Syrian conflict and weak jobs report bring volatility
The news rattling markets today is a mix of apprehension over the U.S. missile strike in Syria and a jobs report that fell far short of expectations.
First, let's talk about Syria. President Trump on Thursday night ordered a cruise missile strike in Syria in response to Syrian leader Bashar al-Assad's recent chemical weapon attack in that country's years long civil war.
While it's still too early to know if the strike will become an isolated attack or the beginning of ongoing U.S. involvement, it has merited worldwide attention. Governments around the globe released statements supporting their allies. Germany, France, Australia and Japan supported U.S. actions, while Syria, Russia and Iran have called it an act of aggression.
In financial markets, overnight trading was quite tumultuous as investors flocked to safety. Gold hit a five-month high and the 10-year US Treasury rallied briefly. Oil prices also increased by 1 percent as investors considered more conflict in the oil-rich Middle East.
On the jobs front, the monthly nonfarm payrolls report came in far below expectations with only 98,000 new jobs reported, compared to estimates of 180,000. Analysts are already blaming the low number on bad weather the week of the survey, which has been known to hurt accuracy of the report. The consensus among analysts is that the number is likely higher than reported, though bad weather and a strong February may have cooled job growth in March.
As monetary policymakers weigh jobs in their calculations, it is likely April's report now carries more weight. We will anxiously be watching to see if March was indeed a blip on the radar or a sign that job creation isn't as strong as expected. If the job market were to show signs of trouble, that may change the Federal Reserve's planned rate increases.
On the bright side for workers, the unemployment rate dipped to 4.5 percent and workforce participation remained at 63 percent, a post-recession high. That's evidence to support the view that the Fed will probably stay on its current course and treat the March report as an outlier.
Understanding guarantee fees
You may recall that in last week's primer on MBS, we discussed the basics of Fannie Mae, Freddie Mac and their role in the mortgage industry. Both are government-sponsored enterprises that buy residential mortgage loans, bundle them into securities and then sell them to investors.
They also provide a guarantee to investors of timely payments on their securities — in short, that they'll get their money in full and on time.
How do they do this? They charge a guarantee fee to lenders, which cover losses if borrowers fail to make their payments; cover the costs of holding the capital needed to safeguard against larger, unexpected losses; and foots the bill for general and administrative expenses.
The fees break down in several ways. First, the enterprises charge lenders a base, or ongoing, guarantee fee depending on the type of loan product they're selling (for example, a 30-year fixed-rate mortgage versus a 15-year and an adjustable-rate mortgage). They also charge the lenders upfront guarantee fees — called loan level pricing adjustments, or delivery fees — based on the borrower's own level of risk (such as his or her credit score and debt-to-income ratio).
These fees then affect pricing for the borrower because lenders will convert the delivery fees into the interest rate on the mortgage, which, of course, the borrower pays over time. Together, the ongoing guarantee fees and the delivery fees comprise Fannie and Freddie's total compensation for providing a guarantee of consistent and timely payments to investors.
Don't think Fannie and Freddie exercise carte blanche in assigning guarantee fees. The Federal Housing Finance Agency oversees these fees and regularly reviews what's being charged and if adjustments are needed to ensure Fannie and Freddie are well-capitalized without overcharging. Most recently, in 2015, the Federal Housing Finance Agency reviewed the enterprises' fees, and determined that they were at appropriate levels.
In our next installment I will talk about servicing fees and mortgage servicing rights (MSR).
Don't forget next Friday is Good Friday, and while it's not an official bank holiday, I'll be taking a break from Market Update. We will be back on Friday, April 21.
