Once one of the biggest mortgage lenders in the U.S., Wells Fargo (WFC) has unveiled plans to step back from the housing market. Instead of going after the entire industry (its previous goal was a 40%-50% market share), the bank is shrinking its mortgage portfolio by restricting loans to only bank clients and minority borrowers. While the business was one of the company’s biggest profit generators over the years, things have gotten tougher amid regulatory pressure and higher interest rates.
That’s not all: Wells Fargo is shuttering its Correspondent lending business, in which the bank lends capital to other firms that sell mortgages as distinct providers. It’s a big deal, as the division accounted for nearly 40% of its mortgage volume as of Q3 2022. Wells Fargo is also reducing the size of its Servicing portfolio by selling billions of dollars worth of mortgage servicing rights to other players in the sector.
“We are making the decision to continue to reduce risk in the mortgage business by reducing its size and narrowing its focus,” said Kleber Santos, CEO of Consumer Lending. “Mortgage is an important relationship product… and we are acutely aware of Wells Fargo’s history since [the cross-selling scandal in] 2016 and the work we need to do to restore public confidence. As part of that review, we determined that our home-lending business was too large, both in terms of overall size and its scope.”
In August, Seeking Alpha covered reports that Wells Fargo would dramatically reduce the size of its mortgage unit and would retrench from its commitment to be No. 1 in the business. It has also taken other steps to simplify its mortgage division over the past three years, like scaling back the refinancing of jumbo mortgages in 2020. As traditional banks continue to withdraw from the industry (JPMorgan (JPM) and BofA (BAC) surrendered mortgage share after the financial crisis), non-bank entities like Rocket Mortgage (RKT) and United Wholesale Mortgage (UWMC) have filled the void, though they are not as regulated and some say it could expose borrowers to additional risks.
US Economy
- The December jobs report topped expectations, signaling persistent strength in the labor market.
- …with state government jobs (mostly teachers) dragging the headline payrolls figure lower.
- The market increasingly expects the February Fed rate hike to be 25 bps rather than 50 bps. Much will depend on the December CPI report.
- Credit card balances continue to surge.
- … as excess savings are depleted.
- Last year’s massive global monetary tightening will remain a drag on US business activity throughout 2023.
- The NFIB small business index surprised to the downside in December.
- The NFIB report points to further weakness in US manufacturing activity, …
- … as fewer industries experience growth, and factory orders slow
- Forecast from Piper Sandler: Many expect CPI moderation this year
- Inflation reports have been surprising to the downside.
- Rent, fertilizer, used car prices all continue to ease
- The inventories-to-sales ratio continues to rise.
- Mortgage applications remain depressed.
- The yield curve inversion deepened this week.
- The CPI report was in line with expectations.
- The headline CPI declined in December.
- Inflation slowed on a year-over-year basis.
- But the core services CPI continues to surge.
- Housing is driving the core services CPI, with shelter inflation hitting a multi-decade high.
- However, leading indicators tell us that shelter inflation should moderate.
- The 10-year/3-month portion of the Treasury curve inverted further.
- The market now expects a 25 bps rate hike next month, with the probability of a 50 bps increase dipping to 10%.
The Fed
Powell doesn’t want to go down in history for letting inflation get out of control and would ultimately turn more hawkish. Inflation is still too high but receded quite a bit the last few months.
That brings us to my one specific forecast: I have been saying for over a year that I believe the Fed funds rate will get to 5%. I now believe it is entirely possible the Fed will not stop hiking until it gets to 5.5%. The operative word there is believe.
Minneapolis Fed president Neel Kashkari this week called for the Fed funds rate to be between 5.25% and 5.5%. When Kashkari, one of the most dovish FOMC members, is signaling almost 5.5%, Powell clearly has buy-in to go “higher for longer.”
That number isn’t random, by the way. Powell has said they want to see positive real rates across the whole yield curve. Inflation backing off to 3% or 4% while Fed funds is 5.5% would do it, even if long-term rates stay in a small inversion. It would be, if not exactly a “normalized” policy, much closer to normal than we’ve seen since 2008.
But this is also where we start seeing other problems. The economy—and certainly financial markets—no longer wants this kind of normalcy. It has adapted to free liquidity. Adapting back won’t be easy, and it certainly won’t be painless.
The Federal Open Market Committee’s 12 voting members differ on where they think interest rates should go this year. But we know they’re unanimously against cutting rates until at least 2024—or at least they were as of December, according to that meeting’s minutes.
That means one of the three possible directions (up, down, sideways) is currently off the table. Rates will thus move either sideways or up—unless the FOMC members change their minds, which is quite possible. They all profess to be “data dependent.” However, the bond market doesn’t believe that. Traders continue to price in rate cuts later this year.
Why is Unemployment so low with the Fed hiking rates?
With the Fed raising aggressively, when there are clearly signs of the economy slowing down in certain sectors, we have to ask why unemployment is so historically low. Some of it is demographic trends but there are other reasons.
- COVID accelerated retirement. Literally millions of experienced and productive workers left the workforce. Maybe for retirement, maybe doing something to stay busy, but they are not showing up in the unemployment numbers.
- Numerous lower-wage service sectors simply saw their employees drop out in 2020‒2021. Higher wages plus disappearing benefits are slowly bringing them back, and even though we read of layoffs and slowdowns, the fact of the matter is there are more jobs than potential workers. You can bet the Fed is closely watching the ratio of available jobs to available workers. That ratio, along with the potential for a credit crunch, is far more important in Powell’s calculation than many other things pundits bring up.
- US businesses “re-shore” their manufacturing and create jobs here. That process is clearly accelerating.
The flattening in manufacturing corresponds exactly with:
- The growth of annual reshoring and foreign direct investment job announcements which accelerated from 6,000/year in 2010 to 350,000/year in 2022.
- A dramatic reduction in the rate of job losses due to offshoring.
Our regression analysis of BLS manufacturing labor data shows the same impact and timing. Conclusion: Manufacturing employment is now 5 or 6 million higher than one would have predicted before the Great Recession.
In theory, the Fed could balance all these moving parts and get inflation down to its 2% target without sparking recession. It is difficult, though, and I have no confidence they can do it. Reminds me of the Yogi Berra quote: “In theory, it works; in practice, it doesn’t.”
The seeds for the 2023 recession were sown a while ago by the relentless decline in the Conference Board’s leading economic indicator, which has now fallen for nine consecutive months. The data go back to 1959 and I can tell you that at no time in the past have we seen a string of weakness like this, with a 5.6% annualized contraction over such a timeframe, that failed to presage a recession within a quarter or two. Call it nine for nine back to fifty-nine. The recession is staring us in the face (and if it is so ‘priced-in,’ why is the consensus calling for positive EPS growth for next year?).
What the Fed is focusing on is the coincident index, which is still on a mild uptrend—but that only tells you where we are today. And the index of lagging economic indicators, which also are hitting new highs at the current time, tells you where we were yesterday. The leading indicator is chock full of leading factors like capital goods orders, building permits, the workweek, and consumer buying plans. The coincident index has nonfarm payrolls, and the lagging index consists of the unemployment rate, wage costs, and consumer services inflation. The Fed is driving the bus all right but is not looking through the front window. Which means what? It means we are going into an outright recession. A national haircut to GDP, rising unemployment, asset deflation, and looming debt defaults. This is the theme for 2023 and is typical for the year that follows the Fed tightening cycle—think 1970, 1975, 1982, 1990, 2001, and 2008.
Inflation will drop a lot more than people think.
We expect downside market volatility along the way in periods where earnings growth is stunted.
Market Data
- The 2023 earnings estimate downgrades continue (3 charts), …
- but the revisions have not yet priced in a recession.
- The S&P 500 is at resistance.
- S&P 500 earnings face their first year-over-year decline since Q3 of 2020.
- Oil production by country:
Quote of the Week
“Before your criticize someone, you should walk a mile in their shoes. That way when you criticize them, you are a mile away from them and you have their shoes.” – Jack Handey
Picture of the Week
Auru River in Turku Finland
All content is the opinion of Brian J. Decker
