Back to Business in 2023
While it’s back to business as usual, it was a fairly quiet week as we settled into the new year. Fast inflation and high interest rates dominated the narrative and upended markets across the world in 2022. When the dust settled, 10-year Treasuries were 200+ BPS higher than the start of the year, the yield curve inverted in a bearish fashion (faster and farther than ever), and mortgage spreads were pushed from stubbornly rich to suddenly cheap. The result was an entire trade-able universe moving out of the money, originations grinding to a halt, and duration becoming a function of illiquid trade flows. U.S. mortgage applications at the end of 2022 dropped to the lowest level since 1996 amid seasonal headwinds and high financing costs.
Overall agency mortgage bond gross issuance for 2022 came in at $1.7 trillion, far above the $1.3 trillion annual average seen during the 2000 through 2019 period, but far below the $3.3 trillion average seen in 2020 and 2021. The MBA’s forecast for 2023 expects originations to fall to $1.9 trillion and the first quarter is projected to be the roughest quarter, with total originations expected to fall to $345 billion. Originations are expected to increase throughout the year, and similarities have been drawn with 2018 in terms of origination volume and margins. Mortgage rates are expected to fall throughout 2023, with the 30-year mortgage rate falling to 5.2% by the end of the year.
Housing and Labor Markets
Housing has traditionally led the economy out of a recession, and we have seen housing starts reach something like 2 million annual units in early stage recoveries. Housing starts are expected to remain depressed, around a 1.5 million annual rate in 2023. The pre-bubble historical average since the late 1950s has been 1.4 million housing starts annually, but the U.S. population is now much larger than it was seven decades ago. The National Association of Realtors estimates a 5 million to 6 million unit deficit in needed housing, so the demand is there. Simply put, homebuilding can’t stay depressed forever, though you don’t build what people can’t afford to buy. Home price appreciation is predicted to slow and eventually turn negative by the end of 2023, although that means annualized single-digit appreciation rather than a crash. Finally, existing home sales are expected to remain low, but improve throughout the year.
The bond markets drive interest rates, and much of the current sentiment in the bond markets is being dictated by the strong domestic labor market, which gives the Fed fuel to further tighten policy. Earlier this week, the ADP figure came in at 235k versus the expected 150k and we also had lower initial jobless claims. Today, payrolls beat estimates, coming in at 223k versus 203k expectations and unemployment declined to 3.5%. The market was almost hoping for a weak report that would have triggered a rally in stocks and bonds as it would have increased the chances that the Fed will pivot from a tight monetary policy to a neutral one.
There are three basic inputs to current inflation: supply chain issues (stemming from the pandemic, though they are largely fixed), housing (expected to fade by the summer), and services ex-housing (read: service sector wage growth).
There are three basic inputs to current inflation: supply chain issues (stemming from the pandemic, though they are largely fixed), housing (expected to fade by the summer), and services ex-housing (read: service sector wage growth). Services excluding housing are the focus of the Fed as the central bank is trying to avoid a wage-price spiral, last seen in the 1970s. A big component of this will be productivity growth, which has been muted. As long as wage growth remains high, the Fed will keep tightening. Fed Chair Powell has insisted that the job openings and quits rate should decrease and wage growth should slow to help bring down prices.
Hawkish FOMC Minutes and Best Business Practices
FOMC minutes released earlier this week indicated that Fed officials are expecting rates to remain elevated in 2023. Though the inflation data for October and November showed welcome reductions in the monthly pace of price increases, consistent with easing supply bottlenecks, the FOMC stressed that it would take substantially more evidence of progress to be confident that inflation was on a sustained downward path. The current restrictive policy approach appears to be best until the FOMC is satisfied with easing inflationary pressures. The FOMC also noted that the Fed Funds futures were at odds with the FOMC, and that no members thought it would make sense for the Fed to start easing in 2023. My two cents is that it’s hard to see the FOMC opening up the sluice gates again anytime soon.
Your hedging model probably dictates what percentage of your pipeline to hedge based on your pull-through at five or six stages of loan manufacturing. Test pull-through at least quarterly and monitor it closely when there’s a lot of volatility. Adding things like new products or branches can change your pull-through numbers. We are not out of the woods yet, and you should be prepared for any further downturn with a written plan that has specific actions to be taken at set milestones for volume declines. Making decisions in the heat of the moment is not as efficient as having a plan that’s thought out well in advance and can be referenced more dispassionately as each milestone is reached.