This week’s HW+ member spotlight features Ben Bernstein, director at Axonic Capital, an investment firm with a deep focus on the structured credit sector of the financial markets. Prior to that, Bernstein held leadership roles in Odeon Capital Group and JPMorgan Chase.
Below, Bernstein answers questions about the housing industry:
HousingWire: What is your current favorite HW+ article and why?
Ben Bernstein: Logan and Sarah’s Monday podcast is my go to. Logan cuts through all the noise and delivers clear concise opinions rooted in the data. So not only do I get updates on what is going on in the housing market but I learn which data points are relevant and how to analyze them. And Sarah always asks insightful questions. On top of that, it is super entertaining!
HousingWire: What has been your biggest learning opportunity?
Ben Bernstein: My biggest learning opportunity (and weirdest job I ever had) was every job I ever had. I started my career at Bear Stearns on February 23 2008. To say that was an interesting time and place to start a career would be an understatement. Two weeks later I was working for JPMorgan and eventually made it to a desk whose focus was working out of the assets that brought Bear down in the first place.
Think funky bonds linked to housing like subprime RMBS and CDOs. Getting to dig deep into what these bonds were and how the underlying mortgages impacted them was priceless. I started at Axonic, a credit fund focused on investments linked to residential and commercial real estate, in November of 2019.
Another interesting time to join an investment firm! Three months later, I was working remotely and figuring out how to be productive from home. Fourteen years into my career and my biggest learning opportunity is right now.
I’m learning new stuff every single day whether it be about the bond market, housing, trading, macro economics, etc. All I need to do is turn around and ask a question out loud and I’ll learn something new.
HousingWire: What is the best piece of advice you’ve ever received?
Ben Bernstein: The best piece of advice I’ve ever received was what is important is what you do when no one is looking. Your reputation, work ethic, success, productivity and integrity are all linked to what you do because you know you need to do it as opposed to what you think other people want you to do.
HousingWire: What’s 2-3 trends that you’re closely following?
Ben Bernstein: I don’t think anyone will be surprised by the trends I’m following these days: Inflation, credit spreads, housing prices and how they are all intertwined. Fortunately I have smart people around me (including HousingWire) to give me their opinions on where we are headed. It’s my job to put it all together. The past two years have been some of the most interesting times in markets and from where I sit I don’t think that will change any time soon.
HousingWire: What keeps you up at night and why?
Ben Bernstein: What keeps me up at night is the state of the housing market. 35+% home price appreciation since COVID-19 began. Two months supply of housing. Mortgage rates going up faster than they ever have. There’s a lot going on!
One thing as bond traders that we do is we look down before we look up. In other words we look at risk before we look at upside. An overheated housing market is something we pay close attention to because we don’t want prices to go down precipitously but we don’t want inflation to run away either. So it’s really an interesting time to be tracking the housing market and all of the ancillary markets that are impacted by it.
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Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It…
Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It will stay top of mind in the week ahead as both the world's two largest economies, the US and China, report July consumer and producer prices.
During the Great Depression, the central governments discovered their balance sheets, and budget deficits became a nearly permanent fixture. This is true even for countries like Germany, which ostensibly shunned Keynesian demand management and embraced "ordo-liberalism." During the Global Financial Crisis, the central bank balance sheet was called into action as policy rates hit zero (and fell into negative territory for the members of the eurozone, Switzerland, a few other European countries, and Japan).
After the Great Financial Crisis, many monetarists and hard-money folks warned of ruinous inflation, which did not materialize. Instead, inflation has soared over the past year or so for most high-income and emerging market countries. The hard-money and monetarists say they told us so. Yet, it took a pandemic of biblical proportions to spur inflation and the Russian invasion of Ukraine. Moreover, there seems to be no correlation between the size of the central bank's balance sheet (as a percent of GDP), government deficit spending during and after the pandemic, and the subsequent inflation.
The Bank of Japan's balance sheet is nearly 135% of GDP. The Fed's balance sheet is about 36.5% of GDP. The ECB's balance sheet is almost 69% of GDP. Japan's central government debt is more than 2.3-times larger than its GDP. In proportionate terms, US debt is less than half as much as Japan's. The eurozone's debt-to-GDP is a little more than 95%. Consider fiscal policy. The cumulative budget deficit in the US for 2020 and 2021 was a stunning 26.4% of GDP. The deficit in the eurozone was less than half the size (12.2%). Japan's was almost 16% of GDP.
We will likely learn next week that the July US CPI (year-over-year) fell below the preliminary EMU reading of 8.9%. The median forecast in the Bloomberg survey sees a 0.2% month-over-month gain, which given the base effect, would be consistent with an 8.8% year-over-year rate. Energy prices have pulled back. Sept WTI fell 5.3% in June and and another 4.3% in July. It is off almost 10% so far this month. The average price of retail gasoline fell 13% in July.
Japan's headline CPI was a modest 2.4% in June. The BOJ's last meeting concluded the day before the June CPI was reported. Its updated forecast put this year's CPI at 2.4% before falling back to 1.3%-1.4% for the next two years. Do not be mistaken. The BOJ's forecasts are not an outlier. Economists surveyed by Bloomberg are also convinced Japan's inflation is temporary. The median forecast is a 1.2% rise in CPI next year, followed by a 0.8% increase in 2024.
Conventional wisdom is that monetary policy will not change until Governor Kuroda steps down next April. The inflation forecasts, if accurate, suggest the new governor will find that the deflation demon has not been slain after all. Although the BOJ's policy rate is -0.1%, it has been trading at -0.009%. The swaps market has it at 0.01% in a year, 0.07% in two years, and 0.11% in three years.
After arguably waiting too long to get going, the Federal Reserve has stepped up its game. It persuaded many, even if not everyone, that it is so determined to bring inflation down that it is willing to risk an economic contraction. This is important because it shows that inflation expectations are anchored. Consider the 10-year breakeven peaked in mid-April a little above 3.05% and fell to the year's low slightly below 2.27% a few weeks ago. It is now hovering in narrow band around 2.50%. In the middle of last month, the two-year breakeven fell to 2.85%, the lowest since October 2021. It popped back to around 3.25% but is approaching the low again. Recall it peaked shortly after the first rate hike was delivered in March 16, near 5%. Doesn't this say something about the Fed's anti-inflation credibility?
While the breakevens have been consolidating, we note the correlation between the changes in the 10-year yield breakeven and oil prices increased to almost 0.60 over the past 30 days, the highest in more than three months. The correlation between the changes in oil and the US two-year breakeven is around 0.83, the highest since the end of 2020. Surely, most observers would agree that whatever attenuated relationship there may be between fiscal and monetary policy on one hand and oil prices on the other, it is overshadowed by several other factors.
Last week, the Bank of England warned that inflation was likely to peak near 13%. That is twice as much as it anticipated at the end of last year when it began its tightening cycle. The main culprit is not monetary or fiscal variables but the supply shock from the energy sector. The BOE is also the first major central bank to acknowledge a recession. Indeed, it warns that the economy will contract for five consecutive quarters, which does not include the second quarter. The UK reports Q2 GDP on August 12, and the median forecast (Bloomberg survey) is for a small contraction.
Nevertheless, the BOE is clearly determined to continue to tighten monetary policy. Governor Bailey is cagey about the pace of hikes going forward, like many other central banks, including the Fed, ECB, and the Reserve Bank of Australia. Yet, the market remains fairly convinced that the central BOE will hike rates by at least another 100 bp in the last three meetings of the year. The BOE is also the first major central bank to announce intentions of actively selling some of its sovereign and corporate bond holdings to shrink its balance sheet quicker than the passive approach of allowing maturing issues to roll off.
The cottage industry of critics put the Federal Reserve in a "damned if they do and don't if they don't" box. First, many wanted the central bank to be more aggressive than even the hawks at the Fed advocated. Then as the economy slows, they are among the first to condemn the Fed for inducing a recession. Endless fodder for the large pipes that deliver the streaming news.
We have staked out a middle ground between those pundits and cynics who have been saying the US is in a recession for a few months and several Fed officials who suggest there is little sign of a broad economic slowdown. Yet, even Powell acknowledges the path to a soft landing is getting narrower. While recognizing we live in a probabilistic world, we see the odds of a soft-landing as minuscule at best.
It is not just because of monetary policy, which is tightening aggressively. Indeed, after the stronger than expected employment report, which saw a new cyclical low in the unemployment rate (3.5%) and the strongest jobs growth in five months (528k), the Fed funds futures were discounting around a 75% chance of another 75 bp hike at next month's meeting that concludes on September 21. The 2-10-year yield curve is inverted by the most since 2000 (almost 40 bp). Fiscal policy is tightening too, and aggressively at that. The OECD projects government spending to fall by 0.1% this year. The median forecast in Bloomberg's survey is for the budget deficit to fall to 4.4% of GDP this year from 10.8% last year. The two-month 25% slide in oil prices is helpful for the soft-landing scenario, but they have still doubled since early 2021, which proceeded the end of the last few business cycles.
Also, the inventory cycle has matured, and from a tailwind last year, it has turned into a headwind. If it weren't for the inventory adjustment, the US economy would have expanded in H1. The good news here is that the drag from inventories may be winding down. Another drag that may replace it is that some sectors that saw strong demand during the pandemic may have built too and cut back. Given that it was slow to take its foot off the accelerator, the Fed's biggest mistake would be to declare victory too early. This risk-reward assessment also injects a human element into the risks of a hard-landing.
The July CPI should offer some comfort that inflation, which jumped in Q2, is steadying at the start of Q3. After rising by 1.0% in May and 1.3% in June, the July CPI is expected to edge up by 0.2%. If so, it would match the smallest monthly increase since November 2020. It would also be consistent with a small decline in the year-over-year rate, which has only happened one other time since last August (in April). However, the core rate may tick up. The median forecast (Bloomberg survey) sees a 0.6% increase, which is the average over the last nine months. This would produce the first increase in the year-over-year core CPI since March. It peaked then at 6.5% and fell to 5.9% in June.
The market still expects the Fed to raise rates aggressively and double the pace of the roll-off from its balance sheet starting next month. The market is now looking for the Fed to hike rates by 125 bp in the last three meetings of the year. Look at what has happened. The year-end Fed funds rate has mostly been between 3.25% and 3.50% for the past two months. It pushed through the upper end after the jobs report.
Moreover, the Fed's hawkish rhetoric and the jobs report did not manage to dissuade the market from pricing in a cut in the Fed funds rate next year. Even if the terminal rate is a bit higher than the market previously thought, it seems more confident of a rate cut in H2 23. Specifically, the implied yield of the December 2023 Fed funds futures is about 33 bp below the yield of the December 2022 contract. Over the course of the week the chances of a cut in Q3 23 were downgraded. At the end of July, the September Fed funds yielded 32 bp less than the December 2022 contract. It closed last week at a 12 bp discount.
The team of economists at ITC found that since 1990, the first Fed cut has come on average 10.6 months after the last hike. It is in a range of five months to 18 months. If the market is right and the Fed finishes its tightening this year, or even early next year, it appears to be pricing in a fairly typical gap.
Much to the chagrin of some of the Fed's critics that put the hawks at the Bundesbank to shame, the market is confident that the economy will reach a point later this year or early next year that will prompt the Fed to ease off its drive. This is the real meaning of the central bank put. They will not pursue the old Mellon recommendation: liquidate, liquidate, and liquidate. The hawks do not have a constituency for it. And that seems global, not just limited to the US. But, of course, like playing three-card Monty, it always looks easy from the sidelines.
China's inflation will be reported after it its reserves (lower), trade surplus (smaller), and lending figures (less). The June CPI was at 2.5% year-over-year, roughly the midpoint seen since the onset of Covid (-0.5%-5.4%). It is expected to have edged up to 2.8% in July. The recovery in pork prices led to the acceleration in food inflation (2.9% vs. 2.3%). The core measure, which excludes food and energy, rose 1.0% year-over-year in June from 0.9% in April and May. Meanwhile, China's PPI is expected to lurch down, possibly below 5%, to its lowest level since March 2021. It peaked at 13.5% last October, and the decline in July will be the ninth consecutive monthly decline.
The subdued price pressures may give the PBOC room to ease policy, but it seems to be in no rush. It is encouraging lending and has offered some fiscal support. It has been mild. There appears to be a window to ease policy in the next couple of weeks. Liquidity conditions have tightened due to several factors, including PBOC draining operations and tax payments, and on August 16, a CNY600 bln medium-term lending facility matured. There are several ways that the PBOC could provide more liquidity, including a new medium-term lending facility, reverse repos, and a cut in reserve requirements.
Disclaimerrecession depression unemployment pandemic yield curve monetary policy rate cut fed federal reserve government debt budget deficit governor recession gdp recovery unemployment oil japan european uk germany ukraine china
Inflation Breakeven and Term Spreads Adjusted for Premia
Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and…
Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and current short rates is also obscured by risk premia. Here are adjusted spreads:
Figure 1: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The adjusted series suggests an upward movement in expected inflation with the expanded Russian invasion of Ukraine, but less than that indicated by the simple Treasury-TIPS spread (and no downward movement recently).
How have recent releases affected inflation expectations? Figure 2 presents a detail.
Figure 2: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The inflation breakeven rises with the GDP advance and PCE deflator releases, but stays constant with today’s employment numbers (strangely). However, to the extent that the Treasury-TIPS spread mismeasures expectations, we should be a bit wary of this result (inflation expectations do drop with the GDP release with the adjusted measure).
What about the 10yr-3mo spread? The unadjusted has taken a big dive in recent weeks, coming close to inversion.
Figure 3: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.
The gap between 10yr-3mo went negative in 2019, and again with the onset of the pandemic. The yield curve steepened sharply with the Georgia special election outcomes, and then counterintuitively rose again with the Russian expanded incursion into Ukraine. The spread dropped sharply from May 6th onward.
The spread incorporates a inflation risk premium so that on average, the yield curve slopes up. Hence, the standard 10yr-3mo spread does not necessarily equal the difference between 3 month yields over the next 10 years vs the current 3 month yield. I show the sum of the future 3 month real yields and future 3 month inflation rates over the next ten years as the pink line in Figure 2. This line probably better shows the heightened expectations of growth in 2021Q1-Q2, as well as the dropoff in perceived growth prospects in May.
The detail suggests the expected asset price responses to the recent releases as well.
Figure 4: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.recession pandemic yield curve spread recession gdp ukraine
Sixth recession red flag raised, despite strong jobs report
On the same day, the BLS revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.
The post Sixth recession…
What a crazy day for my economic model! On the same day, the Bureau of Labor Statistics (BLS) revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.
When I wrote the America is back recovery model on April 7, 2020, and then retired it on Dec. 9, 2020, I knew one data line would lag the most: jobs! I have talked about how job openings would move toward 10 million and that we should get all the jobs we lost to COVID-19 back by September 2022. Well, I was off by two months: Today, the BLS reported that 528,000 jobs were created with positive revisions of 28,000, which gave us just enough to pass the February 2020 levels.
From BLS: Total nonfarm payroll employment rose by 528,000 in July, and the unemployment rate edged down to 3.5 percent, the U.S. Bureau of Labor Statistics reported today. Job growth was widespread, led by gains in leisure and hospitality, professional and business services, and health care. Both total nonfarm employment and the unemployment rate have returned to their February 2020 pre-pandemic levels.
Feb 2020: 152,504,000
July 2022: 152,536,000
The big job numbers we have seen recently are tied to the decline in the job openings data, which lags also, but we do see a decrease in this data line as it appears for now that the job openings data has peaked in this cycle. It recently went from 11.3 million to 10.7 million, and the recent peak was near 11.9 million.
We have seen increases in jobless claims and slighter increases in continuing claims. However, nothing too drastic yet. Again, at this stage of the economic cycle you should focus on the rate of change data.
A tighter labor market is a good thing; this means people with less educational backgrounds can get employed since we have many jobs that don’t require a college education. The unemployment rate did tick up for those with less than a high school diploma in this report.
Here is a breakdown of the unemployment rate and educational attainment for those 25 years and older:
—Less than a high school diploma: 5.9%.
—High school graduate and no college: 3.6%
—Some college or associate degree: 2.8%
—Bachelor’s degree and higher: 2.0%
Below is a breakdown of the jobs created. Every sector created jobs; even the government created jobs. All this was just working our way back from the losses to COVID-19, which I knew would take a bit longer than some people would have thought with the economic data we had in 2021.
Now that we have regained all the jobs lost to COVID-19, what is next?
Hopefully, people know that we weren’t in a recession in the first six months of the year. When you’re in a recession, you don’t create jobs, have positive industrial production data, or positive consumer data in GDP. We had some funky trade and inventory data that tilted the GDP negatively, but the traditional data lines that go negative in a recession are just not there yet.
Even so, because some of the more current data is trending negatively, I am raising my sixth recession red flag today. Allow me to present my case.
Recession red flag watch
Where are we in the economic cycle? I’ve already raised five of my six recession red flags, but until they are all up, I don’t use the word recession.
Let’s review those red flags in order, as my model is based on an economic progression model:
1. The unemployment rate falls down to a level where we start to talk about Federal Reserve rate hikes because the economy doesn’t need as much stimulus for employment gains. For this recovery, the unemployment rate getting to 4% is the level where I raised my first recession red flag. This just means that the recovery is more mature than the earlier stages of the unemployment rate falling. Today it’s currently at 3.5%.
2. The Federal Reserve starts to raise rates. The Federal Reserve started Its rate hike process this year, to start fighting inflation and has been more aggressive recently. This shows that the expansion is longer and that the Federal Reserve is in a mood to tighten policy rather than make it more accommodative.
3. The inverted yield curve. This is more of a market-driven bond yield red flag. I had been on an inverted yield curve watch since Thanksgiving of 2021. This is when the two-year yield and 10-year yield slap high fives and say hi to each other. It’s another progression red flag, reflecting that we are in a more mature stage of the economy. Traditionally you see an inverted yield curve before every recession.
4. Find the overheating economic sector where demand can’t be sustained. Once that demand comes back to normal, people will be laid off. We see this in the durable goods data. A few companies are laying people off or putting into place a hiring freeze.
5. New home sales, housing starts, and permits fall into a recession. Once mortgage rates rise, the new home sales sector does get hit harder than the existing home sales market. The homebuilder confidence index is falling noticeably, and while we never had the housing build-up in credit and sales that we saw in 2005, the builders will slow housing production down with higher rates. I raised my fifth recession red flag in June.
Today, I am raising the last recession red flag, which considers the Leading Economic Index (LEI). This week I presented my six recession red flag model to the Committee For Economic Development of The Conference Board (CED) — the committee that created the leading economic index. “Since its inception in 1942, CED has addressed national priorities to promote sustained economic growth and development to benefit all Americans. CED’s work in those first few years led to great policy accomplishments. One is the Marshall Plan, the economic development program that helped rebuild Europe and maintain peace, the Bretton Woods Agreement that established the new global financial system, and the World Bank and International Monetary Fund.”
6. Leading economic index declines four to six months before a recession. Historically, the LEI fades into every recession, outside a one-time huge economic shock like COVID-19. To raise this flag I needed four to six months of decline, which we saw recently. However, knowing the components of this data line, I know this data line has legs to keep going lower.
As you can see, the LEI doesn’t have a good history of reversing course when the downtrend is in place. We have had times in the mid-1990s when we saw a slowdown but didn’t get a recession.
With that in mind, how might this reverse? Well, the two easy answers are this:
1. Rates fall to get the housing sector back in line.
2. Growth rate of inflation falls, the Fed stops hiking rates and reverses course, as they did in 2018.
Most Americans are working, and job openings are still high enough that people can find work if they need to. However, if you’re asking me how we could see a reversal after all six flags are up, this is it.
So how do I square raising the last recession red flag when we had such a strong job report today? Well, the model isn’t designed to work during a recession. It’s intended to show the progression of an expansion into a recession. As you can see below, this data line fell in 2006, and we were still creating jobs in 2006 and 2007.
During the housing bubble, we had a clear over-investment, and that was in the housing market, so the recession red flag model was evident before the recession. Only three of my recession red flags were up before the COVID-19 crisis; in fact, we were still in expansionary mode if COVID-19 hadn’t occurred.
I can’t describe it any other way: things have been crazy since April 2020. All of us that track economic data have had to adjust to the highest velocity of data movement in our lifetime and have had to make COVID-19 adjustments all the time.
At some point in the future, things will get back to normal. I’ve presented you with my data lines to show we weren’t in a recession the first six months of the year, but the economic data is getting softer and softer. I will be looking for weaker data lines getting to the point where we actually see real recessionary data, which means jobs are being lost monthly, production data falls and companies make adjustments to their business model with greater force.
I’ll take each data point one day at a time and try to make sense of it. Remember, economics done right should be very boring, and always, be the detective, not the troll.
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