I have heard no better analogy in describing the post-election euphoria around future GDP and interest rates then comparing the state of the markets to an escalator. In many people’s minds the economy, thanks to historically low interest rates for an extended period, has put the U.S. economy onto an escalator which will continue to rise for the years to come. The analogy has been used repeatedly in recent weeks and some have come to suggest that not only will the Fed raise rates three times this year but likely four times. Personally, I can think of no worse analogy to describe the markets or the economy today. The challenges faced today are not much better than they were eight years ago. There may be no financial crisis but there is little gun powder the Fed can use today and the increasing national debt is a serious cause for concern.  Below I’ve laid out a case for both sides to the argument as to which direction rates are headed. 

The case for rates staying relatively low is somewhat backwards facing but here are the main points to consider:

• Inflation has been stubbornly low and the forward view of inflation is to remain very low. 
   
• Oil prices appear to be very contained thanks to the US producing more than at any point in time in history; the US is currently the largest producer of oil in the world and experts are calling for oil to drop this year.
   
• The payroll report last week showed wage inflation to be unexpectedly lower than anticipated, especially considering how low the unemployment rate is.
   
• While quarterly GDP has stabilized, it should never be presumed that it will automatically go higher; there needs to be an environment that allows it to move higher and that environment does not exist yet. 
   
• In looking at the world since the financial crisis, $57 trillion in incremental debt has been added; so has the world grown or just borrowed its way into prosperity?
   
• The national debt to GDP ratio has continued to grow exponentially and rising interest rates will only increase the debt load.
   
• The debt ceiling has not been raised and the talk of tax cuts and infrastructure spending will only make the issue more challenging
   
• The legislature is very divided and it’s more likely than not that Republicans will lack full support to pass a tax code overhaul
   
• A stronger dollar will hurt the manufacturing sector

The case for rates moving higher should have and does have a forward-looking slant so it largely relies on speculation:

• Economy has reached full employment.
   
• Although wage inflation moved down slightly last month it has continued to move higher for 2 years
   
• Reduced regulation in the environmental and financial sectors should raise GDP
   
• GDP is anticipated to be over 2% on a year-over year basis for all of 2017 and 2018
   
• The economy continues to add 100’s of thousands of jobs each month
   
• Tax code overall would likely spur short to medium term growth
   
• Infrastructure spending would increase short term growth
   
• Repatriation of billions of dollars could spur growth

Today the 10yr is down to 2.33% based upon doubts that the pro-growth policies will come to fruition.  If the 10yr breaks below 2.29%, then it’s very possible it could go below 2.20%.  From 2.20% could be a material drop to 1.80%.That is very far away but still on the table of possibilities.  If the Republicans deliver on all of their pro-growth promises that have raised the market to these levels then the 10yr could test the 2.60% limit; and from there it could move to 3.00%.  

While economic data is important, global politics will drive markets more than any calendar release.

Today the FOMC raised the benchmark interest rate by 25bps to the range of 0.50 to 0.75%.    This was widely anticipated and the decision by the committee was unanimous.  The FOMC also forecasted the potential for three interest rate increases in 2017 versus the two they anticipated back in September.   Currently the 10yr is trading at 2.55%, the highest in over a year, at a yield last seen in September of 2014. 

 

The Fed reiterated their objective of maximum employment and price stability.  They have long defined price stability as 2% inflation.   The preferred inflation measure of Core PCE is running about 1.7% today, expected to be around 1.9% in 2017 and above 2.0% in 2018.   GDP is expected to top 2.1% in 2017 after likely finishing 2016 at 1.9%. 

 

Of course the statement above is really not that much different than previous statements plus or minus 0.2% here and there.  The overall Fed objective has not changed at all.  The huge question is the big unknown of the upcoming Trump administration and it’s underlying plans for fiscal policy.  Large tax cuts and increased spending would accelerate inflation and would require the Fed to raise interest rates at a much faster pace.

 

Janet Yellen is trying to be very cautious about the Fed’s independence and not making any comments about the potential upcoming changes to the executive branch of the government.  It is important she reflects her opinions about how to expand the economy; and she is well aware she should avoid antagonizing the President-elect.  In her estimation the government should focus on policies that increase worker productivity, as it has stalled for many years.  The economy is near full employment so the only way to grow is through increased productivity.  New fiscal policy will not add many jobs since it’s at full employment but could increase government deficits through less tax revenue and more spending, in her opinion.   I’m in agreement with her on both the tax cuts and increased spending.

 

I do believe the new administration should focus on keeping jobs in the US and potentially repatriating both money and jobs.  That will drive some growth without the expense of existing jobs or deficits.  A tax cut is about the most dangerous fiscal policy the new administration could tackle.   Hopefully Ms. Yellen will be allowed to voice her opinions on future growth of the economy and her independence won’t be threatened by the new administration.  The market certainly doesn’t want to see a war between the two most powerful people in America in 2017.

 

For now, the Fed will continue with the same rhetoric they have for the past several years of maximum employment and 2% inflation.  The market will have to wait until 2017 to find out what the upcoming administration will do with fiscal policy, which will also take time to have an effect on jobs and prices.   However I would expect major tax cuts and additional budget spending to cause interest rates to rise faster than expected based purely on inflation expectations.  Remember, it’s not just inflation that drives rates but inflation expectations.   Keep a close eye on GDP and inflation data, the two big drivers of interest rate swings for the foreseeable future.

 

While the bond market is performing very similar to the infamous Taper Tantrum of 2013, this is a very different market today.   Recall that Taper Tantrum was about removing accommodation.  The rally in the stock market and the selloff in the bond market now is generally centralized around a common theme.  This is a post-election and pre-inauguration frenzy.  The market is trading on hope, hope that the new administration drives growth and inflation along with it. 
 
It might seem odd that given the presidential election was so controversial, that here we stand today in the midst of a major stock market rally.  Little predicted a Trump win and most predicted that if he did win, the stock market would falter and the bond market would roar to lower yields.   Why did so many get it wrong?  Let’s ignore that question as it’s too argumentative and focus on the more important question, which is why is the stock market moving higher and the bond market getting pummeled?  As of this morning the 10yr trades at 2.39%, its highest point since July of 2015 and up 100bps since July of this year. 
 
Let’s look at the facts of the upcoming administration.  It will be dominated by the pro-business Republican party.  Aside from that and pushing politics aside, the general public doesn’t know specifically which policies the Republicans plan to push for.  The fact remains that the market is trading on belief and not much fact  Don’t forget that all of the market movement has happened immediately since Election Day, from the very moment the results came in.  The only thing that has remained constant since Election Day is what I said at the top of this paragraph, the government policies are in full Republican control.  There is still much to be debated and decided: which policies, what is the priority, do you focus on economic or social, which policies do you pass that don’t create broad discontent among all voters, what about the Republican representatives that have to avoid any controversial policies (are they an asset or liability), how do the Republicans remain united?  Does the party ignore Democratic voters and/or do they start a war with Bernie Sanders and Elizabeth Warren?  These are all things that have yet to be determined.  My fear is that this stock market rally is purely an adrenaline rush from an unprecedented and controversial (and nasty) election.  It was a certainty prior to Election Day that whoever won was going to have to deal with a divided country.  How is it that suddenly everything is so rosy?
 
But as the saying goes “The Trend is Your Friend” and the markets direction must be respected. 
 
What about the FOMC?  Their opinions have not changed and they will continue to remove accommodation as they see fit.  They do not see anything yet that has changed their view of the economy or inflation expectations.  “Don’t Fight The Fed” was another one of my more favorite quotes.  The market has priced in a 100% chance of a Fed raise on December 14^th and some have priced in more than a 25bps move next month.  I believe that is excessive.  I do believe that the Fed will raise 25bps next month and they should raise 25bps.  The market is telling them to, the GDP figure this week tells them to and inflation is close to 2%.  Past December, all bets are off.  It’s just too early for this much certainty.
 
 
 
10yr Bond Yields Around the Globe
 
United States                    2.39
Canada                                 1.58
UK                                          1.41
France                                  0.75
Germany                             0.27
Italy                                       1.98
Sweden                               0.52
Switzerland                        -0.19
Japan                                    0.01
Australia                              2.72
South Korea                       2.14

 

Beny Rabuchin
Mortgage Advisor (NMLS 483965)

Cell:  310.488.3200
Fax:  949.258.5186
Email: Beny.Rabuchin@nafinc.com 
Web: www.BenyRabuchin.com

JP Morgan Chase is the most recent bank to adjust its standards for issuing jumbo loans for primary residences and second-homes, according to CNN Money.

Jumbo loans are typically for homes valued at $417,000 or more, but can be as much as $625,500 or $729,750, depending on the county in which the loan is originated, according to the Credit Union Times. This is because loans of up to $417,000, called conforming mortgages, are generally backed by government agencies, according to the Wall Street Journal. Jumbo loans, which exceed the amount government agencies are willing to back, are usually held by the lender or sold to an investor.

Chase previously required borrowers to have a credit score of 740 and make a down payment of 20 percent for primary-residence homes, CNN Money reported. Now, the credit score can be as low as 680 and the required down payment on a loan of up to $3 million is only 15 percent.

For secondary homes, Chase is now requiring a credit score of 680 and a down payment of 20 percent, rather than 30 to 50 percent.

Lowering the Bar

Chase isn't the first bank to begin lowering standards for jumbo loans. Wells Fargo began doing this last summer after Federal Reserve Chair Janet Yellen suggested that fewer restrictions on jumbo loans could help the housing market grow, according to MarketWatch.

"I think banks at this point are reluctant to lend to borrowers with lower [credit] scores," said Yellen during a press conference in June 2014. "It is difficult for any homeowner who doesn't have pristine credit these days to get a mortgage. I think that is one of the factors that is causing the housing recovery to be slow."

Six months prior to Wells Fargo's lowered standards for jumbo loans, the bank began to make it easier for borrowers to get loans by requiring a minimum credit score of 600, rather than 640, if they were eligible for insurance through the Federal Housing Administration. As Reuters reported, Wells Fargo wasn't alone — 39 percent of large banks said they were beginning to lower standards on residential mortgages.

According to Bankrate.com, Fannie Mae also lowered standards for buying mortgages of less than $417,000. The minimum credit score was 620 and down payments could be made with as little as 3 percent.

Credit unions joined the trend, too, by beginning to offer jumbo loans. Credit Union Times reported that Ellie Mae data showed 23 credit unions in California had issued 65 or more jumbo loans in July.

According to the Wall Street Journal, the second quarter of July saw more than $93 billion in jumbo loans — 33 percent more than the first quarter.

Housing Market Affects Loans

Many financial institutions saw a decrease in the number of customers and members taking out mortgages since the Great Recession. The housing market has begun to pick back up, according the National Association of Realtors. Banks have also experienced greater demand for mortgages, Reuters reported.

Tim Owens, the head of Bank of America's retail sales group, told the Wall Street Journal that rising home prices are driving homebuyers to look into jumbo loans.

In addition to the changes in standards for jumbo loans, Chase also rewrote its guidelines for borrowers seeking loans for their primary or second homes, according to a press release from the bank.

"We want to make sure homebuyers can easily understand the benefits of financing with Chase," Chase's Head of Mortgage Loan Originations Steve Hemperly said in the release.

This is all good news for those hoping to buy a home soon: Many are likely to have an easier time finding a mortgage loan, whether it's jumbo or not.