Builder & Lot price Trends; The latest on Fannie & Freddie

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The latest quarterly results of home builders Toll Brothers Inc. and Hovnanian Enterprises Inc. provide minimal optimism for the new-home market going into 2015, as consumers remain reticent and builders use more incentives to bolster sales. The Wall Street Journal reports that, "Toll notched a 10% gain in sales contracts in its fiscal fourth quarter ended Oct. 31, signaling that luxury buyers are continuing their three-year trend of strong home-buying activity. Toll added that its sales in November and the first half of this month are up 16% from the same period a year ago, but it characterized the housing recovery as "extended and uneven." However, builders' recent results have come against comparatively weak numbers from a year ago, when sales suffered as buyers reeled from a rapid, 1-percentage-point rise in interest rates.

In addition, the bottom half of the market remains constrained. For example, Hovnanian, which caters to move-up buyers purchasing their second-generation house as well as some first-time buyers, registered an 8% gain in sales contracts for its quarter ended Oct. 31, falling short of analysts' expectations. Hovnanian added that it relied more heavily on sales incentives to boost its sales, which caused its gross margin to decline to 19.3% from 22.6% a year earlier. Incentives typically entail offering buyers free upgrades or financial assistance such as covering closing costs. Overall, Hovnanian called 2014 "disappointing" for itself and the broader housing industry. Across the U.S., sales of newly built homes are up by only 1% in the first 10 months of this year from the same period last year."

And Zelman & Associates Land Development Survey indicates strong development activity which will assist future lot supply. The land development index increased to 63.3 from 62.9 a month earlier and on average, it takes 15 months for raw land to be developed into finished lots. Finished lot demand decreased for the seventh consecutive month to 67 but finished lot value is up 13% YoY. Demand ratings for finished lots, raw land, builder appetite and investor appetite all declined in October due to irregular homebuyer demand the past few months. Whereas the absolute land acquisition demand score of 67.7 is above the 50-point threshold representative of a typical demand environment.

Along those lines Zelman & Associates released a report that focused on home builder trends. The analysis reported an improvement in the home building sector as seasonally adjusted order trends bounced back in October from a month prior and order growth jumped to 22% YoY, leading to a 30% increase for the public builders. Unfortunately, the pricing outlook was more negative than in previous months due to disappointing results and guidance from public builders during earnings season. The price appreciation over next year is 4.2% and net order price is up 3.7% YoY. Overall, construction costs have increased 3.5% YoY and margins have declined, indicating that incremental pricing power is not enough to counter higher land and construction costs.

There are deals that "look ahead", such as the one that is noted above, but companies continue to deal with legacy issues. Citibank said it will set aside $2.7 billion in legal costs (investigations into FX, Libor and compliance) and $800mm in repositioning charges in Q4. Darn it! Why didn't I go to law school?

What does the Congressional Budget Office think of moving Fannie and Freddie? Here is the latest: "Transitioning to Alternative Structures in Housing Finance." "CBO expects that the role of Fannie Mae and Freddie Mac in the secondary mortgage market will shrink over the next decade under current policy. If policymakers wanted to reduce that role further and lessen the advantages given to the two GSEs, they could use various mechanisms..."

Look at this market! The 10-yr T-note sitting at 2.07% at the close on Tuesday has investors worried about refinances paying off their MBS holdings - until they realize just how much it costs borrowers to fund a loan these days due to lender costs. Still, MBS prices improved again relative to Treasury prices and 30-yr agency securities closed out the day at or near the highs from earlier improving .250-.375.

For news today we've had the MBA's application numbers for last week and we will also have the Consumer Price Index. Applications for U.S. home mortgages fell last week and interest rates declined to their lowest level since May 2013, per the MBA. The seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, fell 3.3 percent in the week ended Dec. 12. Refinancing applications were unchanged, while the gauge of loan requests for home purchases, a leading indicator of home sales, fell 6.9 percent.

But the media seems most focused on this afternoon's conclusion of the Federal Open Market Committee meeting at 1PM CST, and the meaning of every little word and punctuation. After that will be Chairwoman Yellen's press conference to follow at 1:30PM CST. So far, in the very early going, we're at 2.10% on the 10-yr and agency MBS prices are worse a shade.

Executive Rate Market Report:

Starting somewhat like yesterday this morning; at 7:00 the DJIA traded +100, 9:00 +50. The 10 at 7:00 2.11% +5 bps, at 9:00 2.08% +2 bp; 30 yr MBS price at 9:00 -6 bp. The FOMC policy statement and Yellen’s press conference dominate trading today. In the meantime Nov CPI expected down 0.1%, dropped 0.3%, the largest decline since Dec 2008 and the east increase since last February. The core (ex food and energy) expected +0.1% was as expected; yr/yr +1.7%. No inflation on the horizon but most continue to expect the FOMC will signal rates will begin to increase next year; if there is any debate it is about when the Fed will start increasing the FF rate. The Fed likes to look at the PCE data (personal consumption expenditures) measuring consumer spending, it increased 1.4% in October.

In Europe Nov consumer prices increased at the slowest rate in 5 yrs; the EU edging closer toward deflation. The European Central Bank has said it will reassess its existing stimulus policies, which include cheap bank loans and purchases of asset-backed securities and covered bonds, in early 2015, and decide whether to do more to ensure that annual inflation moves closer to its target of just below 2%. Deflation fears also spreading to the UK; inflation fell to a 12-year low of 1% in November, and Bank of England Governor Mark Carney acknowledged it will fall further. Germany’s 10 yr bund set another low yield record today at 0.57%.

Also out this morning, Q3 current account balance, it increased more than estimates to -$100.3B against -$97.5B forecasts.

Yesterday crude oil prices calmed and ended about unchanged; this morning the selling is back on, early trade had oil down another $2.00. Oil traders are almost giving up looking for a bottom after OPEC essentially has lost all control of oil. Oil experts saying OPEC as an influence over oil prices for the last 4 years is all but finished as a major factor on production and price.

The DJIA opened +42 after being 100 points higher in futures trading at 7:00 this morning. At 9:30 the 10 after trading at 2.11% early was 2.07% +1 bp and 30 yr MBSs also recovered from early lows to unchanged on the day and unchanged from 9:30 yesterday.

Cuba/US relations thawed today with Cuba releasing prisoner Alan Gross. The President is scheduled to speak at 12:00 today. Gross got a 15 yr sentence in Cuba, he was working to expand Internet access for Havana’s Jewish community. He was accused of undermining the Cuban state and in December 2009 was sentenced to 15 years in prison. A long overdue defrosting in US/Cuba relations.

More volatility this morning; the stock indexes already have been swinging widely; from +100 in the futures to opening +42 and by 9:45 up 102. The 10 and MBS also swinging around, the 10 early at 2.11%, now essentially unchanged as is the MBS market. Every technical model we use and all of the momentum oscillators are bullish for lower interest rates. The slight near term concern is that the momentum of the current rally is approaching oversold levels suggesting a potential pause and slight uptick is possible. Any selling in the treasury and mortgage markets is not likely to change the bullish technical outlook and will open the door for more buying from traders and investors. Our forecast presently is for the 10 yr note to decline to 2.00% before a potential major trend change.

PRICES @ 10:00 AM

• 10 yr note: -4/32 (12 bp) 2.08% +2 bp
• 5 yr note: -3/32 (9 bp) 1.54% +2 bp
• 2 Yr note: -1/32 (3 bp) 0.57% +2 bp
• 30 yr bond: -14/32 (44 bp) 2.71% +3 bp
• Libor Rates: 1 mo 0.162%; 3 mo 0.242%; 6 mo 0.341%; 1 yr 0.597%
• 30 yr FNMA 3.5 Jan: @9:30 104.38 unch (unch from 9:30 yesterday)
• 15 yr FNMA 3.0 Jan: @9:30 104.12 +4 bp (-2 bp from 9:30 yesterday)
• 30 yr GNMA 3.5 Jan: @9:30 104.90 -23 bp (-15 bp from 9:30 yesterday)
• Dollar/Yen: 117.22 +0.81 yen
• Dollar/Euro: $1.2456 -$0.0055
• Gold: $1198.00 +$3.70
• Crude Oil: $54.82 -$1.11
• DJIA: 17,157.72 +88.85
• NASDAQ: 4576.34 +28.51
• S&P 500: 1987.52 +14.78

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