Top of the Street: A noisy debate on rates, regulation and liquidity along with a cut in FHA premiums and an ongoing squeeze in mortgage credit

With new facts come new opinions, and the recent drop in rates has led Street views on rates lower. Insight on regulation, Volcker, a change in FHA premiums and the FICO impact on mortgage credit. Contributions from Citi, JPM, BAML, the NY Fed, the Fed Board.

Markets: The noisy consensus on rates
The Street’s opinion on almost anything tends to give the greatest weight to the latest prints, and the recent decline in rates is naturally swaying some opinions. The end of 2017 should see US 2-year rates at 1.70% and 10-year rates at 2.60%, according to the emerging consensus, but the range this year should be wide. The 10-year rate could easily swing up or down from that level by 50 bp. It’s a battle between opposing forces. Political aspiration for tax cuts and fiscal spending should push rates up this year, but political compromise should bring them back down. Protectionism would lift inflation initially but eventually slow growth. And the Fed should show readiness to counter any risks of inflation. Growth should improve but still stay low relative to the pre-2008 pace. See Citibank, US Rates Weekly, 06 Jan 2017, JPMorgan, US Fixed Income Markets Weekly: Cross Sector Overview, 06 Jan 2016. (C, JPM, Milepost).

Economy: The uncertain impact of a regulatory rewrite
Every change in regulation creates winners and losers, but the overall impact on the economy is far from clear. It comes down to costs and benefits, according to Bank of America. The Office of Management and Budget estimated in 2015 that major regulatory changes since 2005 had produced more benefit than cost, but those estimates come with big margins of error. About 50% of US businesses today believe there is too much regulation and about 20% that there is too little. The main effect of the regulatory relief promised by the incoming White House consequently may be a boost in confidence and, with it, more investment. Hope springs eternal, if not necessarily based on any clear evidence. See Bank of America’s US Economic Weekly, 06 Jan 2017. (BAML, Milepost).

Markets: A loss of liquidity from Volcker and other regulations
The Volcker Rule’s effort to limit proprietary trading in bank portfolios always ran the risk of putting a pinch on bond market liquidity, but fans of the rule argued that other players would step in to make markets. In fact, Volcker has limited liquidity in parts of the market under stress, according to a recent Federal Reserve Board study. Dealers affected by Volcker have cut back on capital for trading and have lost market share to dealers exempt from the rule. Despite new support from exempt dealers, net liquidity in the corporate debt market that the Fed studied  is down. The elegant and compelling study is here. A second study by the NY Fed looking a wider set of regulatory constraints on trading also finds that liquidity has suffered. The NY Fed study is here.

Markets: A possible tweak to FHA premiums
The Federal Housing Administration on Monday announced a 25 basis point cut in its mortgage insurance premiums, a change that Inside Mortgage Finance reported was in the works last week with “the idea already pitched to Dr. Ben Carson, the Trump nominee to head the Department of Housing and Urban Development.” The cut came in the premium paid at origination, not the premium paid annually afterwards. JPMorgan estimated last week that a cut of this sort would have minor impact on Ginnie Mae MBS pricing, ranging from 2/32s in 30-year 3.0% pass-throughts up to 10/32s in 4.5%s. See JPMorgan, US Fixed Income Markets Weekly: Agency MBS, 06 Jan 2016.

Economy/banking/markets: The post-crisis pinch on mortgage credit
Higher required FICO scores on new mortgages since 2008 has squeezed mortgage credit, according to a Federal Reserve Board study released last month. Higher FICO requirements reduced lending by 2% in the years following the crisis and had measurable effects for up to four years afterwards. The biggest impact has come in young, middle-income or minority neighborhoods. Borrowers with adequate scores that already had mortgages have shown lower mortgage and non-mortgage delinquencies and have borrowed more for other purchases. This Fed study on mortgage credit is here.