Market Commentary 1/20/23

Job Loss & Poor Housing Data Drive Mortgage Rates Lower

It is becoming increasingly difficult to argue that the economy is not slowing. Several major public companies, including Microsoft and Google, have announced layoffs. Now, most economists ally with the recession camp. Retail sales were very poor, existing housing sales are at a 13-year-low, the yield curve is extremely inverted, and long bonds are falling. Nonetheless, the Fed is resolute in raising short-term interest rates to eliminate inflation. Why, with so much negative sentiment, is the Fed dead set on doing this?  The answer lies in what the Fed is seeing in the job market and persistent wage growth. A survey of regional Fed data supports the notion that although wages are moderating, many parts of the job market remain tight and wage pressure has yet to soften. As wages constitute a large chunk of any company’s expenses, higher wages lead to higher prices, assuming the business can pass along those prices. 

Looking at the history of the economy, the Fed has at times, been truly unsuccessful in pushing down inflation. For example, the grim inflation episodes of the late 1970s and early 1980s led to several rate increases and declines. As a result, the Fed had to resort to very high short-term interest rates to finally quell inflation. We suspect that the Fed Chairman does not want to be remembered for failing to get the job done on inflation. He would rather see equity and real estate prices come down than risk a re-acceleration of inflation.

Even with the Fed’s rate hikes, and jaw-boning the markets constantly, financial conditions have eased since late last year. The 10-year Treasury is south of 3.500%, mortgage rates have dipped, and global equities have rallied. This is not what the Fed wants. Therefore, the Fed will be raising short-term rates yet again in early February. Odds are for a .25 bp increase, but don’t count out another .50 bp as their terminal rate target is above 5.00% (Fed Funds are currently at 4.25% -4.50%)

Distress in commercial real estate is starting to make it closer to the front page. There are about $175 billion in troubled loans globally, many of which are coming due later in 2023 and 2024 with the focus being on the office. Some residential areas like Austin and Boise experienced massive price appreciation during the pandemic and are now seeing prices come down. However, strong coastal market prices are holding steady. This is due to the combination of both a robust and diversified economy with low levels of inventory serving as a floor to steep declines. Mortgage rates have drifted lower. Lenders are now thinking about 2023 production goals on how to make loan requests work, especially on the portfolio bank side of the business. This is a welcome development and will certainly help the local real estate market.

Market Commentary 1/13/2023

Interest Rates Drop As Markets Look Beyond Fed Hikes

First, the good news. Inflation is falling and it appears that the Fed is near the end of its tightening cycle. Odds are that the Fed will raise .25 bp in February and again in March before stopping. While inflation is still excessively high, shipping costs have dropped back to pre-pandemic levels, used autos prices have fallen, and other goods have followed suit. Gasoline prices are lower and the supply chain is functioning much more efficiently. The job market remains tight and that is still of some concern for the Fed. However, the pace of wage increases is lessening. Bond yields and mortgage rates have also lowered as the 10-year Treasury is now around 3.44%.  This has helped bring potential home buyers back into the market. 

Now, the not-so-good news. Negative ISM readings, surging credit card debt, an inverted yield curve, and warnings from CEOs such as Jamie Dimon on the state of the economy have all of us on “recession watch.” Generally, it is hard to bet against the U.S. consumer and business owner. Nonetheless, there are signs that consumers are tapping into credit cards more often to pay for life necessities, and business owners are cutting back on staff and hours of work per week. How this plays out over the next couple of months will be an important sign of where the economy is headed.

The hope remains the Fed will thread the needle and the economy may experience a very mild recession. The strong jobs market supports the no-recession argument, while other economic indicators suggest otherwise. The effects of the Fed’s jumbo rate hikes and quantitative tightening have yet to be discerned, as the monetary policy takes some time to work into the system. Lending standards at banks continue to tighten. The overall rise in short-term rates will affect consumers and business owners this year, as debt service costs increase quite dramatically for debtors who either have a floating rate debt or debt coming due.

Home builders reported soft sales volume. While many builders are offering incentives to lure buyers, builders are holding back on price cuts. Housing valuations have held up well and better than some expected. Why? The combination of a low fixed-rate mortgage, a 10-year + period of strict loan underwriting, and a big move-up in home values is keeping pressure on sellers to cut deals. Should the economy move into a recession later in the year, sellers will be more willing to negotiate or list their property for sale as their finances become strained. For the moment, although the housing markets are slow, the drop in interest rates has got buyers looking again. Given that home affordability is stretched, lower rates are needed to jump-start real estate activity. While interest rates are not likely to move to pandemic levels, our experience is that should mortgage rates settle in under 5.000%, borrowers will respond positively. 

Market Commentary 12/16/2022

Recession Fears Escalate As Fed Holds Firm On Rate Hikes 

As anticipated, The Fed raised short-term interest rates by .50 bp on Wednesday. The initial market reaction was neutral, but sentiments changed once the markets digested the Fed’s resolve to fight inflation on Thursday. Additionally, the Fed emphasized its projection that short-term interest rates may go higher than expected due to the very tight labor market. The markets are concerned because the economy seems to be weakening. Major corporations have announced job cuts, credit card balances have risen, and U.S. retail and manufacturing spending has slowed. Market experts are attempting to reconcile how far the Fed is willing to see real estate and equity markets decline, rather than not do enough to squash inflation. The most vulnerable parts of society are hurt by inflation the most. Powell has referenced the need for “pain”(financial pain or the decline in asset prices) several times over the last many months as the unfortunate result of taming inflation.

Across the pond, European central bankers were also very hawkish about where interest rates will need to go to quell inflation. U.S. Treasury yields remain very volatile as expectations of tighter financial conditions loom. Speaking of bonds, the inverted yield curve is an excellent indicator of recession probability. How steeply the yield curve dips signifies to the bond market that a recession is likely.  However, a counterargument can be made for higher interest rates as liquidity is taken out of the system.  It seems logical investors will demand more yield for each unit of risk. Interest rates along the yield curve should move up. Also, onshoring of industrial production and pivoting from just-in-time inventory to certainty-of-inventory, employee demands for higher wages, as well as a low level of “total employed” are inflationary. In the end, the best financial advice this year has been to “not fight the Fed.”  The Fed wants positive real rates across the whole yield curve and fighting the Fed is usually not wise.  While no one can predict the future, we are in the midst of a paradigm shift in interest rates. The results of this shift will be felt in the coming year.

Interest rates have dipped slightly, and that has led to a small increase in activity. Winter has always been a historically slow time of year, but the jumbo hikes the Fed has undertaken have certainly slowed the market. With inflation coming down, the hope is interest rates will normalize and thereby help the real estate market. As 2023 approaches, lenders will have new funding targets, which should help as banks compete for new business. 

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 10/7/2022

More Pain On The Horizon As Fed Pivot Is Deferred

The decent September jobs report had a “good news is bad news” effect on the markets. Traders were looking for signs that the Fed’s super-sized rate hikes are lowering wage inflation, which would indicate that overall inflation may be coming down. While wage growth eased and the overall jobs picture declined, it was not enough to sway the Fed from its restrictive stance. More likely than not, another .75 bp rate increase will occur at the next Fed meeting. Combining these large rate hikes with the balance sheet runoff, also known as QT, is quickly creating very cramped financial conditions. Our suspicion is that it will not take much longer for the Fed to break something in the financial system. Risks are high for a black swan type of event. There is real destruction happening in the marketplace as riskier bond yields start to tick up again. Oil is now over 90 and investor confidence is crumbling. It seems unlikely that the Fed can orchestrate an elegant economic soft landing. Caution remains the word du jour.

It is going to take time for real estate prices to adjust, especially in the way many of us believe they will.  It is simple math. If your cost of carry doubles this quickly, prices and cap rates must adjust despite a limited supply. Next week holds a lot of critical news for CPI, PPI, retail sales, and bank earnings. Buckle up as it is going to be a rough ride as we anticipate these updates. We hope things will not be as painful as the Fed wants us to believe.

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 9/9/2022

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.