Housing Smoke and Mirrors “Equivocation” reported the transition in the housing market, from strength to consolidation, as interest rates rose in expectation of the Fed “Taper“. This transition phase became evident in the data and commentary in July. Moving into August, this has become an unequivocal consensus that the housing market has stalled.
This consensus has yet to become outright pessimism however; so there is a window of opportunity open for the Fed to provide support through its guidance and actions at the September FOMC.
The recent evidence to support a softening in rhetoric and action, by the Fed, has been increasing in the daily news flow; which has now framed the next FOMC meeting as an opportunity to scale back rising interest rate expectations.
Mortgage lenders now warn of more job losses, as the lending and refinance business contracts. What is most alarming is the speed with which they have moved to downsize operations. There has also been an alarming drop in lending standards within the industry. The Mortgage Bankers Association’s Mortgage Credit Availability Index posted a decline in August. Interest rates have risen thanks to the “Taper”; and now have been pushed even higher as the lenders raise the credit risk bar for borrowers. It is therefore fair to conclude that credit in the housing sector is tightening. The “Taper” has now become a “Tightening”; at least as far as the housing sector is concerned.
It is not all doom and gloom in the mortgage sector however. The tightening is not uniform across all subsectors of the mortgage market. The selective tightening can be seen to reflect lender perceptions of credit quality. In Housing Smoke and Mirrors “Equivocation” it was observed that the Jumbo Loan subsector was now commanding tighter lending spreads over benchmark reference rates. This form of credit rationing is rational; and will lead to a choking off in credit for the highly leveraged sectors that represent the greatest risk. These risky sectors should then be covered by the umbrella Federal stimulus and modification acronyms known as HARP and HAMP. There was however an interesting signal that one institution in particular is taking a credit bet in the opposite direction; and increasing its exposure to the most volatile areas of the housing market just as they start to weaken.
JP Morgan is by now infamous for the “Whale Trade” in the credit markets. It would seem that the spirit of the Whale lives on in JP Morgan’s domestic mortgage book. The bank is now increasing its exposure to the very regions of the market that experienced the greatest falls and recoveries in house prices. JP Morgan is getting long Beta in house price terms, just as the rest of the market is going short, in the hope of generating Alpha. It looks like a classic contrarian bet. Capital Economics reported that investor activity was down 20% in the last four months; and that sellers are becoming more aggressive. The pattern of existing home sales continues to increase and diverge from the recovery paths of 2011 and 2012; towards the poor trajectory of 2010 that led to the unveiling of QE2 by James Bullard.
source: Calculated Risk
Hovnanian added to the growing pessimism, with a downbeat commentary based on rising interest rates, in its latest earnings report. Clearly JP Morgan believes that interest rates have backed up too much; and that the Fed is now positioned to unload more liquidity and support for the housing market. JP Morgan reduced housing exposure as the bubble expanded between 2005 and 2008; and now it is taking another contrarian bet as the rest of the market gets bearish.
Jamie Dimon is now wagering again; to rebuild his reputation and the bank’s position with a trademark contrarian bet. The trademark contrarian bet signals the trademark support of the Fed in order to realise the trading profit.