities in Florida, Georgia and Washington state seeing increases of more than 25%.

Since the start of the pandemic, the median rent for a two-bedroom apartment has soared 13.1% to $1,663, Zumper data show.

But rent on newly-signed leases rose 17% from the previous tenant’s lease.

For the New York market, landlords are raising rent prices as much as 70% now that people are flooding back into the city as offices and entertainment venues open up. In July, the median asking rent in New York City surged to $3,000, compared with the pandemic low of $2,750 in January 2021, data from StreetEasy showed.

Of course, rent surge is not surprising given that home prices have surged since Covid given limited inventory and massive Fed stimulus.

Perhaps if The Fed and Federales (Federal government) start reducing their apocalyptic-level stimulus, THEN we will see inflation as transitory.

Mortgage Lender Offering 105% LTV Loan With $500 Down And Downpayment Assistance, FICO Down From 660 To 620 (Into The Storm!)

I call this “lending into the storm.”

A national mortgage lender has just introduced a 105 Loan-to-value (LTV) ratio loan and a lowering of FICO scores from 660 to 620.

Now, the loan still requires 97% LTV with downpayment assistance and gift funds permitted to boost CLTV to 105%.

With The Fed helping to raise home prices at a whopping 20% YoY, …

lenders are trying to find loan products for lower-income households so they can get in on the bubble! Hence, a 105% CLTV mortgage product with reduced credit requirements and increased Debt-to-income requirement rising from 43% to 45%. Also, borrowers can avoid the 3% downpayment requirement and put down only $500.

This is lending into the storm: softening of underwriting requirements as the house price bubble surges. Sound like 2005. This was not supposed to happen. After the housing bubble burst and the financial crisis, The Fed was supposed to encourage counter-cyclical lending (tighten credit standards as a housing bubble worsens). Instead, lenders are lowering credit standards, feeding the house price bubble.

If this was just one lender, I would have barely noticed. But this mortgage is being offered by most banks. And then sold to our GSEs: Fannie Mae and Freddie Mac.

Government mortgage giant Fannie Mae purchases these mortgages in their 3% down programs.

Eligibility and Terms

Desktop Underwriter^® (DU^®) underwriting required
1-unit principal residence, including eligible condos, co-ops, PUDs, and MH Advantage^® (Standard manufactured housing: max. 95% LTV/CLTV)
Fixed-rate mortgages with a maximum term of 30 years and ARMs are eligible (restrictions apply)
Reserves (if required per DU) may be gifted
Combined LTV up to 105% provided subordinate lien is an eligible Community Seconds^® loan
Downpayment assistance found here.

Speaking of lending into a storm, as part of the raft of new legislation designed to spur first-time homeownership in America, a remarkable bill has joined the fray: its sponsors propose creating a new subsdizied 20-year-fixed-rate mortgage program through Ginnie Mae, HousingWire reports.

According to the bill, Ginnie Mae in tandem with the Department of the Treasury would subsidize the interest rate and origination fees associated with these 20-year mortgages, so that the monthly payment would be in line with a new 30-year FHA-insured mortgage. The move – which is an explicit subsidy of one share of the population by another – could, in theory, “allow qualified homebuyers to build equity-and wealth- at twice the rate of a conventional 30-year mortgage.” Instead, what it will do is lead to is an even bigger housing bubble.

As I said, lending into a storm.

US Home Price Growth Hits 20%! While Fed’s Inflation Target Is 2% (Phoenix AZ Growing At Whopping 32.4% YoY!)

The Federal Reserve is dominating the news today as two Fed regional Presidents have resigned (Rosengren [Boston] and Kaplan [Dallas]) for trading irregularities.

Speaking of The Fed, their target rate for inflation is 2%. Yet the Case-Shiller 20 metro home price index just rose to 20% YoY for July. Yes, house price growth is 10 times The Fed’s target rate!!

Now, it is September 28, so this is a report of happenings two months ago. Well, now you know why The Fed ignores housing despite being the largest asset is most household’s portfolio.

A measure of prices in 20 U.S. cities gained 19.9% in July. Phoenix led the way with a 32.4% surge. New York (17.8%), Boston (18.7%), Dallas (23.7%), Seattle (25.5%) and Denver (21.3%) were among the cities that posted record year-over-year increases.

The housing market is over, under, sideways, down thanks to The Fed pumping trillions into a market with limited available inventory.

The Fed is not talking about housing. Or the fact that home prices are growing at 10 times the rate of The Fed’s inflation target.

10-Year Yields Rise Above 1.5% as Central Banks Turn “Hawkish” (FAANG Stocks Trail S&P 500 As Rates Rise)

Central banks are turning “hawkish” in the face of inflation.

(Bloomberg) — Treasuries fell, sending 10-year yields to a three-month high, as traders braced for a testing week of heavy bond auctions and continued to digest the prospect that central banks in the U.S. and Europe will step up the pace of policy tightening.

The yield on 10-year Treasuries reached 1.51%, the highest since June, before settling at 1.48%. The yield has climbed 16 basis points over the past week as the Federal Reserve signaled it may start reducing its asset purchases in November and raising rates as soon as next year. Yields on two- and five-year Treasuries hit their highest levels since early 2020, with a combined $121 billion of the securities set to be sold Monday. A seven-year auction is due Tuesday.

While Treasuries briefly extended the selloff after a report showed durable goods orders exceeded economists’ forecasts, they started to pare losses after U.S. equity futures soured.

Bond yields increased across the globe last week as central banks move to reduce pandemic stimulus. The Bank of England surprised markets by raising the prospect of increasing rates as soon as November, and Norway delivered the first post-crisis hike among Group-of-10 countries. In the U.S., traders pulled forward wagers on an interest-rate increase to the end of 2022 following last week’s Fed meeting.

On the equity side, FAANG stocks trail the S&P 500 as 10-year Treasury yield climb.

We have the 10-year Treasury yield climbing above the S&P 500 dividend yield.

Here are The Fed and The ECB turning “hawkish.”

The Fed Helped Create Housing Bubble I And Then Helped Create Housing Bubble II: The Sequel (Case Study Of Phoenix AZ Home Price Bubble)

Phil Hall of Benzinga wrote a series of excellent articles in four parts for MortgageOrb (although “The Orb” has removed his name). Here are the links to his stories.

https://mortgageorb.com/the-fall-and-rise-of-the-housing-market-part-one

https://mortgageorb.com/the-fall-and-rise-of-the-housing-market-part-two

https://mortgageorb.com/the-fall-and-rise-of-the-housing-market-part-three

https://mortgageorb.com/the-fall-and-rise-of-the-housing-market-part-four

After re-reading these excellent articles on the housing bubble and crash, I thought I would take the opportunity to present a few charts to highlight the housing bubble, pre-crash and post-crash.

Here is a graph of Phoenix AZ home prices. Note the bubble that peaked in mid 2006. The Phoenix bubble correlates with the large volume of sub-620 FICO lending and Adjustable-rate mortgage (ARM) lending. Bear in mind, many of the ARMs prior to 2010 were NINJA (no income, no job) ARM loans.

What happened? Serious delinquenices at the national levels spiked as The Great Recession set in and unemployment spiked.

Since the housing bubble burst and surge in serious mortgage delinquencies, The Federal Reserve entered the economy with a vengeance. And have never left, and increased their drowning of markets with liquidity.

The Fed whip-sawing of interest rates in response to the 2001 recession was certainly a problem. They dropped The Fed Funds Target rate like a rock, then homebuilding went wild nationally and home prices soared thanks to Alt-A (NINJA) and ARM lending. But now The Fed is dominating markets like a gigantic T-Rex.

Oddly, then Fed Chair Ben Bernanke never saw the bubble coming. Or the burst.

Speaking of pizza, Donato’s from Columbus Ohio is my favorite. Founder’s Favorite is my favorite, but they do offer the dreaded Hawaiian pizza (ham, pineapple, almonds and … cinnamon?)

Bleech!

US Homeowner Equity Surged +29.3% YoY (California The Biggest Gainer) Thanks Mostly To Federal Reserve

Since Q2 2020, US homeowners have been big winners in terms of home price gains and equity in their homes. Unfortunately, this means that renters are big losers. Once again, The Federal Reserve is benefiting once segment of the population while punishing the other segment.

Homeowner Equity Q2 2021

CoreLogic analysis shows U.S. homeowners with mortgages (roughly 63% of all properties*) have seen their equity increase by a total of nearly $2.9 trillion since the second quarter of 2020, an increase of 29.3% year over year.

*Homeownership mortgage source: 2016 American Community Survey.

National Homeowner Equity

In the second quarter of 2021, the average homeowner gained approximately $51,500 in equity during the past year.

California, Washington, and Idaho experienced the largest average equity gains at $116,300, $102,900 and $97,000 respectively. Meanwhile, North Dakota experienced the lowest average equity gain in the second quarter of 2021 at $10,600.

Figure 4 National Homeowner Equity Average Equity Gain

10 Select Metros Change

CoreLogic provides homeowner equity data at the metropolitan level, in this graphic 10 of the largest cities, by housing stock are depicted.

Negative equity has seen a recent decrease across the country. San Francisco-Redwood City-South San Francisco, CA, is the least challenged, with Negative Equity Share of all mortgages at 0.6%.

Loan-to-Value Ratio (LTV)

The graph represents National Homeowner Equity Distribution across multiple LTV Segments.

Figure 6 National Homeowner Equity Loan-to-Value Ratio

Since growing home equity lead to lower default risk (or at least losses to the mortgage holder), we are seeing mortgage delinquencies fall after the Covid surge.

Of the top ten cities, Chicago leads in negative equity.

Maybe Fed Chair Jerome Powell is trying to soothe us, like Sam and Dave.

Urkel Economy! US Consumer Confidence Lowest In Decades Thanks To Rising Prices (Home Buying Conditions Fall To 60)

This is the Steve Urkel economy where The Federal Reserve and Federal government screw everything up with their policies (or follicies) and say “Whoops! Did I do that?”

(Bloomberg) — U.S. consumer sentiment rose slightly in early September but remained close to a near-decade low, while buying conditions deteriorated to their worst since 1980 because of high prices.

The University of Michigan’s preliminary sentiment index edged up to 71 from 70.3 in August, data released Friday showed. The figure trailed the median estimate of 72 in a Bloomberg survey of economists.

Buying conditions for household durables, homes and motor vehicles all fell to the lowest in decades. The report said the declines were due to complaints about high prices. Consumers expect inflation to rise 4.7% over the coming year, matching the highest since 2008.

September’s UMich Buying Conditions for Houses fell to 60 … thanks to superheated house prices.

I can just picture Fed Chair Jerome Powell channeling Steve Urkel and saying “Whoops!! Did I do that?”

Covid Blues! 1.6 Million Loans Remain In Forbearance With FHA/VA Leading (Fannie Mae Reports $7.2 Billion In Net Income In Q2 Report)

The Covid epidemic hit the single-family mortgage market hard in early 2020, leading mortgage lenders and servicers to offer FORBEARANCE to borrowers who were having trouble making their mortgage payments due to loss of hours or a loss of job.

Black Knight offers an excellent summary of the forbearance data.

The good news? Active forbearance plans are much lower today than at their peak after the Covid epidemic struck in early 2020 with active forbearance plans peaking in May 2020.

Forbearance plans are due to expire in

What is forbearance, you ask? Forbearance is when a mortgage servicer or lender allows a borrower to temporarily pay their mortgage at a lower payment or pause paying your mortgage. The borrower will have to pay the payment reduction or the paused payments back later.

Despite forbearance, Fannie Mae still reported $7.2 billion in net income in Q2 2021. Notice the difference between single-family SDQ and the SDQ rate without forbearance. Freddie Mac reported $3.7 billion in Q2 2021 net income.

Here is a look at Fannie Mae’s net income over the past year and SDQ rates.

Under the existing seller/servicer eligibility requirements, the Agency SDQ Rate is defined as 100 multiplied by (the UPB of mortgage loans 90 days or more delinquent or in foreclosure for Fannie Mae, Freddie Mac, and Ginnie Mae/Total UPB of mortgage loans serviced for Fannie Mae, Freddie Mac, and Ginnie Mae). Beginning with the financial quarter ending Jun. 30, 2020, the Agency SDQ Rate will include an adjustment for mortgage loans in a COVID-19-related forbearance plan that are 90 days or more delinquent and were current at the inception of the COVID-19-related forbearance plan. The UPB of such mortgage loans shall be multiplied by .30 and added to the UPB for SDQ mortgage loans for the purposes of determining the numerator in the calculation of the Agency SDQ Rate.

Rent Inflation: National Average RENT Rose 10.3% YoY (Fed’s Got A Line On YOU!)

Not only after home prices screaming at near 20% YoY growth, but apartment rents are surging as well.

(Bloomberg) — Apartment rents were up in August from a year earlier in all the top 30 U.S. metro areas, the first time that’s happened since the start of the pandemic, according to a new report by Yardi.

The national average rent in multi-family buildings rose 10.3% from a year earlier to $1,539 — the first double-digit rise in the dataset’s history — after a $25 increase in August, the real-estate firm said. Over the past 10 years, the average pace of growth has been 2%.