Market Commentary 06/24/2022

Treasury Yields Dip On Fears Of Slowing Economy

The economy is slowing. This is evidenced by the recent layoffs amidst many technology companies, lenders, and other businesses that were benefactors of stay-at-home and low-interest rates. The leisure industry remains strong as people continue to spend money on experiences and travel, with the exception of restaurants, which seem a lot less busy. Many clients are complaining about the cost of living which becomes exacerbated in a downward trending equity market. The front-page news of a looming recession and its potential certainly does not help quell public concern. Consumer and business confidence remains low. In my opinion, there is a fairly good chance the economy is already in a recession. It certainly feels that way. 

Inflation Is Always And Everywhere A Monetary Phenomenon

If the Fed has the resolve to break inflation, it will. More clarity should be available by the end of next week when the PCE inflation reading (the Fed’s favorite gauge of inflation) is released. Should that reading come in hot or as expected, the Fed will most likely go up 75 bp again in July. The old saying that “inflation is always and everywhere a monetary phenomenon” rings true these days. The markets will stay volatile during the next few months as the new terminal rate for rate hiking is established. There’s a big chance that the Fed’s double-barreled strategy of increases in rates and balance sheet runoffs could result in them breaking something in the financial system. Caution remains warranted even during strong rallies like today.

I expect the Fed to move above 3% on Fed funds sooner than later. 40% of Americans are now living paycheck-to-paycheck and are struggling to pay for life necessities. The one positive here is that I think the Fed is now taking inflation seriously enough to ensure that it should come down fairly quickly, maybe by the fall. That is just my best guess. Earlier this week, the yield curve continues to be flat and briefly inverted. This is almost always an ominous sign.

Interest Rates In The Ether

How higher interest rates will affect home prices is yet to be established. My belief is that prices will need to come down. Some models are showing a 20% or so draw down in values. However, in supply-constrained cities like Los Angeles, there are still not enough homes to meet demand. Should interest rates remain persistently high, I imagine home prices will slide even in supply-constrained markets. I am hearing from commercial bankers that higher interest rates will have an immediate effect on cap rates and that exit cap rates have been reduced as well. Cautious underwriting is being implemented across the board, which I applaud. Better to stress-test loan applicants than be sloppy in a rising rate environment. I expect as interest rates remain elevated, refinance of real estate will be used to pay down more expensive personal or business debt.  ARM loans and interest-only loan demand has picked up. Borrowers are attempting to offset the rise in interest rates with an interest-only payment. 

Market Commentary 5/20/2022

Equity Market Volatility Pushes Bond Yields Lower

It was another week of agonizing volatility in both the bond and equity markets. Big box retailers reported tighter margins due to high inflation. Economists continue to move year-end targets down. One wonders if all of this negativity signifies an end to selling.  S&P touched correction territory before trading higher into the close on Friday.  Long-dated bond yields fell below 2.800%. Trading remains volatile but orderly.  As we have mentioned previously, don’t expect the Fed to step in and backstop the equity or housing market anytime soon.  Inflation is the Fed’s primary concern and they will tolerate a falling equity market and a higher unemployment rate to subdue inflation. Case in point, the WSJ reported that subprime credit delinquencies are rising from historically low levels as the increased cost of food and energy preys on consumers.  Even the wealthy appear to be cutting back on spending. The soaring costs across all corners of the economy are weighing on people’s confidence and willingness to spend.

Impact On Real Estate & The Global Economy 

Limited housing inventory will keep home prices from falling too dramatically. However, given the wealth destruction incurred in both the bond and equity market, it is difficult to see real estate being impervious to recent events. The dramatic rise in mortgage rates over the last 60 days will push some buyers to the sidelines. 

With China shut down, and the world economy slowing, perhaps long-term interest rates will continue their recent descent. This would be helpful to growth stocks in addition to homebuyers, consumers, and businesses. We hope that long rates don’t move too low, as an inverted yield curve would be worrisome. Housing demand remains healthy, which bodes well overall for the economy.  Should this change, we would become very nervous over a deep recession. 

Next week is important for the markets as the Fed’s favorite inflation gauge, the PCE, is released.  The markets will respond favorably should inflation appear to be topping out.  However, should the reading come in hotter than expected, be prepared for a sobering market reaction. 

 

Market Commentary 5/13/2022

Hot Hot Hot – Inflation Data Substantiates More Fed Rate Hikes 

Inflation paired with a sluggish economy wreaked havoc on the equity markets this week. Equities fell hard (before rising on Friday) while bond spreads widened. Inflation remains public enemy number one as a hotter than expected CPI report confirmed what many of us already know…  Inflation is running strong and has yet to subside. Once inflation seeps throughout the economy, it is notoriously difficult to regain composure without the Fed breaking some part of the economy or the market.  Fed Chairman Powell suggested this much when he said he “cannot guarantee a soft landing” with the economy as the Fed raises short terms rates and begins to tighten its balance sheet. 

Prepare For Continued Volatility 

Expect continued volatility as market participants work through their models on where the Fed funds rate will settle in. This will determine if earnings and multiples on equities require recalibration. The highly speculative crypto space had a horrible week with $800 billion in value evaporating from the market. Fears of systemic risk have been discussed but have since been discounted. These types of conversations take place during bear markets and are often preludes to a market blow-up or recession. 

Real estate remains a favored asset class in times of inflation. This should bode well for a housing market that is already constrained by supply. However, in bad markets, all asset classes tend to re-price. It is hard to say if the supply limits are such as to not affect a drawdown in home valuation.  Banks remain eager to lend and with interest rates increasing, we expect a very competitive lending landscape. This should result in lenders willing to take a tighter margin to get money out the door.  Underwriting standards remain robust, so loan quality remains high. This is good for banks and ultimately the economy. We don’t expect a repeat of the 2008 financial crisis, even though we see a tough year in markets.

Interest rates touched well above 3.000% before falling later in the week.  The yield curve remains very flat as we stay on recession alert. With consumer sentiment and business sentiment negative, this should help slow down spending… And hopefully, bring down demand while lowering inflation.    

Market Commentary 4/1/2022

U.S. Economy Complicated By War, Inflation, Yield Inversion & Strong Jobs Data

Nonfarm payrolls added close to 500,000 new jobs in March in an already tight labor market.  The unemployment rate dipped to 3.600%, a tick above the 50 year low of  3.500% back in February 2020. The long-term jobs picture is concerning as there are many more job openings than jobs available. The large number of job openings relative to the population actively seeking work could cause wage inflation to rise faster than economists prefer. Wage inflation is both sticky and a big component in overall inflation readings. Should companies have to pay even more for new hires, those companies will do all they can to raise prices to offset the higher employment cost. This in turn raises all prices, and so on and so forth.  It becomes clear how inflation can become embedded throughout the economy as you game this out, and why the Fed is talking up rate hikes to cool off the economy and lower inflation expectations. 

The PCE, the Fed’s preferred method of inflation came in at 6.40%, a 40 year high. PCE strips out volatile food and energy costs. Many forecasters see a 9% plus CPI number for March. Inflation is real and probably not going away any time soon. Using the PCE as an example, the Fed funds rate in real term is -6.15% when measured against inflation. This is destructive to savers and imposes a hidden tax on the population. Caution is warranted as the Fed’s policy shift stands for the benefit of main street, which may very well come at the expense of Wall Street.   

With the Fed moving away from QE and intending to initiate both higher rates and QT, there is an increasing probability that the Fed may put the U.S. into a recession. This may not occur in the immediate moment, but prior to the end of 2023. The flattening and momentarily inverted 2-10 yield curve is supportive of this thought. How far the Fed will be able to raise short-term rates is unknown, but bond trading supports not much more than 2.00%-2.500%, which still leaves short-term rates negative when measured against present inflation. Fed hikes much higher than this level could be quite destructive given the absurd amount of U.S. debt. The Fed is truly embarking on a journey “where no man has gone before” when it comes to Fed policy. 

Now, a few general observations. The war in Ukraine remains an international concern, but the markets for the moment seem to have moved past the troubling headlines. Also, the oil markets are trading better which will provide some relief to consumers over time. Mortgage rates are no longer cheap and the rise in interest rates will slow the pace of refinances. There are approximately 6 million homes that can still benefit from a refinance, down from 14 million not too long ago. However, the purchase market remains active. The dream of homeownership has not cooled as of yet. On the higher end, many potential buyers we speak to are looking to make gains from the stock market, or crypto market, to buy real estate. The recent volatility which saw many asset classes get crushed early in the quarter and then resurge probably has a lot to do with the desire to move into the safety of real estate. Moreover, lack of supply (as we have spoken about in many blog posts) will provide a natural floor to how low housing in markets such as Southern California may go down, even if the overall housing market is slowed by rising rates.

Market Commentary 3/25/22

Flattening Yield Curve Worrisome As Economic Growth Slows

I feel as if I have seen this movie before. With that thought in mind, the idea that this time may be different is what makes previous patterns in markets hard to handicap.  But, make no mistake, a flattening yield curve is a worrisome sign. This is especially concerning, given how hot inflation is currently running and where low-interest rates are at present.  The bond market had a terrible week as 30-year mortgage rates hit near 5.000%, which is a dramatic increase from the 3.25% or so rates were at the beginning of the year. I also find it strange that the equity markets are surging on a week when bond yields have risen to levels not seen in several years. The erratic behavior of the market is one reason why it’s so difficult to both predict the future or place big investment bets in one direction or the other. Even when all signs point to an outcome, that outcome may not happen.   

Take housing as an example. Given the lack of housing supply, the way in which rates will affect housing demand remains uncertain. I do expect sales to slow as the combination of very high inflation and much higher mortgage rates are not favorable. Yet, at the moment, many real estate brokers remain very busy and our office has a near-record amount of purchase volume.   

One of the great joys of my job is speaking to so many people each and every week. One client who is in the online retail business informed me that as soon as gas hit $6 per gallon, the business fell off a cliff.  Disposable income is getting eaten up by life’s necessities in a way unseen in over 40 years. Gas prices, food, rent, you name it, and the price is higher.  There is much talk of the strong possibility of a 9%-10% CPI print.  Should this happen, the Fed will need to act quickly and strongly with at least a .50 bp increase in rates and perhaps even do so sooner than their next meeting.  Inflation is beginning to erode economic growth. Bond guru, Jeffrey Gundlach, said recently that he is on recession watch. He looks at the 2-10 and 5-10 Treasury spread as one of his main predictors of a recession. Should both of these spreads go negative from very flat, he fully expects a recession.  A steepening yield curve will give the all-clear. 

Now for the positives. One, real estate has historically been an excellent hedge against inflation. This means that should the markets swoon, investors may want the security of a hard asset such as real estate. Two, a more downbeat mood opens the door to better negotiations between buyers and sellers.  As the market normalizes, there is a chance there will be more homes for sale or that sellers will be willing to work with potential buyers in ways that have not been seen over the last two years. Finally, rates are still attractive from a historical perspective (real rates are deeply are negative when measured against inflation), especially adjustable-rate mortgages (ARMs).  While it seems likely the 30+ year bull market in interest rates has been broken, let’s not forget the 10 year Treasury is still only at 2.48%. 

Market Commentary 3/4/2022

Ukraine Weighs Down On The World As Bond Yields Drop

The Ukrainian-Russian conflict is top-of-mind for global markets. Volatility has soared with the VIX index, a.k.a. the fear gauge rising above 30. This number is important because it represents a more fearful market, as investor sentiment has been trashed by the recent wild market moves. While contrarians would argue to buy when fear is high, this time may be different. It is hard to handicap Mr. Putin. For the moment, neither sanctions nor the threat of being banned from Western nations’ economies has deterred his desires over Ukraine. 

The February Jobs report was solid. Unemployment fell to 3.80% and wage inflation was moderated, which is helpful for bond yields. While oil prices have broken through 100 per barrel and other food sources and commodities linked to Ukraine have also risen greatly, the reason can be explained away due to the Ukrainian conflict.  Wage inflation is the most sticky type of inflation. As those numbers came in below expectation, the Fed has more time to raise rates in the coming months.

These are truly scary times. It feels as if the world has become much more dangerous in just a matter of days. While good for U.S. bonds and to a lesser extent U.S. real estate and U.S. equities, should this conflict drag on, markets may experience continued draw-downs and in effect shake consumer confidence. Real estate has tangible qualities that make it attractive in this type of environment and may hold up better than other types of assets.  However, the odds are increasing that a recession may be on the way, so caution is warranted.  Also, lenders are slowly lowering rates even though our Government debt has dropped precipitously.  The overall market remains near impossible to handicap. 

Market Commentary 1/7/22

Fed Signals Rates Will Rise In 2022 With Inflation Running At 30 Year Highs

It has been a forgettable start to 2022 for the U.S. financial markets, and more specifically, for many tech companies and bond investors. While the last several weeks of 2021 were quite volatile, Wednesday’s hawkish release of the Fed minutes crushed many stocks and also shook the bond market.

Inflation is now a major concern for the Fed. Friday’s Job Report, which contained both positive and negative elements about the employment picture, reinforces the belief that the U.S. economy is near full employment. The current unemployment rate stands at 3.90% with many million job openings still remaining. Wages continue to increase running above many expectations, but, these wage increases are not keeping pace with consumer inflation and this is what the Fed is worried about.

Housing demand remains robust. Should interest rates continue to rise, housing demand and housing affordability will be impacted. However, with the housing supply still too low, housing demand should not dip too much. Lumber will be important to watch as it has quietly gone back up to a 7-month-high. Increased labor costs for construction workers are also a concern along with supply chain issues. Higher rates will force builders to work on keeping costs down on new home builds. It is too early to tell what could happen but homebuilder stocks have not traded well to start the year even as demand is strong.

Another hot CPI report is expected for December, which is due out next week.  While the market is already pricing in the likelihood of ongoing inflation, interest rates will be under continued pressure as both PPI and CPI inflation readings run at 30-year highs. We don’t recommend sitting around waiting for interest rates to abate or the Fed to pump large-scale stimulus into the economy in response to the Omicron outbreak.  Borrowers who have not taken advantage of the ultra-low rate environment still have some time to lock in very attractive interest rates. For those borrowers with complex financials, Insignia Mortgage has several local banks and credit unions willing to work closely with us to approve loans that larger institutions simply won’t take the time to underwrite. Interest-only products are abundant, as are mortgages for second homes and investment properties.

Market Commentary 12/10/21

Interest Rates Hold Steady As U.S. Inflation Hits 39-Year High

Inflation readings rose to levels unseen in almost 40 years, with the CPI index clocking in at 6.80% annually. We don’t expect these readings to cool off anytime soon, as the slow housing-related component of the inflation calculation has risen dramatically.  As an example of how bad the supply chain really is, the local Starbucks I usually go to was out of all breakfast items this morning except for one or two of the less popular foods. The manager informed me that they simply can’t get the food on time or consistently from their suppliers. This is holding true for so many goods, leaving companies scrambling.

Further complicating matters is the imbalance between job openings and job seekers which currently stands at over 5 million. Companies are scratching their heads as the promise of higher wages, signing bonuses, and more flexible hours isn’t filling the void. The dynamics of employment have changed since COVID.  Employees have pricing power for the moment and this will lead to still higher inflation. As wages and fixed costs are elevated, companies will do all they can to pass those costs to customers. Supply chain issues will also force companies to bid up inventory. These factors will keep inflation as a key concern for the U.S. consumer through the foreseeable future. 

Bonds curiously took the hot inflation reading in stride.  The reasons for this are many, but, perhaps long-term bond traders know that these soaring input costs and wage increases will lead to an economic slowdown.  The equity market was unconcerned with the news as well.  Equity traders are working hard to keep the year-end rally intact after a quick but violent shake-out at the start of the month.  Rest assured if inflation stays at these levels or higher, volatile days are ahead. The impact probably won’t start to be felt until early next year.

Housing and real estate remain a great hedge against inflation. Low long-term rates are helping borrowers pay for houses, but with low fixed interest expenses. There is something for everyone in terms of mortgages- from private banking with extra-low rates for the ultra-rich, to the community bank who is eager to gain market share, to the alternative doc mortgage bank who is willing to support customers with or without income verification.  Thankfully, Insignia Mortgage has access to all of these products which are keeping us very busy finding solutions for our many clients.