Dec. 31: Rates, the Fed, World Economies, Affordability, and the Shutdown
How important is it for lock desk personnel to charge the correct fees for rate lock extensions? Very. Lock mistakes were included in Wells Fargo’s latest settlement with states, this time around for $575 million. There were other non-mortgage items listed, however, including opening millions of unauthorized accounts and enrolled customers into online banking services without their knowledge or consent, improperly referred customers for enrollment in third-party renters and life insurance policies, improperly charging auto loan customers for force-placed and unnecessary collateral protection insurance, and failure to ensure that customers received refunds of unearned premiums on some optional auto finance products. (In other legal news, the video industry is scrambling since athletes don’t own their tattoos! Time to lawyer-up with copywrite attorneys.)
Capital Markets
Today is the last trading day of the 2018, and the 10th day of the government shutdown. Some wonder why the government is shutdown when Donald Trump promised to make Mexico pay for the wall. That aside, Federal Reserve officials are considering a switch to a new wait-and-see approach on rate hikes after a likely interest-rate increase at their meeting in December. The new approach could slow down the pace of rate increases next year, and though the broad direction of short-term interest rates will be higher in 2019, as the benchmark rate rises, the Fed is less sure how fast they will need to act or how far they will need to go in assessing how the economy is holding up under moves they have already made. Under the evolving “data dependent” strategy, the Fed could step back from the predictable path of quarterly hikes it has been on for most of the past two years, raising the possibility it might delay rate increases at some upcoming meetings.
Under the old pattern, the Fed would raise rates again in March, but officials now don’t know when their next rate move will be after December as recent market turbulence for now hasn’t much dented the Fed’s view that the U.S. economy is on solid footing, with growth strong and unemployment low.
Inflation, however, has softened in recent months, and falling oil prices probably reduces the Fed’s sense of urgency about raising rates to prevent the economy from overheating. Federal Reserve Chairman Jerome Powell said in a speech last week that under uncertainty of this kind, the prudent decision is to be careful. Any shift from the predictable path of quarterly increases for past two years will have to be communicated. As part of its shifting plans, officials are weighing how to modify language in a central bank policy statement that since December 2015 has described plans for “gradual increases” in the fed-funds rate. In January, officials qualified the phrase by adding the word “further” to signal greater conviction in their plans.
Lenders know that President Trump has criticized the Fed repeatedly for raising rates this year. Fed officials have said they will respond to economic data and not the White House when they set policy. In addition, Fed officials have stressed they are paying greater attention to the delayed impact of their own policy moves. In September, Fed officials estimated that a neutral rate might be between 2.5% and 3.5%, though they are doing their best to avoid interest rate guidance, as Alan Greenspan experimented with in 2003, when inflation was low and the job market soft. The Fed raised rates in quarter percentage point increments at 17 straight meetings between June 2004 and June 2006, and along the way assured investors it would proceed at a “measured” pace. Many believe the Fed’s “measured pace” guidance was a mistake because it locked them in to predictable rate changes and betrayed their own uncertainty about the outlook, and have been clear to investors they do not plan to repeat the strategy.
So a few weeks ago, unanimously, the Federal Open Market Committee decided to raise the fed funds target by 25 basis points in an announcement that nearly mirrored November’s statement. Once again, they highlighted a strong economy, job gains, low unemployment and household spending has indicators that “some further” increases in the target rate would be necessary in the New Year. The expectation, however, has shifted down from three potential rate increases to two according to the members’ dot plots. These plots suggest that the committee believes that a maximum target of roughly 3.15 percent is seen as the neutral point for this cycle. Historically, this is below the maximum of 5.41 percent reached during the last tightening cycle in 2007. The economic projections released with the statement do suggest a slightly lower outlook for 2019 and judging by their reactions, the financial markets were expecting a more dovish tone from the committee regarding future interest rate hikes. Regardless, this announcement marks a change from the consistent every other meeting rate increase we’ve seen over the last year to one of fewer rate hikes. While the degree of those hikes is still expected to be 25 basis points at a time, the timing of those potential hikes will be more difficult to predict in 2019, thus creating an air of anticipation around each meeting.
As I have mentioned, many believe that the current state of the economy is not reflected in the rosy statistics. Economic data recently continues to paint the picture of continues economic expansion in the US during the fourth quarter while markets grapple with issues abroad. Industrial production increased 0.6 percent in November despite flat manufacturing output. Nominal retail sales inched up 0.2 percent in November as falling energy prices held down sales at gasoline stations and continue to fall so far through the first half of December. Despite the drop in gasoline prices, expectations remain high for good holiday shopping metrics due to favorable conditions for consumers. Headline consumer prices were held in check in November due to the aforementioned drop in gasoline prices, but core CPI increases 2.2 percent on an annual basis as the cost of services continues to rise. Total mortgage applications managed a modest increase of 1.6 percent as both purchase and refinance applications increased and rate fell for the third consecutive week. As expected, the Fed increased the target for the Fed Funds Rate another 25 basis points given previous commentary regarding economic conditions and the pace of further increases.
Even in November most of the economic discussion from the previous week centered on the Fed and trade. Multiple Fed speakers reaffirmed the Fed is comfortable with the current pace of interest rate hikes. Would more rate increases give the Fed more ammo to lower rates in the event of a recession? Additionally, we heard that the Fed thinks rates are approaching a “neutral” level; meaning neither stimulative nor restrictive to economic conditions. None of the speakers, however, defined what rate would constitute “neutral” in their view. his change of tone has led many to suggest that the Fed may be close to changing the current rate hike timing of every other FOMC meeting as we move into 2019. It is important to note that beginning in 2019, there will be a press conference with Jerome Powell upon the conclusion of all 8 FOMC meetings instead of the current 4. Previously, we’ve only seen rate changes following FOMC meetings with scheduled press conferences.
A speech by Fed chairman Jerome Powell at the Economic Club of New York introduced some uncertainty into the market’s estimates for future rate increases when he said interest rates were near a level that the Fed would consider to be neutral. Mr. Powell’s comments have caused many to rethink the potential number of rate increases in 2019. The PCE deflator, a main indicator of inflation, remained at the Fed’s inflation target of 2.0 percent in October. The updated to Q3 GDP was unrevised at +3.5 percent and corporate profits in the third quarter rose 10.3 percent from one year ago. Global growth is slowing, however. Consumer confidence was slightly off it’s 18-year high in October to a still very strong reading of 135.7 and it is expected that this optimism will continue to drive consumer spending through the holiday season. In addition to strong consumer confidence, personal income rose 0.5 percent in October with all categories showing gains for the month. While the rising rate environment has caused some concern in the housing market, consumers continued to spend on durable goods, which increased 0.4 percent in October.
What should LOs tell clients who are sitting on the fence about the direction of rates and the economy? After the first Republican unified government since 2005-2006 produced a clear inflection point in the nation’s fiscal policy over the last two year, the U.S. returns to operating under a divided government come 2019, which is generally less conducive to sweeping legislative changes. It is unlikely that Republicans in the Senate and White House will agree to any major changes to the 2017 tax reform bill proposed by Democrats in the House. Conversely, Democrats in the House are unlikely to agree to tax cuts anywhere near the magnitude that occurred in 2017.
Spending is more complicated, as the U.S. is operating under a two-year budget deal that expires on September 30, 2019. Currently, inflation-adjusted discretionary spending will decline in FY2020, leading the federal component of GDP to be a drag on economic growth, as it was from roughly 2011-2014 when there was a significant contraction in discretionary spending. All politicians want to keep their jobs, and a slowdown in growth headed into the 2020 election might lead policymakers to boost spending more meaningfully than forecasted. Conversely, a divided Congress and president could engage in a prolonged budget standoff in 2019 that results in a debt ceiling mess and a sharper deceleration in federal government spending than predicted. Without the 2018 midterms sparking policy outcomes that provide a significant boost to growth and a subsequently more hawkish Fed, interest rate expectations are for the deficit to continue widening over the next few quarters, but for the pace of widening to slow by H2-2019, likely slowing overall growth.
Sales of both new and existing homes have been weakening for the past six months and home price appreciation has finally broken from its earlier breakneck pace, even in many of the nation’s hottest housing markets. Inventories remain tight but are now growing again, and bidding wars are far less common, giving slightly more buying power in this soft sellers’ market.
Although it has improved in recent months, first-time buyers have been struggling with affordability, and higher mortgage rates are discouraging many potential buyers. With demand cooling, inventories have begun to increase and price appreciation has moderated. While prices are rising less rapidly, prices are still rising faster than wages, and higher interest rates are giving buyers pause. The lack of affordable product in the markets where potential home buyers would like to live has helped explain why sales turned down well ahead of this fall’s rise in mortgage rates. With home values and rents soaring near city centers, growth is also creeping back out toward the suburbs, particularly those that are developing their own urban cores. Demand remains strong for amenity-rich apartments located near the city center or in the metro area’s second or third largest employment centers.
Looking at Friday’s bond market, aside from some minor movement between maturities and coupons, rates didn’t do much. The 10-yr note finished at its best level since early February (2.74%, down .05% for the week) while 2s and 5s settled at their best levels since the start of June. The slope of the yield curve was little changed Friday but it steepened during the week. The 2s10s spread ended the week six basis points wider at 22 bps while the 2s30s spread widened by 12 bps to 52 bps. Will it help ARM market share?
The MNI Chicago Business Barometer, aka the Chicago PMI, decreased in December but the overall reading remained elevated thanks to strong order backlogs and an increase in the Production Index.
We learned on Friday that Pending Home Sales decreased slightly, as expected, but is down nearly 8% from a year ago. In a “pay no attention to the man behind the curtain” moment, NAR chief economist Lawrence Yun said there was no reason to be overly concerned and he expects solid growth potential over the longer term given the strong jobs market. He observed that the report had not yet captured the recent decline in mortgage rates, and there is the little issue of the government shutdown leading to fewer homes sold and slower economic growth.
Today is expected to be fairly quiet given an early bond market close and no major economic releases. Rates aren’t much different than Friday evening with the 10-year currently yielding 2.73 percent and agency MBS prices down/worse a couple ticks.