Top of the Street: The biggest drag on inflation, the shift that could slash muni issuance, the new mortgage lender of last resort, a Nobelist’s view of volatility and more

Healthcare may be behind the global slowdown in inflation. Tax reform could slash muni issuance by 33% next year. FHA mortgage defaults rise. Shiller makes a case for low volatility. Contributions from Barclays, GS, JPM, MS, NY Fed and Milepost.

Markets/economy: The biggest drag on global inflation: healthcare
Healthcare has been a clear and persistent drag on inflation worldwide, according to Goldman Sachs. The cost of US healthcare rose 2% to 3% annually from 2002 to 2011 before slowing to 1% since, and other major economies have seen comparable declines. The reasons aren’t clear. But nothing else seems to explain the persistent run of inflation below most central bank targets. Globalization, technology and inflation expectations all come up short, according to Goldman, and overheated labor markets will eventually push inflation up. Goldman’s read seems to line up with the Fed. See Goldman Sachs, US Economics Analyst: What Can We Learns from Lower Inflation Abroad?, 12 Nov 2017. (GS, Milepost).

Markets: The shift that could slash 2018 muni issuance
Issuance of muni debt could fall sharply next year if current proposals for tax reform become law. Both House and Senate proposals end several forms of muni issuance including advance muni refundings, used to retire callable debt before the call date. Advance refundings constituted 25% of total 2016 muni supply. According to Barclays, total muni supply could drop nearly 33% from $400 billion this year to $270 billion next. Tax-exempt supply could drop 50% from $360 billion to $180 billion. The potential drop in issuance has led to a surge of recent buying and tighter muni spreads. See Barclays, Municipal Weekly: Fading the Rally…For Now, 10 Nov 2017. (Barclays, Milepost).

Markets: The new lender of last resort: FHA
Homeowners that have used finance companies in recent years to get mortgage loans guaranteed by the Federal Housing Administration are defaulting at 2- to 3-times the rate of similar borrowers from banks. FHA loans originated in 2014-2015 by finance companies from borrowers with FICO scores below 650, for instance, have cumulative 90-day or longer delinquencies of 11% while similar borrowers from banks come in around 3%.  Finance company borrowers with scores between 726 to 750 show cumulative delinquencies of nearly 2% while bank borrowers show less than 1%. Finance companies seem to be lending to riskier FHA borrowers, and with finance companies now originating nearly 75% of all FHA loans, credit risk at FHA is rising. That is one important reason that FHA may have little or now room to lower borrower mortgage insurance premiums and may have reason to raise them. See Morgan Stanley, Agency MBS Weekly, 10 Nov 2017. (MS, Milepost).

Markets: A Nobelist’s view of low volatility
Whether it’s the daily volatility of S&P returns, the VIX or other measures, stock market volatility is near its lowest levels in decades. But Nobel Laureate Robert Shiller might not be worried. The VIX lately is running around 9-10% while its average since 1990 is 20%. The Fed and other analysts have worried that a sharp reversion to the mean could slash S&P valuation by 5-10%. But Shiller, winner of the 2013 Nobel Price in economics, might argue that volatility is fine right where it is. Shiller has pointed out that a stock’s value is nothing more than the discounted value of its expected dividends, and the volatility of dividends since the 1950s has been about 7%. Other ecoomists argue that low volatility, investor complacency and higher leverage could pose risks to financial stability. The NY Fed digs into Shiller’s case and others’ in this recent post. (NY Fed, Milepost).

Markets: The quiet buyer of MBS: REITs
The top real estate investment trusts added $26 billion in agency MBS from July to September, the biggest REIT buy of MBS since 2012. The top 15 REITs raised $3.5 billion in equity and boosted their overall leverage ratio to 7.6x, with agency MBS often leveraged more. The REITs raised capital as price-to-book ratios climbed over 1.0, although the ratio for the largest has fallen below 1.0 lately. Interest rate exposure dropped slightly while option exposure rose. See JPMorgan, US Fixed Income Markets Weekly: Interest Rate Derivatives, 10 Nov 2017. (JPM, Milepost).

We’ll be back the week of November 27. Happy Thanksgiving!