Market Commentary 12/2/2022

Market Left In Speculation Re: Fed’s Next Move Amidst Stronger Than Expected Jobs Report

It was a very good week for stocks and bonds. Over the last couple of weeks, interest rates have been drifting lower (under 6%), bringing more borrowers to our local real estate markets. However, the better-than-expected jobs report will keep pressure on the Fed to continue its path of higher interest rates. Let me be clear, the rate of increase in interest rate will moderate. But for those who think interest rates are coming right back down, this Jobs Report should put those thoughts to rest in the near term. The reason is that wage growth remains strong and well above previous forecasts. Since employee wages make up for most companies’ largest expense, wage growth places great pressure on businesses to continue raising prices. While the Fed would like to see wage growth in the 2% to 3% range, today’s number of 5.60% was too high. Inflation can only come down so much with wages growing at this clip.  Additionally, with unemployment still under 4.00%, we anticipate another 50 bp increase in the Fed Funds rate when the committee meets later in the month.   

Some good news on the mortgage front.  Fannie/Freddie has now opened up their home loans to over $1 million in high-cost areas. This will help those borrowers looking to purchase in markets that may not have the perfect profile for a balance sheet lender. Fannie/Freddie tends to be less restrictive on post-closing reserves and credit at higher loan-to-values.  Also, as lenders adjust to the higher interest rates, we are beginning to see credit officers at local banks and credit unions approve exceptions with more regularity. A good sign for sure. 

Market Commentary 11/18/2022

Mortgage Rates Continue To Fall In Uncertain World

Over the past several decades, the inverted yield curve has been a tried-and-true recession predictor. With some parts of the year yield at historically wide inversions, financial conditions are becoming too tight. This indicates a strong likelihood that the economy is slowly marching toward a recession. However, there is evidence to the flip side of this argument, including consistently strong employment data, decent capital spending by companies, and a rebounding stock market.

Housing has been hit pretty hard by the 4 super-sized rate hikes by the Fed, with more upset on the horizon with the additional hikes anticipated in December and early next year. The terminal rate should cross 5.00%. Some Fed officials have opined the need to go much higher to stomp out inflation.  A recent Fed study on housing speaks of the potential for a 20% adjustment to prices in specific markets.  Speaking to our market, prices will continue to come down, but the lack of inventory will set a floor for how low prices can go. As long as California continues to be a robust and diversified economy, wealth creation, weather, and opportunity will support prices better than some other parts of the country. Nevertheless, affordable housing remains a big problem on a national level, and the Fed will want to see housing prices fall. Such a decline won’t be as severe in the more undersupplied and desirable areas.

Important Update On Mortgage Products

Insignia Mortgage has located a few portfolio lenders willing to offer very sharp pencils on non-traditional loan products. These non-QM products rely on post-closing reserves more than income analysis.  Loan amounts go up to several million with a 30% down payment. Interest rates begin at 5.00% or so. We share this info because these types of products are crucial for the high-end markets, especially with the move in interest rates. Borrowers are struggling to qualify for loans due to the rapid rise in rates, and the fact that interest-only loans require an additional stress test, making it difficult for well-qualified borrowers to obtain financing. 

Market Commentary 11/04/2022

Fed Raises Yet Again As US Employment Data Substantiates Further Hikes

Markets were in rally mode Friday at the heels of another solid employment report. There have been some signs that wage inflation is moderating. One never quite knows how the market will react to an important economic report, but one thing for certain is the mood was sour heading into Friday’s number. This is especially true after Fed Chairman Jerome Powell’s hawkish bent earlier in the week. Interest rates will need to be higher for longer to combat a stubborn inflation problem. The Fed raised short-term interest rates by .75 basis points for the 4th time in a row. We now see the terminal rate between 5% and 5.50% which will be achieved by the middle of next year. 

Financing Around Inflation

Financing costs, including those for autos, homes, and commercial real estate, have moved up. Who could have imagined a 30-year fixed rate mortgage would be over 7% this year, after beginning the year in the low 3% range (jumbo rates are lower).  With the surge in rates, interest-only loan options are the product of choice in high-priced areas. This product can help offset out-of-pocket financing costs, although the payment does not reduce the principal balance. Unless prices drift lower, this product is one way to manage housing expenses with the hope that interest rates move lower over time. 

Market Commentary 10/28/2022

Markets Anticipate More Dovish Fed Commentary Next Week

The combination of a strong GDP report, the 10-year Treasury bond decreasing from 4.300% to 4.000%, and the signs inflation may be leveling off (albeit slowly) served as tailwinds for the equity markets.  The result is another winning week. Risk-taking has been reignited, with the “fear of missing out” pushing stocks up, even amidst the multiple headwinds circling the economy. We’re hopeful these animal spirits make their way into the real estate and lending markets. The dramatic rise in interest rates will likely keep investors waiting for either a further reduction in real estate prices or a bigger drop in interest rates. Banks remain both cautious and passive in pricing loans, given that risk-free rates will be near 4.000% next week. 

We anticipate next week to be momentous with the Fed meeting mid-week and the release of the October employment report on Friday.  The probability of .75 basis point increase in Fed Fund rates is over 80% and is the most likely outcome when the Fed convenes. The rip higher in the equities market as well as persistent inflation combined with less than awful corporate earnings will justify the Fed’s continued hike on rates. It is important to remember that the Fed will be moving the Fed Funds Rate up by yet another .75 basis points soon, and these are dramatic moves. The impact of these moves will not be immediate. It takes time for these rate hikes to make their way into the real economy. Experts believe the lag effect of these hikes is around 6 months.  Financing costs for consumers and business owners have surged this year, from credit card financing charges to mortgage and auto payments, as well as business and corporate loans. The higher cost of financing will hurt demand as these costs are absorbed.  Many fear that the Fed’s medicine of swiftly raising rates to cool inflation is worse than just living with inflation. We believe the Fed is correct in addressing the inflation problem, but that their pivot from inflation is transitory. Destroying demand through higher rates is a dangerous prescription and could lead to a financial accident.    

Getting a read on interest rates is perplexing. Inflation is still way too high. The Fed’s preferred gauge of recession probability, the inversion of the 3-month to 10-year Treasury, inverted recently.  This supports the notion the Fed has tightened enough and should take a wait-and-see viewpoint. I am certain real estate brokers and mortgage professionals would welcome a break from what has been a formidable marketplace.

Market Commentary 9/30/2022

Mortgage Rates Ease As Economy Shows Signs of Slowdown

Market pain remains the theme. There are simply too many variables to consider for anyone to know what is going to happen in the economy. The UK shocked markets this week when conflicting policy decisions by different parts of the government caused bonds to soar. In addition, the Pound plunged and pension funds cried for help as their treasury positions got smoked. Losses from the UK pensions were magnified due to leverage. Back here in the US, still the best place to invest by far, markets remain rocky. The bond market is back in charge of the direction of equities, real estate, and all other asset classes. Want to see where the world is headed? Continue to watch the 10-year Treasury for a sign. Should it move above 4.000%, there is the expectation pain for the markets will be even more exacerbated. Hopefully, it can find some footing under 3.500%- 3.750%. This would help bring the fear premium out of mortgage and other debt markets. While financing costs remain high, it does not benefit the economy for activity to crawl to a halt. As historical events like the Great Financial Crisis of 2008 and Covid 2020 have shown, it is hard to restart the economic machine once it’s stopped.

Has Inflation Reached Its Peak?    

The Fed’s favorite inflation gauge, the PCE, came in hotter than expected yet again.  However, markets shrugged off this bad news as bonds and equities early on in the trading session, but markets fell apart in the afternoon. This may be a sign that we have reached peak inflation as this report did not cause the market to panic. Our internal conversations with clients support the notion that the economy is slowing. Business owners are starting to hunker down, retail sales of luxury items are slowing (a sign that even the rich are beginning to worry),  restaurants seem much less busy and the residential and commercial real estate markets are materially slower. 

With negativity at 2008 levels across financial markets, perhaps we are nearing the end of the damage to the economy and markets. It is hard to tell, but valuations have certainly come in. A reasonable bottom in the S&P may be approaching (3,200 – 3,400). The Fed will continue to tighten, but, the pace with which they have gone so far may justify a pause or slow down to .25 -.50 bp increases over the coming year-end meetings. This column previously advocated rate hikes and was not excited about ongoing stimulus or other money giveaways, all of which are of course inflationary.  However, the Fed message is clear now, and doing too much too quickly to combat inflation may unnecessarily damage the fragile global financial system.  We think the Fed, like us, is seeing the economy weaken and confidence deteriorate to the point that inflation will subside.    

Market Commentary 9/23/2022

Markets In Turmoil As Fed Raises Rates Yet Again

It was another brutal week for the equity and bond markets. Fed Chairman Powell reiterated his belief that pain is necessary in order to bring down inflation. The Fed raised by 75 bp and emphasized that more hikes are ahead. Chances are very high of a global recession. Bank CEOs are talking about stagflation, or a combination of slow growth, high unemployment, and rising rates. The volatile gyrations in the equity market make us wonder when something will break. Fear is high as it feels as if we are paying back all of the stimulus and easy money policies we’ve had over the last few years… With interest. 

If you listened to the talking heads, you would think there is no loan activity.  While the rapid rise in rates has slowed the pace of activity, there are still transactions happening at the right price. With the rise in interest rates, it is harder to qualify for a mortgage. This will continue to put pressure on housing prices.

Famed bond investor Jeffrey Gundlach spoke after the Fed’s meeting this Wednesday and made some good points.  He sees the S&P bottoming somewhere between 3,500 and 3,000. He is also noticing some very compelling bond opportunities. In particular, he advised that you should never time the bottom. As the market washes out, you should not sell, but look to accumulate for the long term. This same formula applies to real estate investing. Become more opportunistic while there is panic in the air. 

Market Commentary 9/16/2022

All Eyes On Fed Next Week As Markets Remain On Edge

FedEx, one of the premier delivery companies worldwide, warned of a global recession. This is concerning news, given their intimate knowledge of the manner goods and services flow through the global economy. This warning came on the heels of ongoing fears amongst market participants about inflation, Fed tightening, and stagflation anxiety (stagflation is the combination of rising costs, higher unemployment, and slowing growth). One can look at the equity markets as a proxy for deflating asset prices worldwide. Fed Chair Powell echoed this much when he used the word “pain” on two separate occasions when discussing the Fed’s plans to bring inflation down, which is through the combination of higher rates and wealth destruction. One should remember the words “don’t fight the Fed” applies to both uptrends and downtrends.

How Deep Will The Recession Go?

A .75 bp hike on the short-term Fed Funds Rate is baked in at near 100%. However, there is a chance the Fed may go up to 100 bp in hikes. Given the slowdown in housing, the destruction of wealth in many Americans’ retirements, equity/bond holdings, and the grim outlook by business owners, our hope is that a 100 bp hike does not become a reality. Slow and steady may be a better policy. We have advocated for more and faster hikes in previous commentaries, but, the combination of Fed hikes and quantitative tightening (which is just rolling out) may succeed in bringing down inflation.  The aim at this point is to avoid a deep global recession. The comments from FedEx should not go ignored. Next week’s Fed meeting is so important, as a too-aggressive Fed could break something, which would not be good. Breaking inflation by way of an international financial crisis serves no one’s interests and would do more harm than good.  

The Lending Narrative Continues

On the lending side, higher short-term rates and even higher longer rates impede the ability of new buyers to qualify for mortgages. Home builders are trading poorly as are home improvement companies. Housing is a major component of GDP growth so there is no doubt in our minds that the U.S. is in a mild recession.  The bigger question is, how long does this last? When do interest rates top out, how will new and existing home sales and all other property types adjust to much higher interest rates? While there are lenders making practical decisions on applicants, increased mortgage payments have doubled from where they were just a few months ago. This will be a drag on housing prices, even with the limited demand in many large cities. A bit of positive news though, as potential new buyer income is holding up, and many are looking to the current volatile market as a good entry point.   

The great Warren Buffet is famous for saying he is greedy when others are fearful. Well, there is certainly fear in the air. Smart and thoughtful purchases of assets such as real estate or high-quality equities may be at the beginning phase of attractiveness. 

Market Commentary 9/9/2022

Equity Markets Move Higher, Encouraging Soft Landing For The Economy

U.S. equity markets proved resilient against the backdrop of a Hawkish Federal Reserve. Several voting members of the Fed spoke this week and the message was clear: short-term interest rates are going higher to combat inflation. The Fed wants input inflation to go down (think wages and energy) as well as consumption (think feeling poorer due to home value or retirement accounts being down).  However, the equity markets didn’t get the memo and rallied into the weekend.

Markets can sometimes react in a way that may seem irrational initially, but over time proves correct. In my mind, the equity rally suggests inflation may be coming down and job destruction may be happening more quickly. The so-called soft landing for the economy will be the result of Fed tightening. My prediction is there is more pain ahead. Volatile markets both up and down will be the norm for the balance of the year. The Fed will err on the side of higher interest rates for longer, which will put continued pressure on bonds and all investable assets. Remember, it takes time for the Fed’s policies to work their way into the system. That is why caution in this type of environment is so important.  Don’t fight the Fed. 

75 bp seems to be the likely direction in short-term interest rates when the Fed meets later this month.  That number was forecasted to the Wall Street Journal to help mitigate any surprises. The cost of debt is rising quickly. Higher yields are becoming attractive for savers, which is one positive to this so-called “return to normal interest rate” journey central bankers are taking us on. Real estate prices are adjusting as expected in the face of higher interest-carrying costs. Buyer and seller negotiating is back in vogue and all offers are being looked at. 

One interesting phenomenon that’s presented itself has me particularly excited to share. This past week Insignia Mortgage has located three new lending sources which specialize in the following: (1) financing high-net-worth domestic or foreign borrowers, (2) a new regional bank that offers attractive interest-only jumbo loans, and (3) a new commercial bank that offers investment property loans up to 20 million dollars. As rates have increased, so has the appetite to lend for those banks that didn’t chase yield to near zero. While business remains challenging, all is not lost in this wonderful free market economy we get to live in.

Market Commentary 9/2/2022

Russia Gas Closure Spoils A Goldilocks Job Report

Equity markets were soothed earlier in the day due to an as-expected August Jobs Report. Hourly earning increases fell and more people entered the workforce. This is a sign that inflation is forcing people to accept jobs and re-think life without work.  A volatile stock market has pushed older workers back into employment, as retirement accounts have been jeopardized by the traditional 60% stock/40% bond allocation this year. And, just when you thought the equity markets were gaining some footing… Gazprom, the Russian-controlled gas company, shut down its pipeline to Europe citing an oil leak. This news was not unexpected but took equities and U.S. Treasury yields lower. The markets are in some mood. It is virtually impossible to estimate where the U.S. economy, real estate prices, and interest rates are headed. There are simply too many variables to consider and too many black swans circling

Navigating The Gazprom Effect

Taking the Fed at face value, a 50 bp hike is certain. However, one cannot rule out 75 bp, especially if oil starts surging again in response to the Gazprom news. The Baseline Fed Funds rate is gaining support for settling at around 4.00%. Inflation is starting to show signs of moderating, but it is mathematically improbable that it will fall to the Fed’s target rate of 2% in 2023.  Wall Street has had to reevaluate the higher interest rates for a longer Fed narrative as the interest rates start to do their job. Meanwhile equity and bond prices have fallen, real estate is under pressure, and business confidence remains between cautious to downright negative. The return to a more normal interest rate environment is resetting asset prices. 

I want to say a few words about the manner in which I write this weekly blog. While I am personally inclined to be a little more conservative in my thinking, I do my very best to paint a weekly picture of what I am reading. In addition to the news and other industry sources, everything shared in terms of the economy’s direction is combined with the feedback I receive from our network of clients and bank executives. Lately, the current environment is not too positive. In my opinion, we are already in a recession. That is probably going to get worse before it gets better. However, one must remember it is during times of heightened volatility and turmoil that some of the best investments present themselves. So, while I am not bullish on the economy at the moment, I do believe patience will pay off in the form of lower house prices, and better entry points for non-housing investments. 

Market Commentary 8/26/22

Market Commentary 8/26/22

Fed Speech Sinks Market

In his statement at Jackson Hole, Wyoming, earlier this morning, Fed Chairman Jerome Powell asserted that the Fed would “use our tools forcefully” to attack inflation. Powell was abundantly clear (and in my opinion has been clear for some time) that inflation is priority number one for the Federal Reserve. Many on Wall Street are incorrectly assuming the Fed will have their back. In reality, the so-called Fed has put a huge insurance policy at risk-taking for the last 30 years or so. It appears the strike price for this policy to be activated is much lower. Equity markets sold off hard after the speech. The Fed is serious about inflation and warned that further pain is an inevitable future. Powell explained that pain is the “unfortunate cost” that households, markets, and the economy will need to endure to wash out inflation. 

The Impact Of Taming Inflation: Intelligent Decision-Making

A sinking stock market will not be good for home sellers. The pendulum has swung quickly, and buyers are in control. The one boon for housing is that supply is still tight. Many buyers have been waiting for a more buyer-friendly entry point to acquire a new home. Dramatically increasing interest rates present some challenges to both buyers and those sellers looking to step up to a bigger home or downsize.  Intelligent decision-making is back in style. This applies to all investments and big-ticket purchases. Viewing comparables, cost to rebuild, and cost of financing, are all in vogue. This philosophy was forgotten in the last couple of years as momentum took over. We are going back to basics.  

The Fed is gearing up for a 75 bp hike in September. It has been theorized that the Fed balance sheet reduction, also known as QT, is equivalent to another .50 bp. That is the bad news.  The good news is by front-loading Fed hikes and also reducing the balance sheet, we are likely nearing the end of rate hikes. A 4.00% Fed Funds Rate seems to be where the Fed is planning to settle rate hikes for quite some time. As a well-regarded hedge fund manager told me the other day, “we are returning to normal discount rates and a more normal investment environment.” This makes sense and is probably good for the economy in the long term. However, this will be painful to some sectors and to more aggressive investors as a return to normal takes hold in the coming months.