Tag Archives: interest rates

Top Restructuring Banker: “We’re All Feeling Like It’s 2007 Again”

There is a group of bankers for whom “better” means “worse” for everyone else: we are talking, of course, about restructuring bankers who advising companies with massive debt veering toward bankruptcy, or once in it, how to exit from the clutches of Chapter 11, and who – like the IMF, whose chief Christine Lagarde recently saidWhen The World Goes Downhill, We Thrive– flourish during financial chaos and mass defaults.

Which is to say that the past decade has not been exactly friendly to the world’s restructuring bankers, who with the exception of two bursts of activity, the oil collapse-driven E&P bust in 2015 and the bursting of the retail “bricks and mortar” bubble in 2017, have been generally far less busy than usual, largely as a result of abnormally low rates which have allowed most companies to survive as “zombies”, thriving on the ultra low interest expense.

However, as Moody’s warned yesterday, and as the IMF cautioned a year ago, this period of artificial peace and stability is ending, as rates rise and as a avalanche of junk bond debt defaults. And judging by their recent public comments, restructuring bankers have rarely been more exited about the future.

https://s14-eu5.startpage.com/cgi-bin/serveimage?url=http%3A%2F%2Fprod-upp-image-read.ft.com%2F9eb98cae-36da-11e6-a780-b48ed7b6126f&sp=7a7ec5c1567b57624e3bbad2e33954ca

Ken Moelis

Take Ken Moelis, who last month was pressed about his rosy outlook for his firm’s restructuring business, describing “meaningful activity” for the bank’s restructuring group.

“Your comments were surprisingly positive,” said JPMorgan’s Ken Worthington, quoted by Business Insider. “Is this sort of steady state for you in a lousy environment? Can things only get better from here?”

Moelis’ response: “Look, it could get worse. I guess nobody could default. But I think between 1% and 0% defaults and 1% and 5% defaults, I would bet we hit 5% before we hit 0%.”

He is right, because as we showed yesterday in this chart from Credit Suisse, after languishing around 1%-2% for years, default rates have jumped the most in 5 years, and are now “ticking higher”

https://www.zerohedge.com/sites/default/files/inline-images/default%20rates%20rising.jpg

Moelis wasn’t alone in his pessimism: in March, JPMorgan investment-banking head Daniel Pinto said that a 40% correction, triggered by inflation and rising interest rates, could be looming on the horizon.

These are not isolated cases where a gloomy Cassandra has escaped from the asylum: already the biggest money managers are positioning for a major economic downturn according to recent research from Bank of America. And while nobody can predict the timing of the next collapse, Wall Street’s top restructuring bankers have one message: it’s coming, and it’s not too far off.

However, the most dire warning to date came from Bill Derrough, the former head of restructuring at Jefferies and the current co-head of recap and restructuring at Moelis: “I do think we’re all feeling like where we were back in 2007,” he told Business Insider: There was sort of a smell in the air; there were some crazy deals getting done. You just knew it was a matter of time.”

What he is referring to is not just the overall level of exuberance, but the lunacy taking place in the bond market, where CLOs are being created at a record pace, where CCC-rated junk bonds can’t be sold fast enough, and where the a yield-starved generation of investors who have never seen a fair and efficient market without Fed backstops, means that the coming bond-driven crash will be spectacular.

“Even if there is not a recession or credit correction, with the sheer volume of issuance there are going to be defaults that take place,” said Neil Augustine, co-head of the restructuring practice at Greenhill & Co.

The dynamic is familiar: since 2009, the level of global non-financial junk-rated companies has soared by 58% representing $3.7 trillion in outstanding debt, the highest ever, with 40%, or $2 trillion, rated B1 or lower. Putting this in contest, since 2009, US corporate debt has increased by 49%, hitting a record total of $8.8 trillion, much of that debt used to fund stock repurchases.  As a percentage of GDP, corporate debt is at a level which on ever prior occasion, a financial crisis has followed.

https://www.zerohedge.com/sites/default/files/inline-images/corporate%20debt%20to%20gdp%202.jpg

The recent glut of debt is almost entirely attributable to the artificially low interest-rate environment imposed by the Federal Reserve and its central bank peers following the crisis. Many companies took advantage and refinanced their debt before 2015 when a large swath was set to mature, kicking the can several years down the road. 

But going forward “there’s going to be refinancing at significantly higher rates,” said Steve Zelin, head of the restructuring in the Americas at PJT Partners.

And as the IMF first warned last April, refinancing at higher rates will further shrink the margin of error for troubled companies, as they’ll have to dedicate additional cash flow to cover more expensive interest payments.

“When you have highly leveraged companies and even a modest rise in interest rates, that can result in an increase in restructuring activity,” said Irwin Gold, executive chairman at Houlihan Lokey and co-founder of the firm’s restructuring group.

So with a perfect debt storm coming our way, many restructuring firms have been quietly hiring new employees to be ready when, not if, the economy takes a turn for the worse.

“The restructuring business is a good business during normal times and an excellent business during a recessionary environment,” Augustine said. “Ultimately, when a recession or credit correction does happen, there will be a massive amount of work to do on the restructuring side.” Here are some additional details on recent banker moves from Business Insider:

Greenhill hired Augustine from Rothschild in March to co-head its restructuring practice. The firm also hired George Mack from Barclays last summer to cohead restructuring. The duo, along with Greenhill vet and fellow co-head Eric Mendelsohn, are building out the firm’s team from a six-person operation to 25 bankers.

Evercore Partners in May hired Gregory Berube, formerly the head of Americas restructuring at Goldman Sachs, as a senior managing director. The firm also poached Roopesh Shah, formerly the chief of Goldman Sachs’ restructuring business, to join its restructuring business in early 2017.

“It feels awfully toppy, so people are looking around and saying, ‘If I need to build a business, we need to go out and hire some talent,'” one headhunter with restructuring expertise told Business Insider.

“In our world, people are just anticipating that it’s coming. People are trying to position their teams to be ready for it,” Derrough said. “That was the lesson from last cycle: Better to invest early and have a cohesive team that can do the work right away and maybe be a little bit overstaffed early, so that you can execute for your clients when the music ultimately stops.”

Of course, if the IMF is right (for once), Derrough and his peers will soon see a windfall unlike anything before: last April, the International Monetary Fund predicted that some 20%, or $3.9 trillion, of the total global corporate debt is in danger of defaulting once rates rise.

https://www.zerohedge.com/sites/default/files/images/user5/imageroot/2017/04/19/IMF%20debt%20warning%201.jpg

Although if and when that day comes, perhaps a better question is whether companies will be doing debt-for-equity swaps, or fast forward straight to debt-for-lead-gold-and canned food…

Source: ZeroHedge

***

Fortunately, the Dying Do Die

July 6, 2016 marks the point when the US government’s condition became irretrievably terminal. On that date the US Treasury’s 10-year note yield hit its low, 1.34 percent, and has been trending irregularly higher ever since. Historically, debt has been the life support for regimes in extremis. No regime has ever been more in debt than the US government. Its annual deficit and debt service expense are growing, old-age pension and medical programs face a demographic crunch, and now interest rates are rising. One way or the other, the government walking away from some or all of its promises is as set in stone as anything in this life can be.
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Bond Yields And Barbarians

I know Kung Foo, Karate, Bond Yields and forty-seven other dangerous words.

– The Wizard

For forty-four years I have trafficked in the bond markets. I have seen massive inflation, Treasury yields in the stratosphere and risk asset spreads that could barely be included on a chart. At four investment banks I ran Capital Markets, and was on the Board of Directors of those companies, and I have witnessed both extreme anger and one fist fight. It is funny, you know, how people behave when money is sitting there on the table.

One of the things rarely discussed in the Press are the mandates of money managers. Almost no one is unconstrained and virtually everyone is bound by regulations, the tax laws and FINRA and SEC stipulations. Life insurance companies and casualty companies and money managers and Trust Departments and everyone is sidled with something. There are no escapes from the dilemmas.

The markets are a random lottery of meaningless tragedies, a couple of wins and a series of near escapes. So, I sit here and I smoke my cigars, staring raptly at it all. Paying very close attention.

There are two issues, in my mind, to be considered carefully when assessing future interest rates. The first is supply, especially the forward borrowing by the U.S. government. “It’s supply,” Michael Schumacher, head of rate strategy at Wells Fargo (NYSE:WFC), told CNBC’s Futures Now. “When you think about the enormous amount of debt that U.S. Treasury’s got to issue over not just this year, frankly, but next year, it’s staggering,” he said.

Using Michael’s calculations, the Treasury will issue more than $500 billion in notes and bonds in the second to the fourth quarter, pushing the total to around $650 billion for the year. Last year, the total came to just $420 billion. That is approximately a 35% increase in issuance. This raises a fundamental question, who are going to be the buyers and at what levels?

The second issue centers on the Fed and what they might do. They keep calling for rate hikes, like it is a new central bank mantra, and they are increasing the borrowing costs of the nation, corporations and individuals, as a result. I often wonder, in their continual clamor for independence, just who they represent.

You might think that the ongoing demand for higher yields does not exactly help the Treasury’s or the President’s desire to grow the economy as the Fed moves in the opposite direction and tries to slow it down by raising rates. I have often speculated that there might be some private tap on the shoulder, at some point, but no such “tap” seems to have taken place or, if it has occurred, it is certainly being ignored, at least in public.

Here are some interesting questions to ponder:

How much of our U.S. and global growth is real?

How much of it, RIGHT NOW, is still being manufactured by the Fed’s, and the other central banks’, “Pixie Dust” money?

Does the world seem honestly ready to economically walk on its own two feet?

If you answered “No,” to the last question, how do you believe the financial markets will react when they realize that the Central Banks are trying to take away the safety net for the global economies?

Are you really worried about inflation running away from us?

Do you believe that a flat/inverted yield curve has been an accurate predictor of events to come, historically?

Have you run the numbers, can the world’s sovereign nations even afford 4% rates, as predicted by many?

If you answered “No,” do you believe that these nations will suppress yields for as long as they can to push back the “end game?”

Across the pond Reuters states,

Italy’s two anti-establishment parties agreed the basis for a governing accord on Thursday that would slash taxes, ramp up welfare spending and pose the biggest challenge to the European Union since Britain voted to leave the bloc two years ago.

That is quite a strong statement, in my opinion. There are plenty of reasons to be worried about Italy and the European Union now, in my view.

A draft of the accord, reviewed by Reuters, lays out a plan to cut taxes, increase welfare payments and rescind the recent pension reforms. To me, this seems incompatible with the EU’s rules and regulations. These new policies would cost billions of euros and would certainly raise Italy’s debt to GDP ratio, which already stands at approximately 132%.
Reuters also states,

The plan promised to introduce a 15 percent flat tax rate for businesses and two tax rates of 15 and 20 percent for individuals – a reform long promoted by the League. Economists say this would cost well over 50 billion euros in lost revenues.

Ratings agency DBRS has already warned that this new proposal could threaten Italy’s sovereign credit rating. If you have been to Rome, you probably visited the Coliseum. I make an observation today:

The Barbarians are at the Gates!
– Mark J. Grant

Source: by Mark J. Grant | Seeking Alpha

Mortgage Refi Applications Plunge To 10 Year Lows As Fed Hikes Rates

On the heels of the 10Y treasury yield breaking out of its recent range to its highest since July 2011, this morning’s mortgage applications data shows directly how Bill Gross may be right that the economy may not be able to handle The Fed’s ongoing actions.

https://www.zerohedge.com/sites/default/files/inline-images/mortgageinflation1.png?itok=dV-X18sj

As Wolf Richter notes, the 10-year yield functions as benchmark for the mortgage market, and when it moves, mortgage rates move. And today’s surge of the 10-year yield meaningfully past 3% had consequences in the mortgage markets, as Mortgage News Daily explained:

Mortgage rates spiked in a big way today, bringing some lenders to the highest levels in nearly 7 years (you’d need to go back to July 2011 to see worse). That heavy-hitting headline is largely due to the fact that rates were already fairly close to 7-year highs, although today did cover quite a bit more distance than other recent “bad days.” 

The “most prevalent rates” for 30-year fixed rate mortgages today were between 4.75% and 4.875%, according to Mortgage News Daily.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-16_5-18-48.jpg?itok=JaYsBRcs

And that is crushing demand for refinancing applications…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-16_5-09-36.jpg?itok=6saBh_HY

Despite easing standards – a net 9.7% of banks reported loosening lending standards for QM-Jumbo mortgages, respectively, compared to a net 1.6% in January, respectively.  

According to Wolf Richter over at Wolf Street, the good times in real estate are ending…

The big difference between 2010 and now, and between 2008 and now, is that home prices have skyrocketed since then in many markets – by over 50% in some markets, such as Denver, Dallas, or the five-county San Francisco Bay Area, for example, according to the Case-Shiller Home Price Index. In other markets, increases have been in the 25% to 40% range. This worked because mortgage rates zigzagged lower over those years, thus keeping mortgage payments on these higher priced homes within reach for enough people. But that ride is ending.

And as Peter Reagan writes at Birch Group, granted, even if rates go up over 6%, it won’t be close to rates in the 1980’s (when some mortgage rates soared over 12%). But this time, rising rates are being coupled with record-high home prices that, according to the Case-Shiller Home Price Index, show no signs of reversing (see chart below).

case-shiller home price index

So you have fast-rising mortgage rates and soaring home prices. What else is there?

It’s not just home refinancing demand that is collapsing… as we noted yesterday, loan demand is tumbling everywhere, despite easing standards…

https://www.zerohedge.com/sites/default/files/inline-images/C%26I%20loan%20demand_0.jpg?itok=jkH8NimE

But seriously, who didn’t see that coming?

Source: ZeroHedge

Bond Bear Stops Here: Bill Gross Warns Economy Can’t Support Higher Rates

Having thrown in the towel on his bond bear market call two weeks ago, Janus Henderson’s billionaire bond investor Bill Gross now believes that the most recent bearish bond price (rise in yields) will stop here as the economy cannot support higher yields.

As Gross said two weeks ago, yields won’t see a substantial move from here.

“Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV.

“I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-03_7-29-30.jpg

Since then, yields have tested the upper-end of his channel and are breaking out today to their highest since 2011 (10Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-48-50_1.jpg?itok=fFNyLeBx

and back to their critical resistance levels (30Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-50-55_0.jpg?itok=s6Hc1rhv

And now Gross is out with a pair of tweets (here and here) saying that the record bond shorts should not get too excited here…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-13_9-26-13.jpg?itok=hqAROAA1

Bill Gross thinks they won’t be right. He highlights the long-term downtrend over the past 30-years, which comes in a 3.22%.

“30yr Tsy long-term downward yield trend line for the past 3 decades now at  3.22%, only ~4bps higher than today’s yield.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-39-58.jpg?itok=aNdSRwTH

“Will 3.22% be broken to upside?” he asks.

“I don’t think so. The economy can’t support yields higher than 3.25% for 30s and 10s, nor 3% for 5s.

Continuing hibernating bond bear market is best forecast.”

Asa ForexLive also notes, if he’s right it doesn’t necessarily mean the US dollar will reverse right away but it would be a good sign for stocks and would limit how far the US dollar might run.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-44-38.jpg?itok=MS3UBYGJ

So, will Gross be right? Is this latest spike all rate-locks on upcoming IG issuance? And will this leave speculators with a record short position now wondering who will be the one holding the greatest fool bag by the end of the year…

Well worth your time to hear what geo-economic consultant Martin Armstrong has to say.

Source: ZeroHedge

T-Minus… Prepare For Much Higher Long-Term Rates

It is late.  We have been crunching data for three days, and won’t bore you with too much prose.

We will be back to fill in the blanks in the next few days but will leave you with some nice charts and data to contemplate.  They may help explain why the stock market is trading so poorly even with, what appears, to be stellar earnings.

Determination Of The 10-year Yield

There will be many posts to come on this topic as we believe it is the most critical issue investors need to grapple with and get right over the next year.

What is the right price for the U.S. 10-year Treasury yield?

Moreover,  how is the yield determined, and how has it been distorted over the past 20 years by central banks, both foreign and the Federal Reserve?

What does the future hold?

Capital Flows

We agree that inflation, growth expectations, and other fundamental factors weigh heavily on determining bond yields but we always maintain, first, and foremost,

“asset prices are always and everywhere determined by capital flows.” 

New Issuance,  Foreign, and Fed Flows Into The Treasury Market

The following table illustrates the new issuance of marketable Treasury securities held by the public and net purchases by foreign investors, including central banks, and the Federal Reserve over various periods.

https://www.zerohedge.com/sites/default/files/inline-images/may2_flow-tables.png?itok=3SjVchCQ(larger image)

The data show since the beginning of the century, foreign investors, mainly central banks, and the Federal Reserve net purchase of Treasury securities, those which trade in the secondary market, is equivalent to 60 percent of all new marketable debt issued by the Treasury since 2000.

We do not suggest all these purchases were made directly in Treasury auctions, though many of the foreign buys certainly were.

From 2000-2010, foreign central banks were recycling their massive build of foreign exchange reserves back into the Treasury market.  During this period, the foreign central banks bought the equivalent of 50 percent of the new issuance.  Add foreign private investors and the Fed’s primary open market operations, and the total equated to 70 percent of the debt increase over the period.

Alan Greenspan blames the foreign inflows into the Treasury market during this period for Fed losing control of the yield curve, a major factor and cause of the housing bubble, and not excessively loose monetary policy.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. – Alan Greenspan, March 2009

Greenspan raised the Fed Funds rate 425 bps from June 2004 to June 2006 and the 10-year barely budged, rising only 52 bps.  More on this later.

Fed Plus Total Foreign Purchases

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_totalforeign_treasuryborrowings.png?itok=9f8p2oHc(larger image)

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_cenbank_treasuryborrowings.png?itok=-BvhQgmP(larger image)

During the Fed’s QE period,  2010-2015,  foreign investors and the Fed took down the equivalent of 80 percent of  the new debt issuance.

The charts also illustrate that for several of the 3-month rolling periods, net purchases were significantly higher than 100 percent of new supply, distorting not only the 10-year yield, but the valuation of all other asset prices.

Interest rate repression also cause economic distortions, which have political consequences.  Most notably, wealth and income disparities.

Rapid Technical Deterioration

Since 2015, flows into the Treasury market have deteriorated markedly, and the timing could not be worse as new Treasury issuance is ballooning with skyrocketing budget deficits.

During the past twelve months, for example,  net foreign and Fed flows collapsed to just 17.6 percent of new borrowings.  Even worse, the net flows were negative (we estimated March international flows) during the first quarter during a record new issuance of Treasury securities of almost $500 billion.

Can we say, “Gulp”?

Stock Of Outstanding Treasury Securities

Given the rapidly deteriorating technicals and fundamentals — rising inflation –, we believe the 10-year yield should be and will be much higher sometime soon.

That is we are looking for a “super spike” in bond yields, and expect the 10-year to finish the year between 4-5 percent.   The term premium, which has been repressed due to all of the above,  should begin to normalize.

Why is taking so long?

Aside from the record shorts and natural inertia of markets, the stock of Treasury securities remains favorable, as the bulk is still held by the Fed and foreign central banks, who are not price sensitive.

Debt Stock Shortage,  Debt Flow Surplus 

Ironically,  there remains an artificial shortage of the stock of  Treasuries but now a huge glut in the flow.   See here for a must read.

The Bund And JGB Anchor?

Treasuries are at almost at record spreads on some  maturities vis-à-vis the German bund, and foreigners are on a buying strike as the above data show.

How can an anchor be an anchor if there are no buyers?   One asset arbitrage?

It is also not normal for the 10-year to be trading in such a tight range with a record short position in the futures market.  The average daily move in the VIX has increased from 0.20 percent in 2016, to 1.37 percent in 2017, and shorts are now hardly spooked by a 500 point flop in the Dow.

Something must be going on beneath the earth’s crust.  We have our ideas.

Dollar Strength

The recent dollar strength may be a signal foreigners are getting yield-hungry again, however.   We are not so sure the rally has legs.

Market concerns over the political stability of the U.S may trump yield-seeking for the rest of the year.

How Foreign Flows Contributed To The Housing Bubble

We are not going to spend much time here but we are starting coming around to Mr. Greenspan’s reasoning.  The lack of response of long-term yields to a 425 bps increase in the Fed Funds rate from 2004-2006  greatly contributed to the housing bubble.  The 10-year yield only moved up 52 bps from when the Fed started their tightening to when they paused.

Take a look at the chart.

https://www.zerohedge.com/sites/default/files/inline-images/may2_mortgage-debt_gdp.png?itok=yzXhWh6T

The Fed’s interest rate hikes didn’t even put a dent in the momentum of the housing bubble. Household mortgage debt continued to rise from 60 to 72 percent of GDP from the first interest rate hike before the market collapsed on itself.

Bubbles are hard to pop.

https://www.zerohedge.com/sites/default/files/inline-images/may2_phases-of-housing-bubble1.png?itok=a2Dis-7Z

Why Long-Term Yields Didn’t Respond

Simple.

As, always and everywhere, capital flows or the recycling thereof.

The biggest economic event in the past 25 years, in our opinion, is the exchange rate regime shift that took place in the emerging markets in the late 1990’s.  These countries now refuse to allow their currencies to appreciate in any significant magnitude as the result of capital inflows.

They learned some hard lessons in the mid-1990’s with Mexican Peso and Asian Financial Crisis, and the Russian Debt Default.

Balance of payments surpluses are now reconciled with dirty float currency regimes, where central banks intermittently intervene if their currency becomes too strong.

The result was a massive build of global currency reserves, much of which were recycled back into the U.S. Treasury market in the mid-2000’s.

https://www.zerohedge.com/sites/default/files/inline-images/may2_cenbank_treasury_purchases.png?itok=imSym7al(larger image)

The chart illustrates that foreign central bank net purchases of Treasury securities, alone, were equivalent to the over 66 percent of net Treasury issuance during the Fed 2004-2006 tightening cycle.

International  Reserves Drive Gold

The gold price also ramped with international reserves during this period.

We believe the global monetary base, mainly international reserves,  is the main driver of gold.  See here.

Reserves have not been growing witness the punk trading range in gold.  This may change as the U.S. current account blows out again.

https://www.zerohedge.com/sites/default/files/inline-images/gold-and-monetary-base.jpg?itok=USqHmoCM(larger image)

Current Account And Trade Deficits

The Mnuchin crowd are wasting their time in China trying to negotiate lower trade deficits.  Trade deficits are the result of internal imbalances where investment exceeds savings.  See here for another must read.

Introducing trade distortions to artificially lower the external deficit will only accelerate stagflaton, which is already starting to take hold.  Then we will all be worse off.   See here.

Besides, where is Mr. Mnuchin going to obtain the financing for his proliferating budget deficits if his goal is to run trade surplus or balances with our trading partners?

We are all for better terms of trade and protecting are intellectual property rights,  but know and understand thy national income accounting before starting trade wars.

Upshot

We have laid out why we believe, and we could be wrong, long-term yields are unlikely to behave as they did during the last monetary tightening.   That is the a further collapse in Treasury term premia and a yield curve inversion until something breaks.

Unless the U.S. blows up its current account again,  credit expansion accelerates significantly, creating another blast of capital flows into the emerging markets, to be recycled back to the U.S,,  the foreign and Fed financing of the U.S. budget deficit is over.  Punto!

We are preparing for a significant move higher in bond yields.

What Is The Right Real Yield?

Do you really think with the deteriorating flows in the bond market, coupled with rising inflation warrant a 0.5 percent real 10-year yield?

Au contraire!   We believe a 2-3 percent real yield is closer to fair value.

Tack on another 2.5 percent for inflation,  generous as shortages seem to be breaking out everywhere,  and that gets the 10-year to at least 4 1/2 percent.

Timing

A little CYA.   Yields could move a little lower, maybe to 2.80 percent (a stretch),  given the dollar strength as Europe slows, and shorts get spooked.

Our suspicions, however, it is going to be a hot summer.  Higher interest rates and lower stock prices.

Disclaimer

Now let us add our disclaimer.

Even if all our facts are correct,  our conclusions may be completely wrong.

If you have been reading the Global Macro Monitor over the years, you have probably seen it several times.

To illustrate our point, we like to tell the story Abraham Lincoln used to persuade juries when he was an Illinois circuit court lawyer.

The story goes that Lawyer Lincoln was worried he had not convinced the jury during the closing argument of a civil case against a railroad.   The jurors had gone to lunch to deliberate.  Lincoln followed them and interrupted their dessert with a story about a farmer’s son gripped by panic,

“Pa, Pa, the hired man and sis are in the hay mow and she’s lifting up her skirt and he’s letting down his pants and they’re a fixin’ to pee on the hay.” “Son, you got your facts absolutely right, but you’re drawing the wrong conclusion.”

The jury ruled in Lincoln’s favor.

Stay Frosty, Oscar Mike!

Source: ZeroHedge

Bank Sector In Peril As Refinance Activity Crashes Amid Rising Rates

To visualize the impact the recent spike in mortgage rates is having on the US housing market in general, and home refinancing activity in particular…

https://www.zerohedge.com/sites/default/files/inline-images/rates%20black%20knight.jpg?itok=0gskR295

… look no further than this recent chart from the January Mortgage Monitor slidepack by Black Knight: it shows the recent collapse of the refi market using the recent jump in 30Y and mortgage rates.

https://www.zerohedge.com/sites/default/files/inline-images/refi%20candidates%2010y.jpg?itok=xLHSMeR1

As Black Knight writes, it looks at the – quite dramatic – effect the mortgage rate rise has had on the population of borrowers who could both likely qualify for and have interest rate incentive to refinance. It finds that the number of potential refinance candidates has tumbled to the lowest since December 2008.

Some more details from the source:

  • the recent spike in interest rates cut the population of borrowers with an interest rate incentive to refinance by nearly 40 percent in 40 days
    • Virtually all of the decline in potential refinance candidates was among 2009 and later vintages; Fewer than 100K traditional refinance candidates (720+ credit score, <80 percent loan-to-value (LTV) ratio) remain in 2012 and later vintages
  • Approximately 1.4 million borrowers lost the interest rate incentive to refinance in just the first six weeks of 2018
  • 2.65 million potential candidates could still both benefit from and likely qualify for a refinance at today’s rates
  • That is the smallest this population has been since late 2008, prior to the initial decline in rates during the recession
  • Though the population is only 10 percent off its February 2017 mark, rate/term refinance production could see a more significant impact than this might suggest due to increasing burnout in the market
  • A corresponding drop in the average credit score of refinance originations is typically observed when rates rise

To be sure, it is hardly a shock that after a decade of record low rates, the current rise in rates means a collapse in refi activity: after all anyone who could, and would, refinance, already has, while the universe of those who have yet to take advantage of lower rates and are eligible to do so, has collapsed.

Which is bad news not only for homeowners, but also for the banks, whose refi pipeline – a steady source of income and easy profit – is about to vaporize.

Here are some more details from the WSJ: last year, 37% of mortgage-origination volume was because of refinancings, according to industry research group Inside Mortgage Finance. That is the smallest proportion since 1995, and the number of refinancings is widely expected to shrink again this year. In 2012, refinancings were 72% of originations.

While purchase activity has climbed steadily from a post-financial-crisis nadir in 2011, growth in 2017 wasn’t enough to offset a $366 billion decline in refinancing activity. The result: The overall mortgage market fell around 12%, to $1.8 trillion, according to Inside Mortgage Finance.

“The market has just gotten so very competitive because every loan matters,” said Ed Robinson, head of the mortgage business at Fifth Third Bancorp . He added that the bank is contacting homeowners who could be eligible for a refinancing in coming years to help maintain that business, and it is also instructing mortgage-loan officers to focus more on purchases.

We demonstrated this plunge in bank mortgage financing last quarter when we showed the near record low mortgage application activity at America’s largest traditional mortgage lender, Wells Fargo.

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Non-traditional lenders face even greater peril: Quicken Loans Inc. got about 70% of its mortgage-origination volume last year from refinancings, according to Inside Mortgage Finance—a higher proportion than any other large lender.

Of course, the higher rates rise, the more mortgage applications drop, suggesting that contrary to expectations for a rebound in interest expense as Net Interest Margin rises, bank will be far worse off as a result of rising rates as refi activity grinds to a crawl.

Or, as the WSJ explains it, “increased mortgage rates can hamper refinancing activity because many homeowners have rates that are already lower than what lenders can now offer. In other cases, the higher rates cut into the savings a homeowner stands to reap by refinancing a mortgage.”

The Mortgage Bankers Association expects nothing short of a bloodbath: it forecasts overall mortgage-purchase volume to grow about 5% in 2018 but refinancing volume to drop 27%. Refinance applications fell 5% in the week ended March 16 from the prior one, according to the group.

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Here is another example of how higher rates are crushing – not helping – traditional banks: since around the beginning of 2017, Valley National Bancorp , based in Wayne, N.J., has transitioned its mortgage business to 40% refinancing from 90%, said Kevin Chittenden, who runs residential lending. The bank previously relied largely on attracting homeowners through its ads for low-cost refinancings, but has since engaged with outside sales reps who are focused on purchases.

“Refi goes with the rates,” Mr. Chittenden said. “So you definitely don’t want to be too leveraged on refinancings.”

It’s about to get worse. 

Guy Cecala, chief executive of Inside Mortgage Finance, said he expects some smaller nonbank lenders to sell themselves by the end of the year because of the drop in the refinancing market and mortgage originations overall. Unlike banks, nonbank lenders typically don’t rely on branches or ties to local agents, which are traditional tools for capturing mortgage purchases.

Another risk: the return of subprime borrowers. As the WSJ adds, the waning of the refinancing boom also attracts a different type of homeowner than at the beginning. As mortgage rates go up, the average credit score of refinancings tends to go down, according to industry research.

That is partly because savvy borrowers are the ones who tend to take advantage of low interest rates first. Also, some borrowers who are refinancing now are doing so to get rid of their mortgage insurance: Home prices in many parts of the country are going up, meaning some homeowners are less leveraged even if they have paid down only a small portion of their mortgage.

As for “new” mortgage platforms such as Quicken Loans which face an imminent calamity as their refi platform implodes, Chief Executive Jay Farner said the company is still enjoying demand for both purchases and refinancings, including from homeowners whose decision to refinance is focused less on rates and more on consolidating debt or switching to a shorter-term loan.

But, he added, “You’ve got to be a little bit more strategic about how you market, versus what we saw lenders do in the last few years, which is, ‘Hey, rates are low, you should do something now.’”

* * *

The biggest irony in all of the above, of course, is that there are still those who will claim that higher rates in the “new normal” are good for banks. For the far more unpleasant reality: see a chart of Wells Fargo stock.

Source: ZeroHedge

“This Isn’t A Drill” Mortgage Rates Hit Highest Level Since May 2014


A housing bust may be just around the corner. Rates have climbed to a level last seen in May of 2014.

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The chart does not quite show what MND headline says but the difference is a just a few basis points. I suspect rates inched lower just after the article came out.

 

For the past few weeks, rates made several successive runs up to the highest levels in more than 9 months. It was really only the spring of 2017 that stood in the way of rates being the highest since early 2014. After Friday marked another “highest in 9 months” day, it would only have taken a moderate movement to break into the “3+ year” territory. The move ended up being even bigger.

From a week and a half ago, most borrowers are now looking at another eighth of a percentage point higher in rate. In total, rates are up the better part of half a point since December 15th. This marks the only time rates have risen this much without having been at long term lows in the past year. For example, late 2010, mid-2013, mid-2015, and late 2016 all saw sharper increases in rates overall, but each of those moves happened only 1-3 months after a long term rate low.

Not a Drill

So far this month, MBS have stunningly dropped over 200 bps, which easily translates into a .5% or more increase in rates. I’ve been shouting “lock early” for quite a while, and this is precisely why, This isn’t a drill, or a momentary rate upturn. It’s likely the end of a decade+ long bull bond market. LOCK EARLY. -Ted Rood, Senior Originator

Housing Bust Coming

Drill or not, if rising rates stick, they are bound to have a negative impact on home buying.

In the short term, however, rate increases may fuel the opposite reaction people expect.

Why?

Those on the fence may decide it’s now or never and rush out to purchase something, anything. If that mentality sets in, there could be one final homebuilding push before the dam breaks. That’s not my call. Rather, that could easily be the outcome.

Completed Homes for Sale

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Speculation by home builders sitting on finished homes in 2007 is quite amazing.

What about now?

Supply of Homes in Months at Current Sales Rate

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Note that spikes in home inventory coincide with recessions.

A 5.9 month supply of homes did not seem to be a problem in March of 2006. In retrospect, it was the start of an enormous problem.

In absolute terms, builders are nowhere close to the problem situation of 2007. Indeed, it appears that builders learned a lesson.

Nonetheless, pain is on the horizon if rates keep rising.

Price Cutting Coming Up?

If builders cut prices to get rid of inventory, everyone who bought in the past few years is likely to quickly go underwater.