Confounded Interest – Anthony B. Sanders
Financial Markets And Real Estate
As The Federal Reserves twiddles it thumbs, US housing continues to burn … hot!
The Case-Shiller National home price index (HPI) grew at a 19.17% YoY rate in January despite mortgage rate increases.
Where? Phoenix, Tampa and Miami lead the way with Dallas, San Diego and Las Vegas close behind.
And Fed Chair Jerome “Nero” Powell continues to let housing prices burn red-hot!
By the time I get to Phoenix … home prices will completely unaffordable.
Michael Lea and I wrote a paper several years ago arguing that most borrowers would be better-off with an adjustable-rate mortgage than a fixed-rate mortgage. The US is one of the few countries in the world where the 30-year fixed-rate mortgage is dominant. Why is this the case? FEAR of rising mortgage payments with adjustable-rate mortgages (ARMs) while the fixed-rate mortgage (FRMs) have constant payments over the 30-year term.
The reason why the fear of ARMs is unwarranted is that ARMs generally have CAPS on rate increases, either in a given period or over the life of the loan. Of course, READ the loan terms to ensure that the ARMs has restrictive caps on rate increases.
Currently, the 5/1 ARM is at 3.26% while the 30-year FRM is at 4.56%, a spread of 130 basis points.
Mortgage rates of all flavors are rising rapidly with the expectation of Federal Reserve Quantitative Tightening (QT). There are several headwinds that could counter The Fed’s QT efforts such as low GDP growth (Atlanta Fed’s GDPNow real-time GDP tracker is at 0.9% for Q1), the Russia-Ukraine invasion, approaching midterm elections, etc. But as of today, The Fed seems on a collision course with rising mortgage rates.
With the increasing likelihood of Fed rate hikes over the next year, we are seeing an increase in US ARM loan share from 4% to 7.9%, almost a doubling of ARM share. But FRMs are still over 90% of all mortgage originations.
Lending institutions would prefer consumers to use ARMs rather than FRMs since ARMs allow for the transfer on long-term interest rate risk to the borrower, while the FRM sticks the lender with long-term interest rate risk. Hence, we have Fannie Mae and Freddie Mac, the Government Sponsored Enterprises (GSEs) that allow lenders to originate FRMs and sell them to F&F. We are the only country with twin GSEs.
So, while most consumers would be better-off with an adjustable-rate mortgage, the structure of the mortgage market (particularly after the financial crisis) encourages lenders to originate FRMs and sell them to Fannie Mae and Freddie Mac.
But FEAR drives many US mortgage borrowers into the FRM space rather than getting an ARM with a lower interest rate, even if ARM caps would prevent the mortgage rate from rising more than 100 basis points over the life of the loan.
Unfortunately, the US Breakeven 10Y inflation rate hit another all-time high as West Texas Intermediate Crude Oil (Cushing Spot) soars.
But note that the WTI Crude spot rate is still lower than it previous peak in June 2008. What is notable in the above chart is that M2 Money growth YoY has slowed after Covid “Stimulypto”. But M2 is still growing at an 11% YoY clip, much faster growth than pre-Covid rates. So, Federal stimulypto is still in place, helping to drive inflation to the moon.
Example of how crazy this is getting? A house in Toronto Canada (our cousins to the north) just went to $613,000 OVER ASKING PRICE! While some may dismiss this as “Well, that is Canada” it does show how inflation is ravaging home affordability in North America.
As The Biden Administration and Congress pushes Green Energy and demonizes fossil fuels, we are seeing Green Energy commodities such as Lithium (for batteries) soar even faster than oil prices.
Gold may be set to party like its 1999!
And just an update on The US Dollar, Crypto Currencies and Gold. This is just a sample of alternatives to the US Dollar for transactions. Freedom of choice is a great thing!
What a wonderful time to be a politician! As Winston Churchill once uttered, “Never let a crisis go to waste.” To quote Dwight Schrute from The Office, “It is part of the green initiative. And by green, I mean money.”
According to Fed Funds Futures data, The Federal Reserve is now forecasting 9 rate increases over the next year.
Fed Funds Futures are pointing to 8.924 rate hikes by the Fed FOMC meeting on February 1, 2023.
The US Treasury 10Y-2Y curve flattened by 5.5 bps today with the entire curve downshifting.
The Federal Reserve reminds me of The Office episode “Malone’s Cones.” They can’t really explain why they kept rates so low for so long (policy error) and seem to risk collapsing the market with rapid rate hikes without much sensible explanation.
US pending home sales for February surprised to the downside, down -4.1% MoM and -5.4% YoY, as mortgage rates soar.
And inventory remains MIA.
Not surprisingly, March median sales prices are up 17% YoY.
University of Michigan buying conditions for housing is the lowest since the Carter inflation fiasco.
Let’s see if The Fed will continues its plans to raise rates and trim their balance sheet. Or will Powell be “Runaround Jay.”
We’ve got Trouble in Potomac City!
The US Treasury 10Y-5Y curve is going deeper into inversion.
The short end of the Treasury curve is rising, as expected, but declining at the 5 year tenor and beyond.
The aggregate Treasury Index is plunging as Fed Funds Futures signal 8.341 rate hikes over the next year.
Mortgage rates? Climbing as mortgage refinancing applications fall (as expected).
Is The Federal Reserve actually run by The Office’s Michael Scott?
The US Treasury 10Y-5Y curve (aka, the belly of the Treasury beast) has inverted.
It is more about the 10Y Treasury yield rising more slowly than the 5Y yield.
Freddie Mac’s 30Y mortgage commitment rate rose to 4.42%.
Today’s initial jobless claims came in at 187k, the lowest in modern history!! Overheated much?
More fuel on The Fed Fire to raise rates above 0.50%.
Fixed-income trading floors:
This is the chart from hell as The Fed is expected to take interest rates higher.
At least mortgage rates are down slightly today.
With 8+ rate hikes forecast over the next twelve months. Meaning that Powell’s Fed money gun is going to slow.
The news just keeps getting worse and worse. Russia is still assaulting Ukraine, WTI Crude prices are above $100 a barrel and climbing, the Cleveland Browns signed Deshaun Watson to replace Baker Mayfield at quarterback, etc.
But back to energy prices. Since Biden was sworn-in as President, WTI Crude Oil futures are up 125%, regular gasoline prices are up 89%, and diesel fuel prices are up 155%. Diesel is important since America uses diesel-powered trucks to transport goods to market.
Globally? The world inflation rate has grown from 2% in January 2021 to 6.82%. Global food prices are up 24%.
Yes, WTI Crude and Brent Crude are above $100 per barrel.
And coal prices are up 256% under Shoeless Brainless Joe.
Mortgage rates? Bankrate’s 30-year mortgage rate is now above 4.50%.
Let’s see if Dr. StrangeFedpolicy raises rates as aggressively as signaled.
The Federal Reserve is not mentioned in the movies “The Big Short” or “Margin Call”, but The Fed’s policy errors played a big role in the demise of Fannie Mae’s and Freddie Mac’s equity prices.
Here is a chart of The Fed’s many policies errors. Let’s start with The Fed lowering rates too fast around the 2001 recession. They pushed their target rate from 6.5% in December 2000 down to 1.75% after one year and then down to 1% (PE1). As home price growth accelerated, The Fed engaged in their second policy error — raising rates too fast resulting in a dramatic cooling of home price growth. Then came Policy Error 3: the dropping of The Fed Funds Target rate from 5.25% in September 2007 to an eventual 0.25% in December 2008.
With the election of President Obama, The Fed engaged in Policy Error 4: keeping The Fed Funds Target rate too low for too long, combined with their massive asset purchase programs (QE).
Finally, The Fed (under Yellen) finally raised The Fed’s target rate ONCE under Obama, but started raising rates once Trump was elected. The Fed also slowed their QE under Trump which as called “Fed policy NORMALIZATION.” Then COVID struck and The Fed engaged in Policy Error 5: keeping rates too low for too long … again while massively expanding their balance sheet.
Fannie Mae and Freddie Mac, the DC mortgage giants were done in by The Fed’s whipsaw Policy Error machine.
Now we are embarking on PE 5: Powell and The Fed Gang not raising rates but signalling that they will. Like the play “Waiting for Godot.”
Confounded Interest - Anthony B. Sanders 
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