Market Commentary 05/17/2024

Balancing Act: Bonds Rally Amid Mixed Inflation Signals

It was another positive week for bonds as CPI data turned out to be cooler than expected. Inflation concerns eased with a slight dip in mortgage rates by about a quarter point on many products.

However, it’s premature to celebrate just yet, as PPI, or wholesale inflation, turned out hotter than forecast. While companies will always try to pass on input costs, sustained inflation makes transferring these higher prices to the end consumer increasingly challenging. Although a milder CPI print is encouraging, we anticipate the Fed may lower interest rates only once this year, especially given the recent Fed communications suggesting the unlikelihood of a July rate cut.

Despite unemployment being below 4%, a soaring stock market, and consumers still in relatively good shape, the Fed seems inclined towards a “higher for longer” approach with interest rates. There’s a concern that lowering interest rates may fuel animal spirits and exacerbate inflation. Notably, the resurgence of “Roaring Kitty” this week sparked a surge in option trading on some Meme stocks, indicating a shift away from restrictive financial conditions.

Nevertheless, there’s a strong desire to reduce interest rates. If unemployment softens and the unemployment rate hovers around the 4.5% range, then the probability of lowered rates becomes more likely. Lower interest rates would greatly benefit the US Government amidst record deficit spending and the need to fund these deficits with bond issuance.

FNMA Selling Policy Updates 2024: IPC

FNMA has issued 5 Selling Policy updates, signifying a pivotal moment in mortgage lending. Included in these updates, FNMA has clarified the impact of their NAR settlement on IPC caps. If a buyer’s agent commission continues to be a “common and customary” seller cost, it is not counted toward the Interested Party Contribution maximum (between 2% – 9% of the property value).  The standard of “common and customary” has not been formalized and is measured by regional practice. As a recap, under the new system that NAR agreed to in settling the suit, when a home hits the market, listing agents will no longer specify how much the buyer’s agent will be paid. Instead, that fee will be negotiated separately between the buyer and the buyer’s agent. We have included a matrix of the current FNMA IPC maximums below, as well as FHLMC’s matrix for reference. Currently, there is no determination in how the Department of Veterans Affairs will handle potential changes to buyer real estate commissions. Moreover, there is still potential for changes to the FHFA rule that prevents buyers from rolling the listing commission into mortgages. Stay tuned for more updates. Subscribe to our Weekly Market Commentary for more. 

Updated IPC Maximums

Maximum Interested Party Contributions for FNMA loans:

Maximum Interested Party Contributions for FHLMC Loans:

Link to full Selling Policy Updates here.

Market Commentary 5/10/2024

Declining Consumer Confidence Suggests Fragile Economy

We’ve perceived the economy as a mixed bag in the past year, diverging from the rosy outlook of many Wall Street economists. Although official employment and GDP figures indicate strength, the reality for many below the middle class suggests otherwise as individuals juggle multiple jobs to make ends meet. Inflation, often cited as a driver of nominal GDP growth, may be masking underlying economic challenges. This is evident in slowing sales for consumer-oriented businesses like McDonald’s.

Conversely, wealthier segments have thrived amid inflation, benefiting from appreciating asset prices and increased spending power. Nonetheless, recent consumer data suggests widespread struggles. Over the past 60 days, our mortgage brokerage and private lending business have witnessed a surge in requests for traditional and bridge financing, reflecting growing financial strain as the COVID stimulus wanes and inflation persists.

Now, the Fed faces a dilemma. Lowering rates risks exacerbating inflation, yet higher rates strain vulnerable citizens reliant on credit cards, mortgages, and loans. While a rate cut may be delayed until after the election, we’re increasingly optimistic about its likelihood, possibly in a significant manner. We foresee a Fed Funds Rate in the 4%-4.5% range by mid-2025, potentially bolstering the mortgage and housing markets and addressing yield curve inversion. Until then, the real estate sector must weather the storm.

Market Commentary 1/26/2024

US Economy Continues to Impress as Consumer Spending Beats Expectations 

Strong consumer spending and a better-than-expected 4th quarter GDP advocate the soft-landing narrative. The recent PCE inflation report, favored by the Fed, came in as expected with the indication that inflation is cooling. Despite positive economic indicators like a surging stock market, low unemployment, and increased housing activity, there are concerns that the Fed may not lower rates as quickly as some economists suggest. 

Our perspective is that while inflation is cooling, it remains too high when viewed on a 3-year average, which is up over 20%. Wages have not risen at the same pace, leaving consumers with less to spend. Some costs, especially essential expenses, seem to have increased significantly more than 20% when compared to pre-COVID levels. 

There are a few reasons why mortgage rates are showing improvement, and some products have rates below 6.00%. First, with the Fed signaling the end of its hiking cycle, banks can better forecast their cost of funds and price mortgage products along the yield curve. Second, mortgage spreads are tightening, leading to lower rates. Furthermore, with the start of 2024, each bank has new production goals, increasing competition and keeping banks honest on pricing. This is positive news for the housing market and the residential real estate community. 

Turning to national debt and the consumer, the national deficit is over $34 trillion (about $100,000 per person in the US) and is a growing concern. Overspending was once considered a problem for future generations and is now a pressing issue. While there’s no immediate risk of a government default, there’s concern that if bond vigilantes demand higher yields due to perceived risk, bond yields could rise despite the Fed lowering short-term interest rates. While the likelihood of this happening in the short term remains low, it’s worth monitoring. 

Credit card spending remains robust, indicating that consumers are optimistic about the future. However, credit card balances and delinquencies are rising, suggesting that borrowed money is not being repaid as quickly as before. This shift in credit card data, often seen as a high-frequency economic indicator, could be a sign of the economy’s health, with consumers generally in good shape. 

In conversations with various business owners, we observe a mixed economic landscape. Some businesses are thriving, some face challenges, and others remain uncertain about the future. Although the economy appears to be in better shape than expected last year, it remains fragile. Nonetheless, overall business sentiment is more optimistic than the previous year, a benefit to the existing home market while real estate brokers prepare for the busy spring season. 

Market Commentary 1/12/2024

Bond Market Believes Lower Inflation Here To Stay 

For the moment, the bond market is betting on lower interest rates despite a better-than-expected December Jobs report and a hotter-than-forecast CPI print. PPI, or wholesale inflation, helped reinforce the belief that inflation should continue to trend downward, a view we share but with some skepticism. Several hot spots around the world remain and a flair-up of any could adversely affect both the oil and shipping markets, thus creating inflation. For now, that has not happened, but it does remain a concern. Of additional anxiety is the massive Treasury issuance.  This could push interest rates up, but again, for now, the trend is lower rates.  Expectations of lower inflation and increased business confidence have also improved and there is a sense that the Fed may pull off their so-called “soft landing.” We remain cautiously optimistic. Keep a close eye on the coming earnings seasons as a tell to how the economy is performing. More on this in the coming weeks.

The drop in mortgage rates has inspired new applications as activity is picking up across all markets. Also, mortgage prices have benefited from the compression in the spread, which has been unusually high this past year and remains elevated.  Banks seem to be in a better mood as we enter 2024.  All of this is welcomed after a challenging 2023. The combination of Treasury rates under 4% plus tighter margins is leading to some jumbo lenders now offering rates in the 5.500% with banking.       

Market Commentary 1/05/2024

December Jobs Report Keeps Rates Flat

A better-than-expected Jobs Report pushed interest rates above 4% this morning before retreating down. A deeper dive into the Jobs Report suggests the jobs market may be cooling off. With a drop in the participation rate, more temp workers are unable to find jobs and more people accepting part-time work or working fewer hours. Employers remain cautious about firing workers given the difficulty experienced in replacing those workers during COVID and post-COVID. Of additional concern is wage growth, which is still running at 4% plus, a number higher than the Fed would like to see. On Wall Street, some believe the report was good enough to keep the Fed on pause through at least March, perhaps even longer.  

Inflation has cooled on the goods front, but wage and service inflation are still too high. Geopolitical worries abound including the Israel-Palestine conflict, which is starting to create issues with major shipping vessels navigating the Strait of Hormuz, causing a rise in shipping costs and potentially oil prices. The worry here is that one wrong move could spark a regional war which could have unintended consequences, including an oil spike, which could complicate the Fed’s inflation fight.  However, that is an obvious problem so the markets may have already priced in this outcome. One never does know.

We have spoken previously about the path to 5% mortgage rates and we are getting closer. One requirement to reaching this goal is that the mortgage spreads over Treasuries must continue to compress. The Wall Street Journal reported today that this is finally happening, with the expectation that should Treasury rates fall further, the mortgage spread would also follow.

A big reason spreads have been so wide is that banks and investors have been concerned about a drop in interest rates and the refinance risk associated with those drops. With the quick decline from 5% to 4% in the 10-year treasury, lenders are starting to get more competitive on pricing. In addition, another tailwind for real estate brokers and mortgage originators alike is the start of a new year and new volume targets so pricing remains sharp, which has led to much-improved activity to establish the year.

A quick look at programs and types of borrowers

  • High Net worth with banking:                      
    • Rates from 5.250%/6.196% APR. Loan amounts up to $25M
  • Complex high net worth with banking:         
    • Rates from 6.000%/6.488%. Loan amounts to $10M
  • Traditional Jumbo:                                                
    • Rates from 6.000%/6.488%. Loan amounts to $4M
  • No Income Verification Loans:                         
    • Rates from 7.500%/7.603%. Loan amounts up to $2.5M
  • Conforming Loans:                                               
    • Rates from 5.875%/6.032%. Loan amounts up to $1,149,825

Happy New Year!

Market Commentary 12.15.2023

Fed Forecast To Bring Down Rates Pushes Mortgage Rates Lower

The recent dovish pivot by the Federal Reserve, along with projections of up to three rate cuts next year, brought a sigh of relief to the markets. Equities, bonds, gold, and oil, all rallied in response. This shift by the Fed signaled a so-called “soft-landing” narrative. Inflation data has been pointing toward lower inflation as the economy continues to move forward with weak manufacturing data, but a strong service sector.

Mortgage rates also saw a significant drop, with 30-year mortgages now below 6.50%, and adjustable-rate mortgages anticipated to dip below 6%. This is a remarkable change from just a few weeks ago when mortgage products were touching 8%. Let’s delve into the reasons behind this sudden change of heart by the Fed and the markets.

Inflation Trends

Consumer and producer inflation data have been showing positive trends for quite some time. With inflation on the decline, the Fed Funds Rate, currently at 5.37%, stands well above the inflation rate (CPI) of 3.1%. This significant spread is viewed as restrictive, and now the Fed must consider if keeping rates higher for an extended period might do more harm than good. Additionally, signs of a slowing economy are emerging, which further supports the case for lowering interest rates.

Inverted Yield Curve

The yield curve has been inverted for an extended period, and the Fed would like to see it normalize. This normalization would benefit lenders who borrow short and lend long. When long-term interest rates are lower than short-term interest rates, it becomes challenging for lenders to generate profits due to the negative spread. A robust economy requires lenders willing to extend credit. Moreover, the massive US debt and the costs associated with servicing that debt become unsustainable at higher interest rates.

Quantitative Tightening (QT)

The ongoing QT (Quantitative Tightening) may provide the Fed with some flexibility to lower short-term interest rates and allow bonds to run off their balance sheet. Over the past decade, global central banks’ money printing and bond buying have led to enduring issues, as the cost of money became distorted. By lowering the Fed Funds Rate while continuing QT, the Fed remains somewhat restrictive but with a bit less tightening.

Nonetheless, we still anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. When you add a term premium of 1% to 1.5%, that’s where the 10-year Treasury should find its equilibrium.

10 Year Treasury & Employment

As previously stated, we continue to anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. Employment remains tight and wages appear to be sticky (and possibly rising again) which will continue to be monitored by the Fed. This could inhibit interest rates from going much lower than current levels.

For the moment, we will take the late-year gift from the Fed of the prospect of lower interest rates which is leading to a big pickup in borrower inquiries.

Market Commentary 12.8.2023

A Quick Read On Rates, Jobs And Housing

A better-than-expected November Jobs Report took some shine off the recent rally in bonds, which had been surging over the past few weeks. The report was positive, but not great, although it did surprise Wall Street as both new hires and unemployment beat economists’ estimates. Something that is of particular concern and a focus of the Federal Reserve is the slight acceleration in wage growth, adding to some uncertainty about when the Fed might change its stance. The direction of interest rates from here is anyone’s guess, but the stronger-than-expected jobs data likely keeps the Fed in the “higher for longer” camp, at least in our opinion.

Anecdotal evidence suggests that the economy might be slowing, based on reports from local business owners. However, this has yet to translate into jobs data or consumer spending. Inflation, while still at elevated levels, seems to be moderating. Nonetheless, high credit card balances, rising delinquencies, and the overall high cost of debt are indications that consumers are feeling some pressure. Despite these concerns, GDP and other economic indicators still point to the economy being in reasonably good shape. Overall, the prediction suggests that the path ahead is challenging.

Turning to the housing market, activity in the existing home market, particularly in Southern California, appears to be picking up. Interest rates have fallen to under 7%, and some well-qualified borrowers are securing rates as low as 5.875%. This has prompted buyers to reenter the market, taking advantage of small price reductions and more reasonable interest rates. Large-scale home builders are employing various strategies to attract buyers, including helping first-time home buyers qualify for mortgages. Although construction loans from banks remain subdued, the private lending market is bustling, offering more expensive financing with greater leverage, something most developers need to initiate projects.

While there has been a downward trend in interest rates, it’s important to note that we may have reached a bottom, at least for now. A few additional thoughts on this matter; first, the Bank of Japan is likely to move away from its negative interest rate policy, which could exert pressure on bonds worldwide. Second, assuming a 3% inflation rate and real economic growth of 1.5%, the 10-year Treasury rate could stabilize around 4.5%, give or take 0.5%. Finally, it’s worth mentioning that historical interest rates have averaged significantly higher than current rates. While the recent rate increases have caused discomfort, part of the pain is due to the steepness of the rate hikes and the extended period during which rates were held at arguably too low levels. Looking ahead, if the spread over treasuries narrows, it’s conceivable that mortgage rates could range from the high 4s to the mid-5s in 2024, potentially providing significant support to the real estate market.

Market Commentary 12/01/2023

Both Bonds & Stocks Rally Into December

November marked an exceptional month for both bonds and equities. Just a few weeks ago, interest rates surged above 5% and sent mortgage markets into a frenzy. Fast forward to today, and we’re witnessing the 10-year Treasury hovering around 4.25%. In addition, lenders are beginning to reduce interest rates. If this trend persists (we discussed this in previous commentaries) mortgage rates in the mid-5% range could become a reality. This is expected to entice buyers who have been sitting on the sidelines, as more affordable mortgage payments beckon.

Having said that, it’s essential to consider the reasons behind this decline in rates. One perspective is that the market anticipates the Fed will lower short-term interest rates next year as inflation subsides. While there’s cautiousness surrounding inflation, given its deep-seated presence in the economy, the consensus leans toward a more extended timeline to control it. Nevertheless, dovish Fed statements, coupled with moderating inflation data, have relaxed financial conditions as evidenced in the lower interest rates and now flourishing stock market. While there’s optimism that the Fed will engineer a soft landing, reflecting Wall Street’s current sentiment, the recent rally underscores the market’s exuberance. Our concerns are centered around the possibility of eased financial conditions rekindling inflation.

Another narrative suggests that interest rates are declining as bond traders assess the broader economy, indicating an economic slowdown. Assuming a 3% inflation rate and 1.5% GDP growth, a 10-year Treasury around 4.5% appears plausible. For now, the downward rate movement should be acknowledged and leveraged, given that borrowing costs have decreased by 0.50 to 0.75 basis points across the board. This is a significant development.

This year, regions primarily driven by the existing homes market like Southern California have faced challenges. Recently there has been a significant uptick in activity over the past few weeks, encompassing refinance, purchase, and construction loan requests. The drop in interest rates is fostering momentum, and we are encouraged by the resurgence of inquiries. After a challenging year, it’s heartening to hear the phones ringing again. To hear borrowers express enthusiasm about the prospect of interest rates stabilizing at acceptable levels. A welcome development timed for the holiday season. 

Market Commentary 11/17/2023

Mortgage Rates Ease as Inflation Data Arrives Better Than Expected 

Interest rates continue to settle around 4.500% on the 10-year Treasury, with emerging signs of easing inflation and potentially achieving a soft landing for the economy (meaning no recession or a mild one).  Having observed the markets for a considerable time and recalling the challenges the Fed faced wrangling inflation in the 1970s and 1980s, we maintain a cautious stance. We believe the Fed will keep rates higher for an extended period, even though they are likely done with rate hikes for now. 

We are closely monitoring Treasury issuance, given that the US debt load exceeds a concerning $33 trillion. Managing this massive debt ultimately depends on the reduction of interest rates over time. Hence, it is imperative for the Fed to navigate the inflation challenge skillfully. Should they ease too early, there’s the risk of rapid inflation, necessitating rate hikes and possibly the destabilizing of the global economy. Conversely, tightening too much could squeeze businesses and banks, possibly harming the economy unnecessarily. 

The recent drop in interest rates is a welcome development. As we previously mentioned, there’s a chance for adjustable-rate mortgages on residential real estate to settle below 6%. Such a move would be highly beneficial for housing and commercial real estate. With the recent rate decline, our office has witnessed an uptick in larger purchases as buyers cautiously re-enter the market. While underwriting remains challenging, some lenders are making sensible decisions for well-qualified borrowers. Additionally, smaller banks, in their quest for loan volume, are willing to forgo income documentation for borrowers with strong credit, at least 40% home equity, and a willingness to deposit funds with their bank. 

Housing, however, continues to face challenges. Homebuilder sentiment dipped when mortgage rates briefly touched 8%. Housing starts remain sluggish as construction lenders remain cautious and concerned about construction costs as well as affordability. We’re also detecting a broader economic slowdown, influenced by higher interest rates and a 30% surge in most goods prices over the past few years, just as pandemic stimulus funding tapers off. Nonetheless, low unemployment and the resilience of the US economy should not be underestimated.