Tag: inflation

Market Commentary 9/8/2023

Posted on by Damon Germanides

Has Inflation Peaked? Bond Market Yields Suggest Uncertainty… 

Where Does Inflation Go from Here? 

A peak in service inflation may be on the horizon. A noteworthy example is Walmart, one of the nation’s largest employers, which recently announced that new hires will be earning less. This adjustment signifies a potential slowdown in wage inflation, which had surged to unsustainable levels due to the pandemic, supply chain bottlenecks, and substantial government stimulus. Initially encouraged by the Fed, this wave of inflation is unlike anything witnessed in the past 40 years and was largely due to the assumption that inflation would be transitory. 

While we are witnessing some moderation in inflation concerning goods (though still too high by our standards), service inflation remains persistently elevated. This is placing significant strain on businesses of all sizes, as consumers are becoming less tolerant of higher-priced goods and services. This is why the Fed is not rushing to lower interest rates.  

The situation becomes increasingly complex when we consider why interest rates remain high despite indications that inflation might be cooling off. Two key factors come into play. Firstly, the price of oil, hovering around $90 per barrel, is preventing a more significant drop in inflation. Although the Consumer Price Index (CPI) has declined from over 9% to roughly 3.2%, moving from 3.2% to 2% will be a lengthy process for the Fed. Secondly, the massive budget deficits of many developed nations are no longer being disregarded by bond traders (this includes the United States). Our government’s debt burden has led bond buyers to demand higher yields to compensate for the perceived risks associated with holding such bonds. 

Lastly, it is important to recognize that interest rate cycles are lengthy, whether on the ascent or descent. We are currently on an upward trend. Unless significant adverse events occur, this trajectory is likely to persist.  Assuming a 3% long-term inflation rate, it is not inconceivable that longer-dated bonds trade between 4% -5%.   

In the Next Two Weeks… 

Keep a close watch on next week’s inflation readings and the subsequent week’s Federal Open Market Committee meeting. In the current climate, everything revolves around inflation and interest rates. Additionally, pay attention to the 10-year Treasury bond, which is teetering at the 4.25% mark. If it breaches 4.35%, the markets could face a challenging remainder of the year. 

Market Commentary 9/1/2023 

Posted on by Damon Germanides

Bonds Can’t Catch A Break Amidst Unemployment Rate Increase 

The July Jobs Report brought encouraging signals for both the bond market and the Fed. However, the workforce saw an influx of more workers than could be absorbed, resulting in the unemployment rate rising from 3.50% to 3.80%. While wages are still growing, they are beginning to moderate and show signs of trending lower. This shift might provide the Fed with justification to hold off raising rates at its next meeting. Although the futures market indicates around a 40% chance of a November rate hike, we anticipate that this might mark the last rate increase of the cycle (if it does occur). On the other hand, mortgage bonds and Treasury yields oddly increased, potentially influenced by a weakening dollar and surging oil prices. 

Nonetheless, it’s important to avoid drawing broad conclusions from a single report. Commodity price inflation and service inflation remain high, and the Fed would likely want to see more substantial declines in these numbers. Conversations with local business owners reveal that input costs are eroding profits. Passing these increases on to customers is becoming increasingly challenging. The persistent difficulty business owners have in finding staff is keeping wages elevated. Notably, a major national retailer catering to lower to middle-income consumers, Dollar General, has reported that its customers are feeling financial pressure and adjusting their purchasing habits. This demographic has been hit hardest by elevated prices and could be a significant concern for the Fed. This context supports our belief that even if the Fed stops raising rates, a downward shift in interest rates might be a prolonged journey. Fed Funds rates could remain potentially elevated well into 2024 or even 2025. 

Loan Success Takes Grit 

Navigating the mortgage landscape is no longer a straightforward endeavor. While we maintain access to excellent products and lenders and are successfully closing loans, the path can be turbulent. Underwriting guidelines at banks are tightening, debt funds and mortgage banks are grappling with an illiquid secondary market, and limited housing supply in major cities complicates loan qualification. Financing costs have surged while housing prices have remained stagnant, particularly affecting higher-end home purchases. In this landscape, experienced mortgage brokers are proving invaluable by sourcing better-priced loan options, exploring more nuanced alternatives like interest-only or investment property loans, and connecting with smaller banks that embrace innovative thinking. Our broker team at Insignia Mortgage, for instance, achieved over $40 million in closings in July, while our fix-and-flip and bridge lending arm, Insignia Capital Corp, closed over $12 million in business. It was far from effortless. What matters most is that all our clients successfully completed their crucial transactions. 

Market Commentary 8/11/2023

Posted on by Damon Germanides

Rates Can’t Catch A Break  

Although the Fed is making progress in the battle against inflation, a tougher phase awaits in substantially curbing inflation due to the so-called base effects. The forecast for tougher times cemented itself after surpassing last June’s 9 percent plus CPI reading. Some experts on Wall Street anticipate that inflation readings for August may climb higher since July witnessed significant hikes in oil, gas, and other commodity prices. While service and wage inflation has shown moderation, their persistence coupled with recent wholesale inflation figures indicates a larger-than-anticipated rise. Our stance remains that the Fed will not be lowering rates anytime soon, considering the daily struggle of America’s most vulnerable to cope with rising costs. 

The combination of stubborn inflation and a budget deficit of more than 1 trillion dollars puts pressure on US Treasuries and government-guaranteed mortgage debt. Concerned voices are clamoring in response to the size of our debt and its long-term sustainability. Global issues further complicate the US Bond market with Japan’s loosening yield curve control, China and Europe’s economic dilemmas, and the ongoing conflict in Ukraine. Investors are demanding higher yields, a phenomenon reflected in the 10-year Treasury comfortably crossing the 4.00% mark, with longer-term bonds nearing 4.500%. The point at which these elevated yields begin impacting the equity and housing markets is uncertain. However, it is increasingly likely that both sectors will be negatively affected by rising rates. 

We recently emphasized the significance of the Fitch downgrade of the US credit to AA+. Although Wall Street didn’t fully grasp the implications of this situation, the narrative has evolved. Unlike 2011, this downgrade reflects much higher debt/GDP ratios, unsustainable budget deficits, and a more dysfunctional US political system. Whenever the cost of capital is negatively influenced, it deserves serious consideration. 

From our network of banks and lenders, we’re hearing signals that the long and variable impacts of Fed policy are starting to reverberate through the system. Delinquencies and loan modifications on commercial loans are on the rise. Businesses are facing squeezed revenue and operating margins. Credit card balances are soaring. These effects warrant careful observation in the upcoming months. 

Our broker team invests significant time in discovering new lenders, many of whom remain unfamiliar with the market. It might sound biased, but having a robust mortgage broker on your side is crucial in today’s landscape. Transactions are encountering a myriad of issues, and the ability to swiftly pivot to a new lender or solve a problem is invaluable. The Insignia Mortgage broker team excels in both these domains, while also securing the most competitive rates and terms for complex loans. The days of relying solely on one big bank for client loans are long gone. 

During our recent attendance at the Inman conference in Las Vegas, NV, we gathered intriguing insights from various speakers about the market’s current state: 

  • Quicken Loans anticipates improvements in the rate market in the coming months. The drop in mortgage brokers, real estate brokers, and salespersons signifies the existing home market remains somewhat stagnant. While it presents challenges, it could pave the way for those who navigate it successfully. 
  • Traditionally, existing home sales constituted a major portion of the market, but current homeowners are reluctant to move. However, around 25% are planning to relocate within the next few years, aligning with Quicken’s recommendation to persevere. 
  • Zillow predicts that rates will remain high for longer than Wall Street anticipates. Service inflation and housing shortages contribute to inflation, and the focal point for home buyers should be millennials, who are expected to make up 43% of new home buyers. 
  • The mortgage and real estate industry must adapt to AI (Artificial Intelligence), incorporating it into lead generation and follow-up strategies. With AI we can achieve more with less. The challenge lies in how effectively we embrace it. While 20% will seize the opportunity, the remaining 80% might miss out. Those who embrace AI stand to gain efficiency and profitability. 

Market Commentary 8/5/2023

Posted on by Damon Germanides

Bonds & Equities Shaken By Fitch Downgrade Of US Credit

This week was filled with noteworthy economic developments. The bond market experienced significant fluctuations following Fitch’s downgrade of the US credit rating from AAA to AA. The latest July Jobs Report, though weaker than expected, provided some relief to the bond market (which experienced a notable climb earlier in the week). Nonetheless, persistent wage growth and a tight job market continue to challenge the Federal Reserve. As a result, inflation remains a concern at the forefront.

Amidst these developments, other factors are contributing to inflationary pressures. These factors include rising commodity prices, geopolitical tensions, and potential labor strikes. While the immediate impact of the Fitch downgrade may be limited, it serves as a vital reminder that addressing long-term spending issues is important for our nation’s prosperity.

The Future Of Rates & The Impact Of Inflation

The path of interest rates remains uncertain. Some potential scenarios range from further rate hikes due to wage inflation to a soft-landing recession narrative. All outcomes necessitate careful navigation of the Fed’s interest rate and QT policies. While we observe signs of falling inflation, wage inflation persists, leaving room for at least one more potential rate hike (if not two) in the future.

On the other hand, the consequences of the Fed’s substantial rate hikes over the past year and QT policies are gradually seeping into the financial system. As interest rates rise, lenders are tightening their loan offerings. Narrowing such loan options could impact economic growth in the coming months. Even so, it is worth noting that the American consumer has demonstrated remarkable resilience, readily accepting higher interest rates and loan payments.

The normalization of mortgage rates on a historical basis is apparent, but when combined with soaring home prices, the overall cost feels steep. As a result, the existing home sale market has experienced a slowdown in activity. At the same time, some market segments have witnessed odd price increases due to a lack of available housing supply. Despite these challenges, the adaptability of consumers underscores their ability to weather economic fluctuations.

Market Commentary 7/21/2023

Posted on by Damon Germanides

Markets Party On As Risk Appetite Grows Amidst Discounting Higher Rates

The investment landscape remains complex, as it has always been. With the constant influx of daily reports and updates, it’s easy to be distracted by market movements and opinions. In the equity markets, big tech companies have led to significant gains for some investors. Conversely,  a more balanced approach has yielded only moderate returns or worse for others. The risk-on trading sentiment seems to be prevailing, even as interest rates rise and the Fed indicates a prolonged period of higher rates.

In the housing market, although new home builders are thriving, existing home sales face challenges in major cities due to limited inventory.  As many banks pull out of the mortgage market and layoffs have become more common, the mortgage world shows it is not immune to its share of challenges. Smaller banks and credit unions step in to fill the gap, providing opportunities for boutique firms like ours to match borrowers with lenders who prioritize community growth, common-sense underwriting, and personalized service.

New Standards On The Horizon: Inflation, Debt, & Consumer Spending

Equities surge and multiple offers continue to be prevalent in the more affordable section of the housing market. We can’t ignore the broader economic concerns of these behaviors becoming almost the standard as they relate to the inflation fight. Unemployment remains ultra-low and the employment pool tight, commodity prices are on the rise, the 2-year Treasury rate is nearing 5%, and consumers continue to spend (even if by way of debt). It is hard to model how the massive Covid-related money spray and multiple Government stimulus programs will affect inflation. However, there is a greater than zero probability that inflation readings show signs of acceleration come the fall. This may be one reason the Fed is expected to raise rates next week and possibly again in September.

While the markets and consumers seem comfortable with the Fed’s rate hikes, we remain cautious. Powell’s warnings about potential pain may not have materialized yet, but we believe it’s essential to monitor the situation closely.

Market Commentary 7/14/2023

Posted on by Damon Germanides

Mortgage Rates Rally On Cooling Inflation Readings

The latest CPI data indicates that inflation appears to be moving in a favorable direction. The Producer Price Index (PPI) also experienced a decline, which was well received by both the bond and equity markets (PPI measures production costs). Although another 25 basis point rate hike in July is widely anticipated, further increases in the near term seem unlikely. Nonetheless, given the persistent nature of current inflationary pressures, there is concern that a thriving equity market could spur increased spending… Which would potentially lead to a resurgence in inflation. It is worth noting that speculative areas of the equity market, such as Crypto and AI, have performed exceptionally well. Such positive performance suggests the Fed may believe more action is necessary to curb inflation. While higher rates may not be imminent, it is our belief that the Fed will maintain higher interest rates for an extended period, considering that equities have nearly recovered most of the losses incurred in 2022. Additionally, we expect the Fed to continue with quantitative tightening until a significant crisis emerges.

JP Morgan’s better-than-expected outlook for the second quarter has set the tone for earnings season. Wells Fargo, among other banks, also reported earnings and increased loan loss reserves for its commercial portfolio. In the coming weeks, we predict more write-downs of office loans from regional banks, given their significant exposure to commercial office loans. A 2008 redo appears unlikely even as some parts of the commercial real estate market experience growing stresses.

There is a noticeable uptick in purchase money loan activity, potentially driven by added inventory within certain areas. This observation is based on local market assessment, including discussions with realtors, monitoring real estate websites such as Zillow and the MLS, and the presence of more “for sale” signs in the neighborhood. Pre-approval activity is escalating, with a majority of pre-approvals falling within the $1 million to $3 million price range. In terms of refinances, we are seeing a growing number of requests. The majority of these refinance requests are coming from self-employed borrowers who aim to consolidate higher-interest business debt, credit card debt, or commercial debt through a home loan refinance.

Market Commentary 7/7/2023

Posted on by Damon Germanides

Yields Rise As Strong Wages All But Ensure Fed Rate Hike

The ADP report this Thursday marked a significant week for the bond market, as both Treasury and Mortgage rates exhibited a notable increase. Fortunately, Friday’s employment report met expectations, easing some pressure on bonds. The probability of the Fed raising rates later this month is now nearly 100%, with elevated wage inflation and the strong job market. In addition, bond traders are realizing that interest rates will remain high for an extended period, due to persistent global inflation and forecasts of potential interest rate hikes in other countries (like the UK).

Some argue for the Fed to exercise patience and assess the long-term effects of their rate hikes on the US consumer and the economy. Despite this pushback, there are signs that the rate increases are making an impact. Banks are becoming more cautious with their underwriting box, consumers are exercising caution in their purchases, manufacturing data is declining, and credit card balances are rising as stimulus funds dwindle. One might wonder where we would be if the AI investment theme didn’t re-ignite animal spirits. Additionally, large apartment investment firms are facing challenges as floating rate debt reaches a tipping point, where monthly interest expenses exceed property cash flow. The pain of higher interest rates is gradually spreading beyond the office sector to other real estate asset classes.

An illustrative example demonstrates the risks of buying at very low cap rates:

  • 2021 Investment Environment Net Operating Income: $100,000 Cap Rate: 3.75% Value: $2,667,666
  • 2023 Investment Environment Net Operating Income: $100,000 Cap Rate: 5.75% Value: $1,739,130

This example equates to a loss of almost 35% on the property due to the movement in cap rates. While we don’t anticipate a systemic crisis in commercial real estate, buyers who relied on aggressive assumptions and maximum leverage may face difficulties ahead.

Rate Hikes & Real Estate: What’s Next?

Higher interest rates are influencing the existing housing market, resulting in continually elevated home prices, despite interest rates returning to 7%. This situation may limit what potential buyers can afford. Furthermore, the potential for an increase in housing supply seems plausible if equity markets reverse course in response to ongoing Fed rate hikes. Sellers may choose to sell their homes while existing home market inventory remains tight, rather than waiting for a recession or other negative events. Notably, the Southern California superluxury market is experiencing a swell in inventory as ultra-wealthy individuals are less inclined to expand their home portfolios. It will be intriguing to observe what factors will entice these buyers back into the market. Only time will reveal the answer.

Market Commentary 6/30/2023

Posted on by Damon Germanides

Equity Markets Dismiss Central Banks’ Inflation Concerns

The resilience shown by the equity markets and the US economy has surprised many, us included. While we have previously expressed concerns about a possible recession, the economy continues to strengthen. Most forecasters have interpreted the upward revisions to GDP, a tight labor market, and a stabilizing housing market as a sign of two more rate hikes to be added by the Fed. This prediction comes amidst rising worries over the economy picking up the pace again. The latest PCE report has indicated a slowdown in overall inflation. Nonetheless, the report still highlighted persistent service inflation at 4.6%, supporting recent comments from the Fed about the need for higher interest rates in the long run.

A Case For Higher Rates

Real estate investors typically focus on interest rates, construction costs, and cap rates. On the other hand, the equity market is a key indicator of consumer sentiment, risk appetite, and innovation. The recent surges in the tech-heavy Nasdaq index should drive increased demand for home purchases and renovations. Individuals who have seen their equity holdings rebound may be more inclined to invest in a larger and better home. Despite the cooling of the spring buying season, we are witnessing a rise in pre-approvals for new homebuyers. These buyers are willing to accept higher interest rates in a tight existing homes market, likely due to an increase in their financial assets. This so-called wealth effect is what the Fed is trying to curb, but even with substantial rate hikes, its impact has yet to materialize fully. Consequently, we believe that the Fed may veritably raise rates further, with a 6% Fed Funds rate not outside the realm of possibility.

A Case For Lower Rates

Conversely, an argument can be made for maintaining rates at current levels. With consumer spending slowing down, as stimulus measures wind down, and as lenders become more cautious in their underwriting criteria. Each day, higher interest rates have an impact on real estate investors, business owners, and borrowers, as the cost of financing all types of debt has significantly increased. While goods inflation has declined, service inflation may follow suit. Rental prices are also dropping. While the equity markets have experienced a rally, most gains are attributable to a handful of large technology companies. Excluding these companies would leave the overall market relatively flat. Additionally, the 2-10 spread, a measure of the yield curve, is significantly inverted by over 100 basis points. Such inversion is generally seen as a concerning sign and may indicate that financial markets are already facing significant constraints.

Market Commentary 6/23/2023

Posted on by Damon Germanides

Rates Fall As Economy Shows Signs Of Slowing

I wanted to share an observation with you regarding the recent rate hike journey initiated by the Federal Reserve. Over the past few weeks, Insignia Mortgage has witnessed a significant upsurge in inquiries for cash-out refinances, bridge loans, and second mortgages. Borrowers are seeking these solutions to address higher interest-rate debt or growing financial obligations. We attribute this rise in inquiries to borrowers experiencing loan adjustments from increased interest carry, coupled with the Fed’s hints of higher rates for a longer duration.

Bank underwriting remains stringent for best rate execution, as evident from the latest senior loan officer survey. The impact of these tightening lending conditions on the residential and commercial real estate markets is yet to fully unfold. So far, the housing sector has shown resilience, while the commercial office market faces more challenges. Looking ahead, we anticipate an intriguing landscape in 2023 and the first half of 2024. Higher interest rates will likely necessitate price adjustments to accommodate the increased cost of capital for leveraged property acquisitions.

The Lending Pool Outlook

While some lenders strive to keep interest rates at 6.000% or below, we acknowledge that the pool of lenders offering moderate rates and flexible underwriting continues to shrink. However, at Insignia Mortgage, we remain committed to diligently exploring the market and identifying lenders capable of closing transactions efficiently. We are seeing a big uptick in the non-QM space as borrowers struggle to qualify for a loan. These non-QM programs are helping as they are less strictly underwritten, but carry a higher rate for the commiserate risk.

Market Commentary 6.9.2023

Posted on by Damon Germanides

Markets In Rally Mode Heading Into Fed Week

Various markets are displaying unpredictable behavior as the US financial landscape presents challenges. Despite concerns expressed by many public companies regarding earning growth, inflation, and increased capital costs, several AI-focused tech giants have propelled equities back into a bull market. Residential real estate, too, remains resilient. Despite higher mortgage rates, housing stocks are near all-time highs and prices are holding steady in most market segments.

While leading economic indicators and sentiment readings suggest a potential recession, employment data continues to surpass expectations. The most recent weekly unemployment figures were higher than anticipated. Credit conditions remain tight, with further tightening observed. Currently, default rates remain relatively low, primarily concentrated in commercial office spaces to date. The likelihood of a soft landing in the economy has improved. The recent substantial equity rally prompts speculation about the potential for a different outcome this time despite the memories of significant market downturns (the 2000 tech bubble and the 2008 financial crisis) still resonating among older generations.

Looking Ahead: Inflation & Rate Hikes

The upcoming Federal Reserve meeting carries significant weight as investors eagerly anticipate insights from Chairman Powell and the committee. The consensus points to a hawkish pause in rate hikes, with another potential increase in July. That being said, recent equity market strength and surprise rate hikes in countries like Australia and Canada suggest that a 0.25 basis point hike in June cannot be entirely ruled out. The release of important inflation reports early next week may further influence the committee’s decision, especially if it reveals a higher-than-expected inflationary environment.