It has been the longest bull market in modern history, enabled by massive Central Bank intervention. But with trade wars raging, Brexit, Presidential impeachment over something, etc., there remains a significant risk of a recession over the next 12 months.
If we look at the normalized change in the 10Y-3M curve minus normalized change in 10Y yields, we can see a heightened recession risk.
Lower yields and steeper curves are not a good recipe.
And then we have the decline in S&P 500 earnings estimates.
May be? How about definitely, along with improved expectations for economic growth.
(Bloomberg) — The Federal Reserve says that its Treasury-bill buying program isn’t the same as quantitative easing. But the advance in U.S. equity prices alongside the central bank’s growing balance sheet suggests to some that the effects may not be wildly different.
The central bank, driven by the need to tamp down problems in funding markets with liquidity injections, has expanded its balance sheet from as little as $3.76 trillion at the end of August to $4.05 trillion. That growth has, in effect, already reversed close to 40% of the shrinkage that the Fed began in late 2017. The S&P 500 Index, meanwhile, has climbed more than 7% since the end of August and this week reached new record highs.
To calm funding markets and improve its control over short-term interest rates, the Fed has used measures including the implementation of repurchase-agreement operations and a $60 billion per month program to acquire T-bills. Officials argue that the T-bill buying isn’t QE because, unlike several of the central bank’s previous asset-purchase programs and reductions to its benchmark rate, it isn’t aimed at lowering long-term borrowing costs and affecting the economy.
Peter Boockvar, chief investment officer at Bleakley Financial Group, says that in the eyes of the market this is just semantics.
“Markets view any increase in the size of the Fed’s balance sheet as QE,” he wrote in a note to clients on Monday.
Stocks, have of course, also been buoyed by other factors, ranging from an improving outlook for global growth and the prospects of a U.S. China-trade deal to better-than-expected earnings and the Fed’s three quarter-point rate cuts this year. But previous QE episodes were certainly instrumental in helping to fuel the post-crisis rally in equities, and signs of history repeating could well be adding to market buoyancy.
Of course, continued robust consumer consumption is helping.
The latest version of the twice-yearly report, meant to flag stability threats on the Fed’s radar, highlighted the rate squeeze facing banks and insurers, noting that it could erode lending standards.
“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers, and other financial intermediaries could come under stress and spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the U.S. central bank said in the report.
Fed Chairman Jerome Powell suggested to lawmakers on Thursday that low interest rates might be a permanent part of the economic landscape.
“We’re in a world of much lower interest rates,” he told members of the House Budget Committee. “That seems to be driven by long-run structural things and there’s not a lot of reason to think that will change.’
Fed Governor Lael Brainless said in a statement Friday that the low-for-long environment “and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.”
The bulk of the work on the report was done before September’s repo market tumult, which prompted the Fed to pump reserves into the banking system to boost money market liquidity. Still, the report does briefly address problems with the short-term repurchase agreements.
“Pressures in the repo market spilled over to other markets, including the federal funds market,” the report said. “The Federal Reserve took a number of steps beginning in mid-September to maintain the federal funds rate within its target range and to ensure an ample supply of reserves. Pressures in short-term funding markets subsequently abated.”
The central bank appeared to take a more relaxed view of the rising stock market than it did in its last report in May.
While equity prices remain high relative to corporate earnings, they are consistent with the low level of interest rates, the Fed said.
“Over the past couple of years, equity prices have been high relative to forecasts of corporate earnings,” according to the report. “However, other measures of investors’ risk appetite in domestic equity markets are in the middle of their historical ranges.”
You mean like the Shiller CAPE (Cyclically Adjusted Price Earnings) ratio … that is near the level seen on Black Tuesday of 1929.
And then we have former Fed Chairs Ben Bernanke and Janet Yellen who kept The Fed Funds Target Rate (Upper Bound) at near zero from late 2007 to late 2015 (and then FINALLY raised the target rate in Dec ’15). As Meryl Streep uttered in Death Becomes Her, “NOW a warning?”
And then we had the joint rate-repression regimes of Bernanke and Yellen. Note the decline in the 10-year Treasury yield from over 4% in 2008 to under 2% today.
Yes, The Fed has suddenly come to the realization (after 11 years of low-rate policies) that low rates can spark instability.
Green projects (like California’s bullet train from Victorville to Las Vegas, supposedly to protect the environment) and buzz words like “sustainability” are all the rage. So much so that Swedish high school student Greta Thunberg in traveling the globe like an environmental Stephen of Cloyes, and Nicholas of Cologne (Children’s Crusade of 1212), spreading the doom and gloom about global warming. In fact, San Francisco is painting a mural of Greta to raise awareness for her environmental crusade.
But where is the Greta Thunberg for government fiscal responsibility and pension reform? THAT is a real problem too!
Consider this graphic from George Mason University’s Mercatus Center showing the fiscal health of states. Pension-laden states like Illinois, Kentucky, New Jersey, Connecticut and Massachusetts are last the US in terms of fiscal health. Primarily due to overpromised public sector pensions. (Note: Virginia is currently the 13th healthiest in terms of fiscal condition). Illinois is the worst.
How bad is the fiscal condition in Illinois? They are leading the midwest in net outmigration (and poor Indiana is seeing a positive net immigration, some from Illinois). Of course, tax crazy New York is seeing a large net outmigration, but it isn’t as bad as Illinois!
Subprime mortgages (that is, loans made to subprime borrowers) are like the dinosaur — extinct. But as Ian Malcolm said in the movie Jurassic Park … life finds a way. They simply morphed into a less-threatening sounding product: the non-qualified mortgage (NQF).
(Bloomberg) The subprime mortgage-backed bond may be dead in America a decade after it helped trigger the global financial crisis, but a security with some of the same high-risk characteristics is starting to take off.
It’s called the non-qualified mortgage — basically a loan granted to borrowers whose checkered financial record made them ineligible for conventional mortgages.Lenders have bundled more than $18 billion worth of these loans into bonds this year that they then sold to investors, a 44% increase from 2018 and the most for any year since the securities became common post-crisis.
This surge in issuance of non-QM bonds, as they’re called, comes just as some initial indications of delinquency rates on the loans are starting to emerge. The short answer: They’re high. About 3% to 5% in some bonds, according to Barclays Plc. That’s multiples of the current 0.7% delinquency rate on Fannie Mae loans.
And while no one is saying these bonds are in danger of defaulting any time soon, their newfound popularity does reflect the growing risk that yield-starved investors are taking to boost returns at a time when the U.S. economy is slowing. It’s similar to the way demand for junk bonds and securities backed by fast-food franchises and private credit have all surged this year. In the case of non-QM bonds, coupons on the debt can be north of 5%. A typical Fannie Mae mortgage bond sold nowadays has a coupon closer to 3.5%.
“It’s obviously disturbing this late in the cycle to see originations for these loans at the kind of level they’ve kicked up to,” said Daniel Alpert, managing partner at Westwood Capital. “The housing market is not quite ready for a big infusion of this product.
The non-QM bond market is for now, at least, way too small to cause the kind of broader disruptions that subprime bonds did when they soured en masse a decade ago. (That’s what she said!) Moreover, the bonds are built to withstand tougher housing downturns than they used to be, and the borrowers aren’t as risky. The securities may face some sort of hit if the housing market weakens, but it won’t be severe, Alpert said.
“It’s not the subprime we remember from 2006 to 2007,” said Mario Rivera, managing director of the Fortress Credit Funds business, which has bought non-QM bonds. “It’s more of a second or third inning of non-QM. We’re getting the best collateral before the more aggressive lending comes in.”
But fund managers’ willingness to plow money into these securities shows how the intense suspicion that met mortgage bonds after the housing bubble burst last decade is starting to slowly fade. The subprime mortgage crisis triggered hundreds of billions of dollars of losses for investors.
There are more than $27 billion of outstanding bonds backed by non-qualified mortgages now, a small fraction of the approximately $10 trillion mortgage-bond market. In 2007, there were around $1.8 trillion of bonds backed by loans to non-prime borrowers.
The “non-qualified” moniker refers to any mortgages that don’t meet rules from the Consumer Financial Protection Bureau that went into effect in 2014. Many investors and issuers expect the market for non-QM bonds to grow. A temporary rule that lets Fannie Mae and Freddie Mac buy some home loans that don’t meet all the qualified-mortgage rules is set to expire in 2021. That will result in more debt being available to be bundled into non-QM bonds. Redwood Trust Inc., which issues mortgage securities, estimated in May that some $185 billion of home loans bought by the government-backed agencies annually would be considered non-QM.
JPMorgan, Angel Oak
A handful of lenders, including JPMorgan Chase & Co., Angel Oak Capital Advisors and Caliber Home Loans have been making the non-qualified mortgages and bundling them into bonds.
Borrowers’ scores in non-QM bonds are typically lower than what’s seen in other mortgage securities without government backing, like credit-risk transfer securities. But the consumers typically have relatively small debt loads compared with their incomes and the value of their homes. In many recent deals, non-QM borrowers have average credit scores in the low to mid 700s, a level credit reporting groups generally deem “good” to “very good.” Subprime borrowers typically have scores of 660 or less.
The bonds themselves also have more safeguards for investors than they used to. According to a Fitch Ratings analysis, an average of 36% of principal would have to be lost before the top-rated slice took a hit. The cushion in crisis-era “alt-A” bonds with the same rating was just 6%.
“There’s a lot more cushion, as there should be,” said John Kerschner, head of U.S. securitized products at Janus Henderson Group Plc, which manages $360 billion. “You can get some comfort that even if defaults inch up, the losses from those defaults aren’t going to be egregious.”
But even if non-QM bonds aren’t toxic, they have real risks. Many borrowers with non-qualified mortgages offer lenders bank statements to verify income instead of more stringent tax returns. Fitch says such documentation may offer only partial verification, and these borrowers could have unstable income because, for example, they own small businesses.
Making non-qualified mortgages can be legally riskier for lenders. If a borrower misses payments, and it turns out they shouldn’t have received the loan in the first place, they can sue the lender or even the securitization trust that owns the loan. Qualified mortgages have more legal protections for lenders and bondholders.
The strength of the housing market has helped support the bonds for now. Home-price appreciation has slowed over the past year, but the average U.S. house value still rose more than 2% in August from a year earlier, according to S&P CoreLogic Case-Shiller data. In a downturn similar to the financial crisis, when home prices contracted around 34% between 2006 and 2012, Barclays expects only the riskiest, lowest-rated portions of most non-QM bonds to lose money.
That’s partly why Barclays says the top-rated portions of non-QM bonds are a good buy at current prices. (Famous last words!) The notes tend to pay down quickly, because borrowers refinance into more conventional mortgages when they can. And the securities offer higher yield relative to alternatives like credit-risk transfer bonds.
“At least for now, credit concerns for most non-QM deals should be modest for investors who purchase the investment grade-rated classes,” Barclays strategist Dennis Lee wrote in a note in September.
That is, as long as there isn’t a home price bubble that bursts like in 2008. Like the stock market could.
US employment is out for October. The GM strike is over, but it crushed the manufacturing sector. But bartenders and restaurant waitstaff led the jobs addition.
Payrolls increased 128,000, topping estimates, and revisions added 95,000 jobs for the prior two months, suggesting the labor market remains broadly healthy
Wage growth rose 3% on an annual basis, and the prior month’s year-over-year gains were revised higher. While broadly decelerating, wages continue to support consumer spending and drive the record-long expansion forward
Today’s report is good news for the Federal Reserve and Chairman Jerome Powell. It supports Powell’s description of the labor market as “strong” and his view that the economy is in a good place
A few quirks in today’s report subdued what would have been a knockout number. The GM strike took a 41,600-job bite out of payrolls, while the roll-off of some temporary 2020 census workers shaved an additional 20,000
The unemployment rate edged up to 3.6%, which is still extremely low. It also reflected an influx of about 325,000 people into the labor market, which is a good thing
Where the jobs added were:
So, it looks like Powell and Richard Clardia, the Vice-chair of the Federal Reserve will view this jobs report as a reason to pause rate cuts.
The Dow jumped 250 points on the positive jobs report.
Meanwhile, there are jobs galore at establishments like Paddy’s Pub and Brion’s Grille on George Mason University campus!
After watching NY Jets’ QB Sam Darnold’s disastrous game against the NE Patriots (he claims he saw ghosts!), the existing home sales report from the National Association of Realtors is a moderate success!
US Existing Home Sales declined 2.2% MoM in September as mortgage rates rose slightly.
The median price for existing home sales fell as EHS inventory continued its seasonal decline.
Perhaps Sam Darnold should join the cast of Supernatural as a hunter instead of throwing 4 interceptions and a fumble.
Let’s hope Browns’ QB Baker Mayfield sees open receivers and not ghosts against the Patriots on Sunday!!