Tag: inflation

Market Commentary 02/23/2024

Posted on by Damon Germanides


The Promise Of AI & How It Will Affect Real Estate

As the promises of artificial intelligence (AI) and machine learning continue to propel equity markets, significant transformation lies ahead for various industries, including the mortgage business. While this shift may evoke both excitement and apprehension, embracing AI-driven processes offers the potential for increased efficiency, streamlined operations, and enhanced profitability.

But why is a real estate newsletter delving into the realm of AI? The answer lies in recognizing AI as a disruptive technology poised to revolutionize our lives akin to milestones like the automobile and flight. Moreover, it serves as a deflationary force, gradually reducing costs across goods and services.

In the context of residential real estate and mortgage origination, AI has the potential to identify promising prospects within each of our networks by leveraging vast computing power to assess probabilities. For realtors, AI can pinpoint prospective buyers or sellers based on life circumstances or shifts in employment status and provide real-time triggers. 

This forward-looking optimism in the market has implications for interest rates, likely keeping them elevated for longer periods due to positive economic outlooks. As equity markets surge and financial conditions ease, individuals are inclined to spend more. Such increased activity prevents inflation from being lowered, delaying the anticipated rate cuts by the Federal Reserve. Consequently, interest rates have risen, with conforming loans hovering in the mid to upper 6% range, and jumbo loans around 6%.

In line with our assessment, a major Wall Street research firm has reached a similar conclusion: the overall expense of retaining a home you no longer desire is likely to bolster existing inventory. This is particularly true with rents on the decline and so many multi-family units becoming available. Such a trend has the potential to ease some of the strain on housing affordability and open up fresh opportunities in the real estate market.

Market Commentary 02/16/2024

Posted on by Damon Germanides

 

Inflation Proves Sticky As Interest Rates Rise

We are sensing not all is well in the world and that it’s time to be mindful that the rise in equities doesn’t tell the whole story. For those who follow these things, company after company is laying off workers suggesting that the unemployment rate may be headed higher. Commercial real estate loan portfolios held by large banks are increasingly at risk. The US debt now well above $34 trillion is no longer tomorrow’s problem.  Massive Treasury issuance in the coming months may put additional pressure on bond yields.

Of additional concern is a hotter-than-expected CPI print, and the stickiness of service-related inflation. Friday brought yet another disappointing inflation report, with the PPI or wholesale inflation readings leveling off.  As we have suggested in past commentaries, inflation is a tricky beast, and bringing it down to 2% from current levels will take time. This has pushed out the odds of the first-rate cut to June from March, which was the belief of the markets a short while ago. 

We are now left with the higher for longer interest rates story, which we think should increase the supply of homes and bring down home pricing over time. Outside a person’s mortgage as a reason to keep their home, there is the dramatic rise in the costs to maintain the home along with the cost of insurance, as well as the climbing expense of overall living, which may work to realtors’ favor this spring (especially for empty nesters). Simply holding on to a home because of a low mortgage makes less economic sense if the other expenses rise enough to offset the benefits. 

On the positive side, the single-family 1-4 lending market remains quite liquid. The combination of big and small banks, mortgage banks, and Life Co firms in the space has created a considerable suite of products. Also, because rates are not likely to go up much further banks are tightening spreads on loans to win deals. 

Listed below are examples of some of the more interesting products:

  • 1st mortgages up to 80% to $10M and 75% to $20M with rates starting a touch above 6%
  • 1st mortgages with 10% down program available up to $3M with rates starting above 7%
  • 1st mortgages with 40% down and no income or employment verification loans up to $3.5M. Rates start at mid 7%
  • 1st mortgages crossing other properties with no down payment up to $15M with rates in from 6%-7%
  • Construction loans for personal residences up to 65% of cost to $15M with rates from 6%7%

Market Commentary 02/09/2024

Posted on by Damon Germanides

Direction Of Economy Uncertain As S&P Breaks 5K 

If you’re feeling confused about the economy’s trajectory, you’re not alone. As a recap, the stock market has been soaring to new heights driven largely by the optimism surrounding AI. Certain high-frequency indicators like auto and credit card delinquencies have spiked. Inflation levels are off at a rate over 20% higher than in previous years. Finally, many in the US remain unsettled about their future as they are forced to live paycheck to paycheck, even while earning over $100K per year. 

Just weeks ago, Wall Street anticipated six or more rate hikes, but now forecasts have been revised down to perhaps four. Ongoing hints from the Fed suggest potential interest rate reductions by mid-year. We reiterate inflation is public enemy number one and that is why the Fed will move very carefully with rate reductions.  

Despite ongoing challenges, the housing market remains resilient, with homeowners reluctant to part with their low-rate mortgages. Nonetheless, the limited housing supply continues to strain affordability. Paradoxically, lower interest rates could stimulate existing home inventory, alleviating supply constraints and offering more choices to buyers. 

Commercial real estate, particularly office spaces, is facing significant pressure. Prolonged interest rates raised by the Fed may hasten the exposure of poorly underwritten transactions with historically low cap rates, rendering them unfinanceable. Additional events, such as the collapse of a large European real estate fund (as reported in the WSJ) hint at more difficulties ahead for this sector. 

Amidst robust economic data, low unemployment, and a thriving stock market, long-term interest rates are likely to remain relatively stable for now. Our forecast of the 10-year Treasury trading between 4% to 4.5% remains consistent, with inflation settling around 3%. 

Market Commentary 2/02/2024

Posted on by Damon Germanides

US Economy Defies Skeptics With Blowout Jobs Number

Skeptics grappling with conflicting data between the substantial increase in state unemployment figures and the recent non-farm payroll data were surprised by the blowout December Jobs Report. It showed that hourly earnings exceeded expectations, and the unemployment rate remained at a low 3.7%. Additionally, treasury yields surged, with the 10-year Treasury rising above 4% mid-day.

Today’s nonfarm payroll report highlights the strength of the US economy while also diminishing the likelihood of a Fed rate reduction in March. The Federal Reserve had recently met and signaled that a rate cut in March was improbable. The stellar earnings from companies like Meta and Amazon, as well as record highs in the stock market further suggest the overall health of the economy, making the Fed question if they should consider rate cuts in a seemingly robust environment. Better to keep rate cut powder dry in the event of a financial accident or deep recession.

Nonetheless, it’s essential to consider the backdrop of numerous layoff announcements. Despite the dominance of big tech companies in financial news, all is not entirely well in the broader economy. A significant regional bank experienced a 40% drop in its stock price due to issues related to its commercial real estate portfolio. UPS, often considered a barometer of economic activity, reported significant layoffs and plans to cut 12,000 jobs. While the exact timing of a potential negative jobs report remains uncertain, there are indications that the economy might be showing signs of weakness. This could lead to lower bond yields later in the year, though perhaps not as soon as initially anticipated by Wall Street.

Inflation is on the decline but may not reach the 2% target anytime soon. Hot wars in the Middle East and robust consumer spending are creating uncertainty on inflation. However, even with a baseline assumption of 3% inflation, the Fed still has room to cut short-term interest rates by as much as 1.00% to 1.5% from the current 5.25%. This would keep rates in a “restrictive territory” without harming the economy and the banking system. Lower rates would particularly benefit real estate activity. The expectation is that rates will trend lower come August.

One consideration for lower rates, even with elevated inflation, is the global surge in government debt, with the US being no exception at over $34 trillion in debt. The Fed is cognizant of this massive liability and might be compelled to lower rates to assist the Treasury in servicing the country’s bill. The size of the US debt is gradually becoming a prominent issue that cannot be ignored any longer.

Market Commentary 1/26/2024

Posted on by Damon Germanides

US Economy Continues to Impress as Consumer Spending Beats Expectations 

Strong consumer spending and a better-than-expected 4th quarter GDP advocate the soft-landing narrative. The recent PCE inflation report, favored by the Fed, came in as expected with the indication that inflation is cooling. Despite positive economic indicators like a surging stock market, low unemployment, and increased housing activity, there are concerns that the Fed may not lower rates as quickly as some economists suggest. 

Our perspective is that while inflation is cooling, it remains too high when viewed on a 3-year average, which is up over 20%. Wages have not risen at the same pace, leaving consumers with less to spend. Some costs, especially essential expenses, seem to have increased significantly more than 20% when compared to pre-COVID levels. 

There are a few reasons why mortgage rates are showing improvement, and some products have rates below 6.00%. First, with the Fed signaling the end of its hiking cycle, banks can better forecast their cost of funds and price mortgage products along the yield curve. Second, mortgage spreads are tightening, leading to lower rates. Furthermore, with the start of 2024, each bank has new production goals, increasing competition and keeping banks honest on pricing. This is positive news for the housing market and the residential real estate community. 

Turning to national debt and the consumer, the national deficit is over $34 trillion (about $100,000 per person in the US) and is a growing concern. Overspending was once considered a problem for future generations and is now a pressing issue. While there’s no immediate risk of a government default, there’s concern that if bond vigilantes demand higher yields due to perceived risk, bond yields could rise despite the Fed lowering short-term interest rates. While the likelihood of this happening in the short term remains low, it’s worth monitoring. 

Credit card spending remains robust, indicating that consumers are optimistic about the future. However, credit card balances and delinquencies are rising, suggesting that borrowed money is not being repaid as quickly as before. This shift in credit card data, often seen as a high-frequency economic indicator, could be a sign of the economy’s health, with consumers generally in good shape. 

In conversations with various business owners, we observe a mixed economic landscape. Some businesses are thriving, some face challenges, and others remain uncertain about the future. Although the economy appears to be in better shape than expected last year, it remains fragile. Nonetheless, overall business sentiment is more optimistic than the previous year, a benefit to the existing home market while real estate brokers prepare for the busy spring season. 

Market Commentary 1/12/2024

Posted on by Damon Germanides

Bond Market Believes Lower Inflation Here To Stay 

For the moment, the bond market is betting on lower interest rates despite a better-than-expected December Jobs report and a hotter-than-forecast CPI print. PPI, or wholesale inflation, helped reinforce the belief that inflation should continue to trend downward, a view we share but with some skepticism. Several hot spots around the world remain and a flair-up of any could adversely affect both the oil and shipping markets, thus creating inflation. For now, that has not happened, but it does remain a concern. Of additional anxiety is the massive Treasury issuance.  This could push interest rates up, but again, for now, the trend is lower rates.  Expectations of lower inflation and increased business confidence have also improved and there is a sense that the Fed may pull off their so-called “soft landing.” We remain cautiously optimistic. Keep a close eye on the coming earnings seasons as a tell to how the economy is performing. More on this in the coming weeks.

The drop in mortgage rates has inspired new applications as activity is picking up across all markets. Also, mortgage prices have benefited from the compression in the spread, which has been unusually high this past year and remains elevated.  Banks seem to be in a better mood as we enter 2024.  All of this is welcomed after a challenging 2023. The combination of Treasury rates under 4% plus tighter margins is leading to some jumbo lenders now offering rates in the 5.500% with banking.       

Market Commentary 1/05/2024

Posted on by Damon Germanides

December Jobs Report Keeps Rates Flat

A better-than-expected Jobs Report pushed interest rates above 4% this morning before retreating down. A deeper dive into the Jobs Report suggests the jobs market may be cooling off. With a drop in the participation rate, more temp workers are unable to find jobs and more people accepting part-time work or working fewer hours. Employers remain cautious about firing workers given the difficulty experienced in replacing those workers during COVID and post-COVID. Of additional concern is wage growth, which is still running at 4% plus, a number higher than the Fed would like to see. On Wall Street, some believe the report was good enough to keep the Fed on pause through at least March, perhaps even longer.  

Inflation has cooled on the goods front, but wage and service inflation are still too high. Geopolitical worries abound including the Israel-Palestine conflict, which is starting to create issues with major shipping vessels navigating the Strait of Hormuz, causing a rise in shipping costs and potentially oil prices. The worry here is that one wrong move could spark a regional war which could have unintended consequences, including an oil spike, which could complicate the Fed’s inflation fight.  However, that is an obvious problem so the markets may have already priced in this outcome. One never does know.

We have spoken previously about the path to 5% mortgage rates and we are getting closer. One requirement to reaching this goal is that the mortgage spreads over Treasuries must continue to compress. The Wall Street Journal reported today that this is finally happening, with the expectation that should Treasury rates fall further, the mortgage spread would also follow.

A big reason spreads have been so wide is that banks and investors have been concerned about a drop in interest rates and the refinance risk associated with those drops. With the quick decline from 5% to 4% in the 10-year treasury, lenders are starting to get more competitive on pricing. In addition, another tailwind for real estate brokers and mortgage originators alike is the start of a new year and new volume targets so pricing remains sharp, which has led to much-improved activity to establish the year.

A quick look at programs and types of borrowers

  • High Net worth with banking:                      
    • Rates from 5.250%/6.196% APR. Loan amounts up to $25M
  • Complex high net worth with banking:         
    • Rates from 6.000%/6.488%. Loan amounts to $10M
  • Traditional Jumbo:                                                
    • Rates from 6.000%/6.488%. Loan amounts to $4M
  • No Income Verification Loans:                         
    • Rates from 7.500%/7.603%. Loan amounts up to $2.5M
  • Conforming Loans:                                               
    • Rates from 5.875%/6.032%. Loan amounts up to $1,149,825

Happy New Year!

Market Commentary 12.15.2023

Posted on by Damon Germanides

Fed Forecast To Bring Down Rates Pushes Mortgage Rates Lower

The recent dovish pivot by the Federal Reserve, along with projections of up to three rate cuts next year, brought a sigh of relief to the markets. Equities, bonds, gold, and oil, all rallied in response. This shift by the Fed signaled a so-called “soft-landing” narrative. Inflation data has been pointing toward lower inflation as the economy continues to move forward with weak manufacturing data, but a strong service sector.

Mortgage rates also saw a significant drop, with 30-year mortgages now below 6.50%, and adjustable-rate mortgages anticipated to dip below 6%. This is a remarkable change from just a few weeks ago when mortgage products were touching 8%. Let’s delve into the reasons behind this sudden change of heart by the Fed and the markets.

Inflation Trends

Consumer and producer inflation data have been showing positive trends for quite some time. With inflation on the decline, the Fed Funds Rate, currently at 5.37%, stands well above the inflation rate (CPI) of 3.1%. This significant spread is viewed as restrictive, and now the Fed must consider if keeping rates higher for an extended period might do more harm than good. Additionally, signs of a slowing economy are emerging, which further supports the case for lowering interest rates.

Inverted Yield Curve

The yield curve has been inverted for an extended period, and the Fed would like to see it normalize. This normalization would benefit lenders who borrow short and lend long. When long-term interest rates are lower than short-term interest rates, it becomes challenging for lenders to generate profits due to the negative spread. A robust economy requires lenders willing to extend credit. Moreover, the massive US debt and the costs associated with servicing that debt become unsustainable at higher interest rates.

Quantitative Tightening (QT)

The ongoing QT (Quantitative Tightening) may provide the Fed with some flexibility to lower short-term interest rates and allow bonds to run off their balance sheet. Over the past decade, global central banks’ money printing and bond buying have led to enduring issues, as the cost of money became distorted. By lowering the Fed Funds Rate while continuing QT, the Fed remains somewhat restrictive but with a bit less tightening.

Nonetheless, we still anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. When you add a term premium of 1% to 1.5%, that’s where the 10-year Treasury should find its equilibrium.

10 Year Treasury & Employment

As previously stated, we continue to anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. Employment remains tight and wages appear to be sticky (and possibly rising again) which will continue to be monitored by the Fed. This could inhibit interest rates from going much lower than current levels.

For the moment, we will take the late-year gift from the Fed of the prospect of lower interest rates which is leading to a big pickup in borrower inquiries.

Market Commentary 12.8.2023

Posted on by Damon Germanides

A Quick Read On Rates, Jobs And Housing

A better-than-expected November Jobs Report took some shine off the recent rally in bonds, which had been surging over the past few weeks. The report was positive, but not great, although it did surprise Wall Street as both new hires and unemployment beat economists’ estimates. Something that is of particular concern and a focus of the Federal Reserve is the slight acceleration in wage growth, adding to some uncertainty about when the Fed might change its stance. The direction of interest rates from here is anyone’s guess, but the stronger-than-expected jobs data likely keeps the Fed in the “higher for longer” camp, at least in our opinion.

Anecdotal evidence suggests that the economy might be slowing, based on reports from local business owners. However, this has yet to translate into jobs data or consumer spending. Inflation, while still at elevated levels, seems to be moderating. Nonetheless, high credit card balances, rising delinquencies, and the overall high cost of debt are indications that consumers are feeling some pressure. Despite these concerns, GDP and other economic indicators still point to the economy being in reasonably good shape. Overall, the prediction suggests that the path ahead is challenging.

Turning to the housing market, activity in the existing home market, particularly in Southern California, appears to be picking up. Interest rates have fallen to under 7%, and some well-qualified borrowers are securing rates as low as 5.875%. This has prompted buyers to reenter the market, taking advantage of small price reductions and more reasonable interest rates. Large-scale home builders are employing various strategies to attract buyers, including helping first-time home buyers qualify for mortgages. Although construction loans from banks remain subdued, the private lending market is bustling, offering more expensive financing with greater leverage, something most developers need to initiate projects.

While there has been a downward trend in interest rates, it’s important to note that we may have reached a bottom, at least for now. A few additional thoughts on this matter; first, the Bank of Japan is likely to move away from its negative interest rate policy, which could exert pressure on bonds worldwide. Second, assuming a 3% inflation rate and real economic growth of 1.5%, the 10-year Treasury rate could stabilize around 4.5%, give or take 0.5%. Finally, it’s worth mentioning that historical interest rates have averaged significantly higher than current rates. While the recent rate increases have caused discomfort, part of the pain is due to the steepness of the rate hikes and the extended period during which rates were held at arguably too low levels. Looking ahead, if the spread over treasuries narrows, it’s conceivable that mortgage rates could range from the high 4s to the mid-5s in 2024, potentially providing significant support to the real estate market.

Market Commentary 12/01/2023

Posted on by Damon Germanides

Both Bonds & Stocks Rally Into December

November marked an exceptional month for both bonds and equities. Just a few weeks ago, interest rates surged above 5% and sent mortgage markets into a frenzy. Fast forward to today, and we’re witnessing the 10-year Treasury hovering around 4.25%. In addition, lenders are beginning to reduce interest rates. If this trend persists (we discussed this in previous commentaries) mortgage rates in the mid-5% range could become a reality. This is expected to entice buyers who have been sitting on the sidelines, as more affordable mortgage payments beckon.

Having said that, it’s essential to consider the reasons behind this decline in rates. One perspective is that the market anticipates the Fed will lower short-term interest rates next year as inflation subsides. While there’s cautiousness surrounding inflation, given its deep-seated presence in the economy, the consensus leans toward a more extended timeline to control it. Nevertheless, dovish Fed statements, coupled with moderating inflation data, have relaxed financial conditions as evidenced in the lower interest rates and now flourishing stock market. While there’s optimism that the Fed will engineer a soft landing, reflecting Wall Street’s current sentiment, the recent rally underscores the market’s exuberance. Our concerns are centered around the possibility of eased financial conditions rekindling inflation.

Another narrative suggests that interest rates are declining as bond traders assess the broader economy, indicating an economic slowdown. Assuming a 3% inflation rate and 1.5% GDP growth, a 10-year Treasury around 4.5% appears plausible. For now, the downward rate movement should be acknowledged and leveraged, given that borrowing costs have decreased by 0.50 to 0.75 basis points across the board. This is a significant development.

This year, regions primarily driven by the existing homes market like Southern California have faced challenges. Recently there has been a significant uptick in activity over the past few weeks, encompassing refinance, purchase, and construction loan requests. The drop in interest rates is fostering momentum, and we are encouraged by the resurgence of inquiries. After a challenging year, it’s heartening to hear the phones ringing again. To hear borrowers express enthusiasm about the prospect of interest rates stabilizing at acceptable levels. A welcome development timed for the holiday season.