Rates and Equities Continue Their Fall Amid Economic Pressure

Uncertainty continues to creep into the economic picture as investors try to balance fear with optimism. While there are signs that the economy is still strong and growing, there are also plenty of warning signs within the stock market about a potential recession.

This week we saw another yield curve inversion with the 3-month note yield rising above the 10-year Treasury note rate. This time, the separation was the largest since the financial crisis.

Typically, investors and analysts look at yield curve inversions as a predictor of a recession. The one that they believe is the key indicator is the difference between the 10 and 2-year notes. That inversion has continued to stay positive albeit flatter than investors would like.

The trade war with China has continued to bring volatility to equities with the S&P 500 seeing the hardest hits. This month alone, the S&P has lost 4%.

Once again, we are seeing the silver lining of a volatile stock market in the form of interest rates moving lower. The 10-year Treasury note yield continues to drop closing at 2.22% on Thursday, down another .10% for the week pushing mortgage rates down with it. This week’s Freddie Mac average on a 30-year fixed rate mortgage was 3.99%. That’s the first time rates have dropped below 4% since January of 2018. The chart below from Freddie Mac shows the path of interest rates on 30-year, 15-year and 5/1-year ARM.

Credit Suisse equity strategist Patrick Palfrey sees this as a sign that the economic outlook isn’t positive. “Interest rates are a barometer of what future expectations are,” said Palfrey. “It’s a good gauge of what investors are focused on. If interest rates are falling, it’s likely the outlook is less bright.”

This ongoing trade war has also put more pressure on the Federal Reserve’s patient stance on rates. Many bond investors are taking the position that further signs of economic weakness or downturn will force the Fed to lower rates.

The Fed is basically working a balancing act right now between a pre-emptive move or a too little too late attack. “There’s a cost to the Fed moving rates around a lot,” said Minneapolis Fed President Neel Kashkari. “We can add our own uncertainty and volatility to the markets and the economy.”

 

HOME PRICES CONTINUE TO LOSE STEAM

The double-digit annual gains on home prices have stopped, according to the latest S&P Core Logic Case-Shiller home price index. The prices on homes are still gaining but those gains have been consistently waning over the last six months. March home prices rose by just 3.7%, down from 3.9% in February.

Big cities like Seattle, which saw 13% rate gains a year ago, have now tanked to just 1.6% gains. Overall, the 20-city composite went from 6.7% to 2.7% annual gain over the last year. We are still seeing the same trends, however, as lower-end prices continue to see the biggest gains with high-end homes seeding the most price softening.

Chief Economist for the National Association of Realtors, Lawrence Yun, said, “Home price appreciation has been the strongest on the lower-end as inventory conditions have been consistently tight on homes priced under $250,000. Price conditions are soft on the upper-end, especially in high tax states like Connecticut, New York and Illinois.” He continued on saying, “The supply of inventory for homes priced under $250,000 stood at 3.3 months in April, and homes priced $1 million and above recorded an inventory of 8.9 months in April.”

Perhaps because of the lack of inventory on the lower end price points, home sales dropped from March to April by 1.5%. Despite this stat, Yun believes that “it’s inevitable for sales to turn higher in a few months” because of steadily rising mortgage applications and consumer confidence.

 

A TREND RETURNS

Mortgage Real Estate Investment Trusts seem to be making a comeback. According to The Wall Street Journal, Mortgage REITs have “increased their mortgage-bond portfolios by almost 28% to $308 billion over the 12 months through March.” Mortgage REITs are simply groups that purchase mortgages or mortgage-backed securities to earn the income from interest on the investments.

As the Federal Reserve has started trimming its own bond holdings, REITs that are focused on home loans have become an important source of capital in the housing market. Although seen as a riskier due to perceived lack of oversight, Mortgage REITs saw a resurgence in 2018 raising $6.2 billion in equity. Analysts believe they’ll see that same positive revenue growth in 2019, especially with the push toward privatization of government sponsored enterprises Fannie Mae and Freddie Mac.

What’s interesting about the resurgence is some analysts are seeing banks take a step back from the mortgage market while still being the investors for the REITs. Chief Executive Officer for Annaly, Kevin Keyes, explained it simply, saying, “We’re doing the things they don’t want to do.”

 

Greg Richardson

Contributed by Greg Richardson, MAXEX Managing Director

Greg Richardson is Managing Director at MAXEX, LLC, based in Atlanta, GA. He has 30 years of experience in capital markets, including trading, banking asset and portfolio management, mortgage banking secondary marketing and accounting. MAXEX is the only platform in the mortgage industry to offer a centralized clearinghouse that enables buyers and sellers to trade anonymously with multiple counterparties using a single standardized contract.