What’s Up with Mortgage Refi’s?

This week's most important headlines for investors will be the earnings reports from the mega-cap tech stocks, as we will see if capital flows back into those names after the recent pullback. From an investing standpoint, this will be more important than political overtones, as earnings and the Fed’s rate decision will have more influence over stock market returns.

Mortgage Refinancing Activity is Troubling

It is possible that homeowners are being forced to refinance their homes at current high rates because they have no additional savings to supplement their income to pay their living expenses. The Mortgage Bankers Association releases a weekly report on single-family housing activity every Wednesday. Their data includes mortgage applications, purchases, the current mortgage rate, and refinancing activity. Despite a recent dip in mortgage rates to 6.87%, purchases are down 14% yearly. What is up is refinancing activity, at 15% over the prior week alone, and it is now at its highest level since August 2022. Mortgage rates were under 5.5% in August 2022, so the strong refinancing activity is puzzling.

The Mortgage Bankers Association says the refinancing activity is driven by those who bought homes when rates were much higher. However, 30-year mortgage rates were above 7.25% between October and November 2023, so those refinancing to lower their mortgage rate cannot represent all the activity. When we look at the 50% rise in less than three years in consumer credit card balances at large banks and the estimates that the excess pandemic savings from 2020 have been spent, it makes sense that some homeowners are forced to refinance their low interest rate mortgage at the current high rates. This predicament, of course, could create major problems if the recent increase in initial claims for unemployment insurance begins to accelerate because monthly mortgage payments have just increased for many consumers. This added burden is not good for an already stressed consumer base.

Fedspeak, Waller Style

Federal Reserve Governor Christopher Waller, an influential member of the FOMC, gave a speech outlining the three paths inflation could take to reach the Fed’s 2 percent goal. He is clearly in the soft-landing camp, describing labor as being in a “sweet spot” but warned that upside risks to unemployment are “higher than we have seen for a long time.” He mentioned that the demand for labor has fallen relative to an increasing pool of job seekers, pushing the ratio of job openings to unemployed workers back to pre-pandemic levels. This fact is hopeful because it will cap wage inflation pressures. He said labor markets are loosening, not weakening, because the Layoff Rate has been steady at 1.0%. Because we expect job weakness, we are monitoring that Layoff Rate for signs of an uptick.

Regarding inflation, he believes that there is increasing evidence that “the first quarter inflation data may have been an aberration and that the effects of tighter monetary policy have corralled high inflation.”

Waller ended his speech discussing three different paths inflation data could take:

• Optimistic: Significant but not high probability of continued favorable inflation readings. Outcome: “rate cut in the not-too-distant future.”
• Less Optimistic: Most likely scenario of uneven inflation data. Outcome: “rate cut in the near future is more uncertain.”
• Pessimistic: Low Probability but the worrisome possibility of an inflation resurgence. Outcome: no rate cut in 2024.

The swing factor is the labor market. What would alter Waller's view toward a more immediate rate cut would be if there is a significant deterioration in the employment outlook. We believe that the Fed will be forced to cut rates primarily to boost weak labor demand and the overall economy. 

China Third Plenum: Xi Again, Naturally

The Chinese Communist Party’s Third Plenary Session concluded last Thursday, and because its goal was setting the foundation for significant economic and political changes over the next five years, the lack of concrete fiscal stimulus details disappointed investors. The communique started out right, recognizing the “arduous tasks of advancing reform and development and ensuring stability at home.” However, that was framed by the idea of  “adhering to the general principle of pursuing progress while ensuring stability.” We had hoped for specific new actions, but the Plenum delivered only platitudes and a promise of more of the same. We were teased with the vow to “Pursue coordinated reforms in the fiscal, tax, financial, and other major sectors,” but no deliberate steps were outlined.

One line within their objectives regarding deepening reform caught our attention: “Improving the Party's capacity for leadership and long-term governance. The reform tasks laid out in this resolution shall be completed by the time the People's Republic of China celebrates its 80th anniversary in 2029.” This was tied in with a discussion about continuance of leadership, which is important since Xi’s (unprecedented) third term ends in 2027. The  communique ended with “a call was issued to the whole Party, the entire military, and Chinese people of all ethnic groups to stay closely rallied around the Party Central Committee with Comrade Xi Jinping at its core.” Therefore, any chances of a regime shift toward more open markets cannot occur, with the current regime simply tightening its grip and strongly suggesting a fourth term under Xi. 

What to Look for This Week

1. Best for last: Friday, July 26 at 8:30 a.m. E.S.T. US Personal Consumption Expenditure Price Index for June. The series peaked two years ago, and it differs from the Consumer Price Index because CPI uses a fixed basket of goods and services, while PCE adjusts for goods and services based on current spending habits. Because the Fed is almost certain to keep rates unchanged at their meeting, PCE theoretically should not have a big impact, but because it is coming a few days before the Wednesday, July 31 rate decision, it will have an outsized market impact if it comes in either too high or low relative to the Cleveland Fed’s 2.4% y/y expectations for headline and core (ex-food and energy) expectations.   

2. Wednesday, July 24 10:00 a.m. E.S.T. the Census Bureau releases June New Home Sales. It is no news that high mortgage rates and prices have weighed heavily on affordability, and May sales were the lowest in six months. In the May report, April data was revised sharply higher by 10%, so we will look at the revisions as well as the June data. Out earlier that day at 7:00 a.m. E.S.T. is the Mortgage Bankers Association Refinance Index. 

3. Thursday, July 25 9:30 E.S.T. (Friday morning in Japan) Tokyo Consumer Price Index data for July is released. It is important due to its proximity to the Bank of Japan’s July 31 Monetary Policy Meeting. Any upside surprise from the 2.2% y/y consensus for core CPI could weaken USDJPY and weigh on global markets.