Category Archives: Mortgage

Wholesale inflation nears the Fed target – helping REITs

Wholesale inflation nears the Fed target—helping REITs – Ravenzlo Blog

Market Realist

The Producer Price Index measures inflation at the wholesale level

Inflation at the wholesale level has been typically taken to predict inflation at the consumer level. In a normal business environment, producers pass these increased costs to consumers, which would decrease the disposable income if wages didn’t rise accordingly. A little inflation is considered a good thing.

Deflation causes a lot of economic problems, especially for the Fed. Since interest rates can’t go below zero, if deflation increases, it causes real (inflation-adjusted) interest rates to increase. This is exactly what we don’t want to see in a depressed economy.


Inflation is also a debtor’s best friend. As inflation increases, wages and prices increase, which means that the relative size of the debt decreases. Given the shaky state of most household balance sheets, the Fed would really like to create inflation, provided it results in increased wages. If wages don’t co-operate, the Fed could end up making matters worse. If commodity prices increase while wages stay flat, consumers end up with even less disposable income.

Increasing inflation has historically meant that the Fed was getting ready to raise interest rates. A disappointing inflation report would cause stocks and bonds to sell off as investors react to a tighter Fed. These days, the Fed isn’t overly concerned about inflation. As long as unemployment is elevated and inflation is below 2%, the Fed will consider itself to be failing at both of its mandates—price stability and unemployment.

Prices at the wholesale level fall as prices at the consumer level rise

The PPI rose 0.4% in June after falling 0.2% the month before. Ex-food and energy rose 0.2%. On an annualized basis, the producer price index rose 1.9%, and 1.8% ex-food and fuel.

This report will probably give the Fed some comfort. The Fed still fears deflation and will maintain ultra-low interest rates and continue with asset purchases until unemployment falls below 6%. That said, the Fed prefers to use the Personal Consumption Expenditures index to measure inflation, not PPI or CPI.

Implications for mortgage REITs

Low inflation means the Fed will be able to maintain short-term interest rates at low levels for the foreseeable future. This means mortgage REITs like Annaly (NLY), American Capital Agency (AGNC), MFA Financial (MFA), Capstead (CMO), and Redwood Trust (RWT) need not fear an increase in their borrowing costs—at least in the near future. Provided the long end of the curve stays the same (and the ten-year curve seems to have found a range here), their net interest margins should remain robust. They should be able to maintain their dividends. Investors who wish to make a directional bet on interest rates should look at the iShares 20-year bond fund (TLT).

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From Wells to Morgan Stanley, What to Watch as Banks Report

From Wells to Morgan Stanley, What to Watch as Banks Report



With legal woes and slow trading conditions hurting many banks, the second quarter isn’t expected to be much to write home about.

Wells Fargo & Co. starts off the bank earnings season when it releases second quarter results Friday morning. The San Francisco-based lender is followed by Citigroup Inc. on Monday, J.P. Morgan Chase & Co. and Goldman Sachs Group Inc. on Tuesday, Bank of America Corp. on Wednesday and Morgan Stanley on Thursday.

At the halfway point of 2014, large banks have taken a step back from last year, when the six behemoths had their highest net income since 2006 and finished the year with five consecutive quarters of profit and revenue growth.

Both streaks ended in the first quarter. Now in the second, revenue at the big six U.S. banks is expected to decline again, this time by 5.6% to $101.4 billion from the previous year, according to estimates from analysts polled by Thomson Reuters. Profits are expected to fall 10.3% to $19 billion, as banks face a tough comparison with a strong second-quarter a year earlier.

Some analysts say the slump may be temporary. Legal costs could subside soon and lending growth is showing signs of life. Trading, one of the least predictable businesses, could also pick up in the second half, some analysts say.

Here’s a look at the big themes that will drive whether this quarter proves to be a disappointment or promises some happy surprises for bank shareholders.

1.Trading Troubles

Big banks’ second-quarter trading numbers and any commentary around how market volumes and volatility are panning out in the current quarter will be closely watched for signs of whether the slump in fixed income, currencies and commodities trading is close to abating. Equity trading revenue will also likely be “materially lower” in the second quarter, say analysts at Fitch Ratings. And some analysts have gone so far as to cut estimates on investment banks as far out as 2016, citing what they say will be a prolonged slowdown in FICC trading. In the past couple of weeks however, there have been a few rays of hope as client activity appears to have picked up in June. Citigroup Inc. analyst Keith Horowitz predicts that markets revenue could rise somewhat in the second half as compared with a year earlier.

2. Lending Trending Up

Loan growth is expected to have stayed strong in the second quarter. “We are now in the early phases of a truly sustainable acceleration,” write analysts at Oppenheimer. Commercial and industrial lending is expected to continue to grow, while consumer lending could also start picking up. Analysts at Deutsche Bank note that period-end loans for the largest 25 U.S. banks are up 2.2% as of the second-quarter’s end, from a year earlier. Mortgage banking is also expected to rebound in the second quarter from the first, with the Mortgage Bankers Association projecting that originations will rise 18% sequentially, although they predict these will be down 50% on a year-over year basis.

3. Lower Expenses, Lumpy Litigation

Sluggish revenue growth has driven banks to double down on expense cuts, although large additions to litigation reserves in recent quarters have thrown a wrench in that effort for several big banks. For the second quarter, for instance, analysts expect Bank of America Corp. to add between $1 billion and $4.6 billion in legal costs tied to a potential settlement with the Justice Department. Separately, Morgan Stanley analysts recently slashed their earnings forecast for Citigroup after The Wall Street Journal and other media reported that Citigroup was near a $7 billion settlement with the Justice Department over soured mortgages. With litigation outside of the banks’ control, many are focused on real-estate costs. Analysts at Raymond James recently noted that while banks will likely continue to streamline their branch footprints, much of the “proverbial low hanging fruit has been picked, which could make it harder to cut expenses going forward.

4. Investment Banking

Slumping trading is expected to be mitigated by stronger investment banking revenue in the second quarter, with mergers and acquisitions revenue a particular bright spot. Citigroup analysts note that announced M&A volumes are up 73% from a year earlier. Equity capital markets volumes are up 26% from a year earlier, but debt capital markets growth slowed to just 1% in the second quarter, due to tough comparisons with a year earlier, says Citigroup.

5. Credit Tailwind Could Slow

Declining reserves for loans that could sour have padded bank profits for years, but that tailwind may finally be coming to a halt. “It’s no secret that loan loss provision expense has been running at unsustainably low levels as banks release the sizable loan loss reserve builds incurred during the financial crisis,” wrote analysts at KBW in a recent note. “But, such releases cannot last forever even if credit quality remains benign.” Once provisions rise and releases ebb, banks will be forced to once again rely mainly on growing revenue and cutting costs to deliver earnings growth.

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