USA – Page 10 – Digital Finance Analytics (DFA) Blog

FED Holds In November (But Expect A Rise In December)

Information received since the Federal Open Market Committee met in September indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

There was no mention of the deterioration in data with policymakers describing household spending growth as strong even though core retail sales stagnated in September. This unambiguously positive outlook is a signal of the central bank’s commitment to raising interest rates. There’s no doubt that the Fed will hike in December, especially if stocks maintain their current recovery.

The T10 Bond Rate went higher.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

US Bank Capital Requirements Eased

Moody’s says that relaxed regulatory oversight for the largest US regional banks would be credit negative.

On 31 October, the US Federal Reserve (Fed) proposed revisions to the prudential standards for the supervision of large US bank holding companies to implement the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act) that became law in May of this year. The proposal would apply less rigorous capital and liquidity standards to most large regional bank holding companies with less than $700 billion of consolidated assets or less than $75 billion of cross-jurisdictional activity, a credit-negative.

In particular, the Fed proposals would relax current supervisory requirements for banks with assets of more than $250 billion, which goes beyond the Act’s primary focus on banks below that threshold. However, the proposal is still consistent with the Act’s emphasis on regulation that increases in stringency with a firm’s risk profile, defining four categories of banks as described and named in Exhibit 1 (other firms are no longer subject to the Fed’s enhanced prudential standards under the Act).

The 11 firms in Category IV would be subject to significantly reduced regulatory requirements under the proposal, including public supervisory stress testing every two years instead of annually. These firms would also be permitted to exclude accumulated other comprehensive income (AOCI) from capital and would no longer be subject to the liquidity coverage ratio (LCR) or proposed net stable funding ratio (NFSR) rules. Internal liquidity stress-testing would be required quarterly rather than monthly.

The four firms in Category III would be subject to modestly reduced regulatory requirements under the proposal. They would no longer have to apply the advanced approaches (internal models-based) risk-based capital requirements but would remain subject to the standardized approach requirements. Like Category IV firms, they could elect to exclude AOCI from capital. However, they would still be subject to the annual public supervisory stress tests. Their LCR and NFSR requirements would be reduced to between 70% and 85% of full requirements.

The changes in capital and liquidity requirements for Category III and IV firms are likely to reduce their capital and liquidity buffers, a credit negative. Moreover, the reduced frequency of capital and liquidity stress testing could lead to more relaxed oversight and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since fewer firms will participate in the public supervisory stress test.

Category I and II firms would not see any changes to their capital or liquidity requirements. The proposals do not address the US operations of foreign banking organizations, but a proposal on their supervision will likely be forthcoming.

US Banks to See Diminishing Returns from Rising Rates

US banks should begin to see less and less benefit to earnings from rising short-term interest rates over the coming quarters, Fitch Ratings says. Net interest margins (NIMs) have continued to expand on a year-over-year basis due to the ongoing ability to lag funding costs relative to loan and investment portfolio repricing.

However, Fitch expects funding cost betas (or the proportion of the change in funding costs relative to the change in short-term interest rates) to continue to accelerate over the remainder of 2018 and into 2019. This could result in margin expansion stalling or even eventually reversing, which has begun in some markets driven by strong competition for both loans and deposits. Moreover, if longer-term interest rates continue to float upward and housing supply remains tight, Fitch expects to see further diminished levels of revenue generated from mortgage-banking operations across the industry.

Given how low rates were for so long, most U.S. banks had positioned their balance sheets to be asset sensitive. Banks that had been more asset sensitive at the beginning of the Fed tightening cycle were generally rewarded with margin expansion. By and large, these banks have shorter duration loan and investment portfolios, as well as strong core deposit franchises. Consequently, funding cost betas have remained lower relative to earning asset betas.

However, as low-or-no-cost deposits continue to either roll off balance sheets or rotate into higher cost deposit products such as money market savings accounts or certificates of deposits (CDs), returns from rising rates could diminish over time. Moreover, as the competitive environment for loans continues, Fitch believes loan spreads could remain tight, resulting in lower earning asset betas as short-term rates increase.

As seen below, in the past two tightening cycles, funding costs proved more sensitive to increasing rates than asset yields. This is in contrast with what has been experienced in the current tightening cycle so far, but funding cost betas have begun to close the gap.

Banks with low loan-to-deposit ratios should be able to maintain some flexibility to choose between repricing deposits and allowing some deposit runoff, which could allow for modest NIM expansion. On the other hand, those seeking to grow deposits to fund loan growth are likely to see funding costs continue to rise.

Rising rates, along with tight supply in the housing market, should also continue to pressure the revenue generated by and subsequent net income from mortgage operations at U.S. banks. Mortgage originations fell 16% at JPMorgan and 22% at Wells Fargo in 3Q18 on a year-over-year basis. Smaller mortgage competitors such as Hilltop Holdings saw originations fall 8% year over year and pre-tax income within the segment fall over 60%, weighing on the company’s overall earnings performance.

The Mortgage Bankers Association forecasts mortgage originations to fall 6% in total for 2018 (led by a 24% drop in refinancings) after a 17% decline in 2017. Lower originations should result in continued fee income pressure and lower production margins as the industry right sizes its overcapacity.

Taken together, these two factors have the potential to reverse the NIM and revenue expansion that most banks have been experiencing going into 2019. Still, Fitch does not believe there will be broad ratings implications for US banks from NIM expansion stalling or even compressing, nor due to less profitable mortgage operations. Moreover, continued benign asset quality as well as better operating efficiency driven by digitization efforts could contribute to stable earnings performance over coming quarters.

US Employment Data Reaffirms FED Rate Moves

The US Bureau of Labor Statistics released their October 2018 data overnight. It was another strong result, with the unemployment rate steady at 3.7% and 250,000 additional jobs added. Over the year, average hourly earnings have increased by 83 cents, or 3.1 percent. More evidence that the FED will continue its path of lifting rates.

The unemployment rate remained at 3.7 percent in October, and the number of unemployed persons was little changed at 6.1 million. Over the year, the unemployment rate and the number of unemployed persons declined by 0.4 percentage point and 449,000,respectively.

The number of long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged at 1.4 million in October and accounted for 22.5 percent of the unemployed.

The labor force participation rate increased by 0.2 percentage point to 62.9 percent in October but has shown little change over the year. The employment-population ratio edged up by 0.2 percentage point to 60.6 percent in October and has increased by 0.4 percentage point over the year.

The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) was essentially unchanged at 4.6 million in October. These individuals, who would have preferred full-time employment, were working part time because their hours had been reduced or they were unable to find full-time jobs.

In October, 1.5 million persons were marginally attached to the labor force, little changed from a year earlier. (Data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Among the marginally attached, there were 506,000 discouraged workers in October, about unchanged from a year earlier. (Data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The remaining 984,000 persons marginally attached to the labor force in October had not searched for work for reasons such as school attendance or family responsibilities.

Total nonfarm payroll employment increased by 250,000 in October, following an average monthly gain of 211,000 over the prior 12 months. In October, job growth occurred in health care, in manufacturing, in construction, and in transportation and warehousing.

Health care added 36,000 jobs in October. Within the industry, employment growth occurred in hospitals (+13,000) and in nursing and residential care facilities (+8,000). Employment in ambulatory health care services continued to trend up (+14,000). Over the past 12 months, health care employment grew by 323,000.

In October, employment in manufacturing increased by 32,000. Most of the increase occurred in durable goods manufacturing, with a gain in transportation equipment (+10,000). Manufacturing has added 296,000 jobs over the year, largely in durable goods industries.

Construction employment rose by 30,000 in October, with nearly half of the gain occurring among residential specialty trade contractors (+14,000). Over the year, construction has added 330,000 jobs.

Transportation and warehousing added 25,000 jobs in October. Within the industry, employment growth occurred in couriers and messengers (+8,000) and in warehousing and storage (+8,000). Over the year, employment in transportation and warehousing has increased by 184,000.

Employment in leisure and hospitality edged up in October (+42,000). Employment was unchanged in September, likely reflecting the impact of Hurricane Florence. The average gain for the 2 months combined (+21,000) was the same as the average monthly gain in the industry for the 12-month period prior to September.

In October, employment in professional and business services continued to trend up (+35,000). Over the year, the industry has added 516,000 jobs.

Employment in mining also continued to trend up over the month (+5,000). The industry has added 65,000 jobs over the year, with most of the gain in support activities for mining.

Employment in other major industries–including wholesale trade, retail trade, information, financial activities, and government–showed little change over the month.

The average workweek for all employees on private nonfarm payrolls increased by 0.1 hour to 34.5 hours in October. In manufacturing, the workweek edged down by 0.1 hour to 40.8 hours, and overtime was unchanged at 3.5 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls, at 33.7 hours, was unchanged over the month.

In October, average hourly earnings for all employees on private nonfarm payrolls rose by 5 cents to $27.30. Over the year, average hourly earnings have increased by 83 cents, or 3.1 percent. Average hourly earnings of private-sector production and nonsupervisory employees increased by 7 cents to $22.89 in October.

The change in total nonfarm payroll employment for September was revised down from +134,000 to +118,000, and the change for August was revised up from +270,000 to +286,000. The downward revision in September offset the upward revision in August. (Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.) After revisions, job gains have averaged 218,000 over the past 3 months.

US Housing’s Minor Slump

According to Moody’s, U.S. housing is in the midst of a minor slump.

Housing starts fell 5.3% to 1.2 million annualized units in September, close to our forecast of 1.195 million but weaker than the consensus of 1.22 million. Revisions were mixed. Starts are now shown to be 1.268 million annualized units in August (previously 1.282 million) and 1.184 million in July (previously (1.177 million).

Turning back to September, single-family starts fell 0.9% to 871,000 annualized units. Multifamily starts dropped 15.2% to 330,000 annualized units. It’s likely that Hurricane Florence hurt housing starts in September. To assess the potential impact, we look at the not seasonally adjusted starts in the South, which fell 17.3% in September, the most for any September since 2007. Total permits fell 0.6% to 1.241 million annualized units, weaker than we had anticipated. The good news is that single-family permits rose 2.9%, reversing some of the 5.3% decline in August. The trend in single-family permits has weakened, and starts are still running ahead of permits, which isn’t overly favorable. For the sixth consecutive month, multifamily permits dropped, falling 7.6% in September. However, permits are still running ahead of multifamily starts, suggesting a pickup in starts in the next couple of months.

Housing starts lowered our high-frequency GDP model’s estimate of real residential investment in the third quarter. The impact on GDP wasn’t significant. We are playing a little catch-up and Wednesday’s run of our high-frequency GDP model also incorporates the monthly Treasury budget and industrial production for September. Federal government spending is coming in stronger than previously thought, which boosted our estimate of third quarter GDP while September industrial production had no effect. Overall, third quarter GDP is on track to rise 3.3% at an annualized rate.

September U.S. retail sales disappointed, but the details were solid. Nominal retail sales rose 0.1%, well short of both our and consensus expectations. A decline in sales at gasoline stations and large drop in restaurants weighed on growth in total retail sales. Odds are that Hurricane Florence hurt spending at restaurants, consistent with past hurricanes. Our forecast had penciled in a decline in restaurants, but gasoline was a little surprising. Building material store sales slipped in September, but there should be a hurricane boost in October. Overall, Florence was a net negative for retail sales in September and there is little evidence of a boost from sales of the new iPhone.

The key for GDP is control retail sales, or total excluding autos, building materials, gasoline and restaurants. Control retail sales rose 0.5% in September but they were revised lower in each of the prior two months. Overall, control retail sales were up 4.8% at an annualized rate in the third quarter. September control retail sales suggest that real consumption likely rose 0.4%, which lowered our highfrequency GDP model’s estimate of real spending in the third quarter from 3.7% to 3.5%. This is still a solid quarter for consumer spending.

This week we also updated our cost estimates for both Hurricane Florence and Hurricane Michael. For Michael, we have increased our estimate of property losses to between $17 billion and $20 billion. Lost output due to disruptions and power outages remains between $4 billion and $6 billion, leading to a total price tag of $21 billion to $26 billion. We lowered our cost estimate for Hurricane Florence to $30 billion to $38 billion.

On the policy front, the minutes of the September Federal Open Market Committee meeting didn’t contain many surprises, and the discussion about whether it’s appropriate to eventually have a more restrictive monetary policy was healthy. It was not as hawkish as recent comments by Federal Reserve Chair Jerome Powell, who said that monetary policy is nowhere near neutral, which implied even more rate hikes. Therefore, the minutes don’t alter our subjective odds of a December rate hike (90%) nor our expectation that the Fed will raise rates once per quarter until they hit the terminal rate around 3.5%.

There is a strong consensus within the Fed that monetary policy will turn restrictive. Only a “couple of participants”—meaning two out of 16—would not favor going into restrictive territory absent clear signs of overheating and rising inflation. They are in the clear minority, but the discussion of restrictive monetary policy shouldn’t be surprising; this has been clearly evident in the Fed’s so-called dot plot, which since September 2017 has shown that the actual fed funds rate would eventually be set above the long-run equilibrium rate.

There were no other heated debates in the minutes. One interesting tidbit was the mention that there is little evidence to suggest that the upward pressure on the federal funds rate relative to the interest on excess reserves is attributable to any shortage of aggregate reserves in the banking system. We think the jury is still out on this, and this is important because the supply of reserves is going to be key in determining how much the Fed can reduce its balance sheet as well as the timing for the completion.

Fed Minutes Underscores Higher Rates Ahead

The Federal Reserve released the minutes relating to the 26th September decision to lift rates. The impression from the more detailed disclosures is that more hikes are likely, and perhaps quicker than originally expected. Members agreed to remove the sentence indicating that “the stance of monetary policy remains accommodative.”

US Mortgage Rates continue higher.

This is what the FED said:

In their discussion of monetary policy for the period ahead, members judged that information received since the Committee met in August indicated that the labor market had continued to strengthen and that economic activity had been rising at a strong rate. Job gains had been strong, on average, in recent months, and the unemployment rate had stayed low. Household spending and business fixed investment had grown strongly. On a 12-month basis, both overall inflation and inflation for
items other than food and energy remained near 2 percent.

Indicators of longer-term inflation expectations were little changed on balance.

Members viewed the recent data as consistent with an economy that was evolving about as they had expected. Consequently, members expected that further gradual increases in the target range for the federal funds rate would be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Members continued to judge that the risks to the economic outlook remained roughly balanced.

After assessing current conditions and the outlook for economic activity, the labor market, and inflation, members voted to raise the target range for the federal funds rate to 2 to 2¼ percent. Members agreed that the timing
and size of future adjustments to the target range for the federal funds rate would depend on their assessment of realized and expected economic conditions relative to the Committee’s maximum-employment objective and symmetric 2 percent inflation objective. They reiterated that this assessment would take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

With regard to the postmeeting statement, members agreed to remove the sentence indicating that “the stance of monetary policy remains accommodative.” Members made various points regarding the removal of the sentence from the statement. These points included that the characterization of the stance of policy as “accommodative” had provided useful forward guidance in the early stages of the policy normalization process, that this characterization was no longer providing meaningful information in light of uncertainty surrounding the level of the neutral policy rate, that it was appropriate to remove the characterization of the stance from the Committee’s statement before the target range for the federal funds rate moved closer to the range of estimates of the neutral policy rate, and that the Committee’s earlier communications had helped prepare the public for this change.

In choppy trading in the US on Wednesday, it appears the markets are coming to accept higher rates ahead. The Dow Jones Industrial Average fell 91.74 points, or 0.36 percent, to 25,706.68.

The Fear Index eased a little to 17.40, down 1.25%, but volatility still stalks the halls.

The S&P 500 lost 0.71 points, or 0.03 percent, to 2,809.21.

The Nasdaq Composite dropped 2.79 points, or 0.04 percent, to 7,642.70.

The 10-Year Bond rate continued higher ending at 3.207, up 0.88%.

US Banks’ Mortgage Revenue Will Stay Depressed As Interest Rates Rise Further

According to Moody’s, on 11 October, the Federal Home Loan Mortgage Corp. reported that US 30-year fixed-rate mortgage rates reached their highest level since April 2011.

The average rate was 4.90% for the week that ended 11 October, compared with 3.91% a year earlier. For US banks, higher mortgage rates will constrain mortgage origination volume, keeping their once-sizable mortgage banking revenue at depressed levels, a credit negative. Higher interest rates will also heighten the potential that some customers will have trouble servicing their existing debt and could translate into weaker credit quality, a further negative for US banks.

Mortgage banking revenue at US banks has been on a downward trajectory for some time. This reflects both a drop in origination volume and lower gain-on-sale margins. The volume decline has followed a multi-year period during which consumers took advantage of rising home values and historically low interest rates to refinance their mortgages. Now that refinancing volume is at a lower level, home purchases are the source of most current originations.

Reduced gain-on-sale margins reflect heightened pricing competition that resulted from excess industry capacity. Going forward, although volume may not increase because of the climb in interest rates, gain-on-sale margins could rise as industry capacity contracts.

The 12 October third-quarter 2018 earnings reports from some of the country’s largest banks illustrate these trends. As shown in the exhibit below, both Wells Fargo & Company and JPMorgan Chase & Co., the country’s two largest mortgage originators, released results that showed mortgage banking revenue remains at or near multi-year lows. Specifically, at Wells Fargo, although mortgage banking revenue climbed in the quarter, for the nine months that ended 30 September 2018, mortgage banking revenue accounted for 3.9% of total firm-wide revenue, down from 10.5% as recently as 2013. At JPMorgan Chase, mortgage banking revenue declined in the third quarter and, on a year-to-date basis, it accounted for just 1.3% of total firm-wide revenue, down from 5.4% in 2013.

The recent rise in mortgage interest rates makes it unlikely that US banks’ mortgage banking volume and revenue can rebound materially in the next few quarters. However, given that mortgage banking has long been a cyclical business, the banks can improve their profitability by reducing capacity, as they have done in prior periods of lower volumes. Indeed, both Wells Fargo and JPMorgan Chase were reported to have reduced hundreds of positions within their respective mortgage banking units in the past few months. We believe both firms’ recent performance and response are representative of the wider industry trend More broadly, the recent rise in interest rates heightens the potential that some borrowers will have trouble servicing their existing debt, raising the potential of higher loan delinquencies. However, the US economy remains robust and the banks’ latest earnings reports show continued strong credit quality, an indication that higher rates have not yet undermined existing loan performance.

US Markets Get The Jitters

Overnight the US markets took a dive on the back of higher interest rates with the S&P 500 and the Dow marking their biggest daily declines since Feb. 8, and technology stocks at the center as investors jettisoned more risky assets. Plus, Investors were also worried about the impact of trade tensions on corporate profits and Hurricane Michael’s landfall in Florida adding to the uncertainty.

The U.S. 10 Year Treasury yields rose again in extension of a trend over the last few weeks fuelled by solid U.S. economic data that reinforced expectations of multiple interest rate hikes over the next 12 months.

It ended at 3.17, down 1.58% on the day, while the 3-month Treasury was up 0.12% to 2.27.

The CBOE Volatility Index (VIX), Wall Street’s “fear gauge,” rose 7 points, or nearly 44 percent, to 22.96, going above 20 for the first time since April 11 and hitting its highest close since April 2.

The Nasdaq ended at 7,422 and registered its biggest daily drop since June 24, 2016, hurt by technology stocks which had their biggest one-day drop since August 2011.

The S&P 100 ended the day down 3.41 percent, to 1,239, nearly 5% off its recent September highs.

The Dow Jones Industrial Average (DJI) fell 831.83 points, or 3.15 percent, to 25,598.74, a reversal from recent highs.

Gold however hardly moved, sitting at 1,198 almost flat for the day.

The Aussie slide further against the US dollar, and is currently silting at 70.59.

Expect more bad news from the local market today as uncertainty reigns supreme. It’s too soon to tell is this is another blip, of a more fundamental swing in confidence, but we think the higher US rates are the key. So expect more falls ahead.

The local market opened lower.

The Great Bond Sell-Off

The US 10 Year Bond has spiked higher, in response to strong employment growth and comments from the FED, suggesting that interest rates in the US could rise faster and further. So we discuss the news.

In short, the global sovereign bond market breadth is looking sick.

The US 10 Year Bond Yield has spiked to 3.195, up 1.06% as I write this, and looks to be set to climb higher, to levels not seen in more than seven years. The ADP National Employment Report showed private payrolls jumped by 230,000 jobs in September, the largest gain since February, while a report from the Institute for Supply Management showed services sector activity hit a 21-year high in September. Simply put, when the economy is firing on all cylinders and when traders have reason to defend against the possibility of even faster growth and inflation (something today’s data may well suggest), rates are forced to move higher.

Traders now see a 78.8 percent chance of a 25 basis point hike at the December meeting of the Fed, up from 77.4 percent a week ago. In contrast the 3-Month Bound Yield rose only 0.09% to 2.225, so the signs of an inversion have not really changed much.

But it’s worth looking more broadly. Here is an interesting picture, with the red line showing the 200 day moving average breadth of global sovereign bond yields in the developed markets. In other words, it shows what proportion of global government bond yields are trading below their 200 day moving average.

We are seeing fewer and fewer 10-year government bond yields trading below their 200 day moving averages. This suggests that government bond yields will continue to rise. The signs are there. In that context, the US 10-year government bond yield is the bellwether.

But there is something else here too. The US 10-year government bond yield is breaking higher at a time when bond market volatility is tracking around record lows.

Market watchers will tell you that low volatility is a good predictor of future higher volatility. We often see such low volatility around turning points in the markets.

So, putting this all together, it looks like bond yields will be rising higher – with significant consequences for our local banks funding. Already the BBSW has risen to more than 18 basis points from its February lows, having tracked lower recently. The changes in the US 10-Year will flow through into the international capital markets, and on into funding, and local mortgage rates.

US Mortgage rates skyrocketed today, in relative terms. It was the single worst day in nearly 2 years, and among only a few days where effective rates moved more than 0.10%.

In addition, the Aussie will go lower. The exchange rate with the US dollar has fallen to 70.90, and is likely to fall further. Not only does risk importing inflation into Australia but it also puts more pressure on the RBA to lift the cash rate. Foreign money could well flow out, seeking the higher returns on offer elsewhere.