Morning Report: James Bullard spooks the markets

Vital Statistics:

S&P futures3,918-49.25
Oil (WTI)83.97-1.62
10 year government bond yield 3.77%
30 year fixed rate mortgage 6.59%

Stocks are lower this morning after hawkish comments from St. Louis Fed President James Bullard. Bonds and MBS are down.

St. Louis Fed President James Bullard gave a speech which suggested that a “sufficiently restrictive” Fed Funds rate would need to be somewhere between 5% and 7%. The chart that freaked out the markets is below:

Bullard is basing this recommended policy rate on the Taylor Rule, which is a formula that calculates the ideal Fed Funds rate based on inputs such as the real interest rate, inflation, and the output gap. The punch line is that based on the current situation the Fed Funds rate should be at least 5%.

The stock and bond rally of the past week has been driven by hopes the Fed is set to pivot to looser monetary policy, and it is reversing on this speech. Note we will get Neel Kashkari (noted hawk) speaking this morning as well.

Housing starts came fell 4.2% MOM and 8.8% YOY to a seasonally-adjusted annual rate of 1.42 million. Building Permits fell to 1.53 million. Separately, the MBA reported that mortgage applications for new homes decreased 28.6% from a year ago. This number is not seasonally adjusted, so that factor is playing a part here, however mortgage rates above 7% is the primary driver.

Interestingly, the average loan size fell to $400,616 which is a function of slower home price growth and declining interest in higher-priced homes. It doesn’t look like average selling prices for the builders are declining yet, and the barometer of luxury homes – Toll Brothers – has an October FY, so we won’t hear from them until early December.

The increase in mortgage rates means some potential homebuyers can no longer afford to buy a house they ordered a year ago. This is causing people to lose any sort of deposit they put down. This is happening even if the builder ends up selling the property to a different borrower at a higher price.

Just under 2 million mortgages were originated in the 3rd quarter of 2o22, according to data from ATTOM. This is down 19% from the second quarter and 47% from a year ago. The 47% decline was the largest in 21 years. “There are no surprises in this quarter’s loan origination numbers, as the unprecedented jump in mortgage rates has battered both the purchase and refinance markets,” said Rick Sharga, executive vice president of market intelligence at ATTOM. “Prospective homebuyers have been priced out of the market by the combination of 7 percent mortgage rates and higher home prices. And refinance activity will probably continue to decline, since the majority of homeowners have loans with sub-4 percent interest rates.”