Week In Review: Comparing the economy of 1968-1972 to today.

Last week was pretty uneventful for market-moving economic data, however we did get the ISM numbers, and prices paid keeps increasing. It looks like inflation definitely picked up in January and February. The ISM Manufacturing Index showed a substantial increase in prices paid, although the Services Index showed a small decline. Regardless, pricing pressures remain in the economy. Most of the Fedspeak was hawkish as well. All eyes will turn the jobs report next Friday.

Last week was pretty brutal for the mortgage industry as interest rates keep ratcheting higher. Rates started the month of February around 6.1% and ratcheted higher to close out at 6.67%. This was due to a combination of an exceptionally strong January jobs report, and disappointing prints on inflation.

The Fed Funds futures are now handicapping a 25 basis point hike in March, another 25 in May, another 25 in June and a coin flip for one more 25 basis point hike. The futures do see a chance of rate cuts in 2023 as they see the Fed Funds rate ending up in a range of 5.25% - 5.5%.

The CME has just started the probability calculations for 2024, and the markets see quite a bit of easing from the Fed in 2024. The market is predicting the December 2024 Fed Funds rate to be back down to 4% - 4.25% and the second most likely option is 3.75% - 4.0%.

It seems almost implicit in this forecast that the Fed has overshot and a recession is only a matter of time. The problem with this forecast is that the labor market is super-strong. While the January jobs number seems to be too good to be true (I suspect there might be some seasonality noise), the initial jobless claims numbers are the lowest we have seen since the US had a military draft in the late 1960s. So is it conceivable that you could have a recession with a super-strong labor market? In fact, the answer is yes, indeed.

The late 1960s seem to be a pretty similar situation to today. In late 1968, the Fed Funds rate was around 5.5% and it ended up hitting 10.5% by mid 1969. This is about as dramatic a hike in rates as we have seen in 2022. By late 1969, the US had entered a recession. Interestingly, the unemployment rate was around 3.5% at the time, so it isn’t impossible to enter a recession with a super-strong labor market.

Below is a chart of the Fed Funds rate and the unemployment rate from 1968 - 1972. If you wanted to put where we are today compared to them, we are in mid-1969, right about the time of the moon landing. The economy started a recession about six months later. and the Fed funds rate started falling soon thereafter. Note that the unemployment rate when the US entered a recession was still in the mid-3s, where we are today. FWIW, I do think this is probably the most similar situation to the current environment.

We saw strong wage growth during this period as well, with average hourly earnings around 6.5%. Even during the recession, wage growth remained brisk. The chart below shows the annual increase in average hourly earnings during this period.

Don’t forget that the economy of the late 1960s had a lot of government stimulus through LBJ’s policy of guns and butter - i.e. fighting the war in Vietnam and introducing massive new entitlements. Government spending as a percent of GDP increased from 21.9% in 1965 to 24.2% in 1968. This is a dose of fiscal stimulus that rivals COVID policies. In 1969, the yield curve inverted as well, pretty dramatically with the 10 year bond yield at 6.7% and the Fed Funds rate above 8%. Inflation topped out at 5.8% before the recession.

The similarities between then and now is pretty stark. Massive fiscal stimulus, check. Rapidly, rising inflation, check. Inverted yield curve, check. Super strong labor market, check. Aggressive monetary tightening, check.

So, if history repeats, we should top out with the Fed Funds rate soon, and enter a recession late in 2023. Which makes the Fed Funds futures for 2024 probably a good bet. Certainly the inverted yield curve suggests a strong possibility of a recession in the near term. If MBS spreads continue to tighten and we start seeing falling rates late this year and next, we should see a pretty big improvement in affordability.

The numbers from Rocket were downright awful. Seriously. Rocket reported a loss for the fourth quarter, which was no big surprise. But the actual numbers were paint a grim picture. Origination volume fell 25% from the third quarter and 75% compared to a year ago to $19 billion. Revenues fell 15% from the third quarter and a whopping 81% on a year-over-year basis. Gain on sale margin fell to 2,17%, which the company attributed to a purchase special.

Rocket’s number do show the vulnerability of its direct-to-consumer business model. Push button, get mortgage makes a lot of sense in a refi environment. The convenience of being able to download and ap and get a quick quote is worth a lot. When purchasing a home, it sounds like homebuyers ask for a recommendation from the realtor, and that where Rocket struggles. Yes, Rocket does have a broker business, but its bread-and-butter is its ap. Rocket is betting that its ancillary services like Truebill will lower its customer acquisition costs and help it drum up more purchase activity.

Like it or not, the homebuying experience is still largely a face-to-face, relationship-driven business. And people generally recommend someone they know. Rocket’s advantage is that the consumer interacts with an ap, which means it doesn’t have to pay loan officer commissions, which is a huge advantage. The downside is that it doesn’t have loan officers talking to realtors on a daily basis. And realtors recommend lenders they know and trust.

You can see the difference in United Wholesale’s numbers. They reported a roughly 50% decline on a year-over-year basis. United Wholesale has impressive technology as well, but the face-to-face aspect of mortgage origination seems to be more than an excess cost in a purchase environment; it is also a competitive advantage. This year will be dominated by purchase activity, and if the forecast above is correct, it should generate some refi activity in 2024.