Shelter from the Storm(s)

Episode Summary

Executive Summary: The episode covers a busy week in macro data and Fed policy, emphasizing continued disinflation in CPI, softer labor signals, and the Fed’s decision to pause while projecting more hikes. It then shifts to a deep interview with Mark Calabria on housing finance, mortgage servicer fragility, pandemic forbearance, and why he believes the mortgage system still has structural weaknesses despite avoiding a systemic crisis in 2020.

Main Topics: Inflation is cooling, but core pressures remain (Priority: 5/5): Mark Sandy and Chris Toritis interpret the latest CPI as broadly encouraging: headline inflation has fallen sharply from its 2022 peak, and they expect further moderation as vehicle prices and shelter inflation ease. They note, however, that core inflation is still elevated and the speed of decline matters for Fed policy. Fed pause, dot plot, and communication strategy (Priority: 5/5): The hosts discuss the Fed’s decision to hold rates steady while signaling two additional hikes this year. They argue the dot plot may be as much about jawboning markets and preserving credibility as it is the committee’s true internal forecast. Labor market softening and recession risk (Priority: 4/5): They weigh claims that the labor market is easing, citing unemployment claims and forthcoming benchmark revisions, but disagree on recession timing and probability. The conversation centers on whether job losses and tighter credit could tip the economy into recession later in 2024. Credit stress in commercial real estate (Priority: 4/5): The discussion highlights rising CMBS delinquencies as an early warning sign of credit deterioration, particularly in office, retail, and multifamily properties, even though delinquency rates remain low by historical standards. Mark Calabria’s career and housing-policy worldview (Priority: 3/5): Calabria traces his path through academia, the homebuilders, HUD, Congress, Cato, the White House, and FHFA, framing his perspective as rooted in industrial organization and mortgage-market structure rather than standard macroeconomics. Pandemic mortgage forbearance and servicer support (Priority: 5/5): Calabria explains the policy logic behind FHFA’s forbearance design during COVID, arguing it was intentionally easy to enter but not forgiving, and that servicer support was narrowly targeted to avoid unnecessary bailouts. Structural fragility in mortgage finance (Priority: 5/5): The interview closes on Calabria’s concern that the mortgage market is overly reliant on nonbank servicers funded by warehouse lines, making it vulnerable in a risk-off environment. He argues for a stronger depository role and warns against assuming bailouts are the right fix.

Key Arguments: Inflation is moving decisively lower from its peak, with vehicle prices and shelter inflation expected to continue pulling CPI down over the next 6-12 months. Core inflation remains sticky, so the key policy issue is not direction but speed: the Fed wants sufficient confidence that inflation will keep slowing. The Fed’s two-hike dot plot likely serves a signaling role, reinforcing that the committee is not ready to declare victory or validate market expectations of easier policy. Labor-market data and employment revisions suggest job growth is slowing, which supports the case for fewer hikes and raises concern about future recession risk. Commercial real-estate credit deterioration is starting to show up in CMBS, though current delinquency levels are still far below crisis-era peaks. FHFA’s COVID-era forbearance design worked because it relied on quick entry, back-end verification, and strong borrower incentives to exit responsibly. A major reason mortgage servicers did not collapse in the pandemic was that losses were shared across the system and Fannie/Freddie retained substantial servicing responsibility. The nonbank mortgage model is inherently fragile because it depends on short-term funding and thin balance sheets, and regulators are unlikely to manage that fragility well in a crisis. Calabria believes the mortgage system needs structural reform, not reflexive bailouts, because moral hazard can worsen leverage and long-run vulnerability.

Data Points: CPI inflation peak: 9.0% - Consumer price inflation peaked in June 2022, according to the hosts. May CPI inflation (year over year): 4.0% - Latest CPI print discussed on the episode, viewed as a sign of disinflation. Core CPI inflation: 5.3% - Used to show that underlying inflation is still elevated despite lower headline inflation. Inflation excluding shelter: 2.1% - Host points out that non-shelter CPI is much closer to target. Inflation excluding food and shelter: 1.0% - Used rhetorically to argue broad price pressures are easing outside key sticky categories. University of Michigan 1-year inflation expectations: 3.3% - Consumer inflation expectations fell sharply in the latest survey reading. Peak U. Michigan inflation expectations: 5.4%-5.5% - Referenced as the earlier high in 2022 for one-year-ahead expectations. Initial jobless claims: 262,000 - Two consecutive weeks at this level were cited as a sign the labor market is easing but not collapsing. Moody’s CMBS delinquency rate: 4.5% - Commercial mortgage-backed securities delinquency rate increased meaningfully but remained low historically. CMBS delinquency rate during pandemic: 7.5%-8.0% - Referenced as a comparison for how much worse conditions were during COVID. CMBS delinquency rate after financial crisis: 10% - Referenced as a historical stress benchmark. Fed funds rate target: Just over 5% - Current policy rate after the June meeting. FOMC projected additional hikes: 2 quarter-point hikes - Dot plot indicated more tightening despite the pause. Recession probability for next year: 40%-45% - The hosts’ estimated odds for an NBER-defined recession between June 2023 and June 2024. Recession probability for 2024: About two-thirds - One speaker’s higher estimate for recession risk in the next calendar year. Mortgage forbearance peak in Fannie/Freddie book: 6.7% - Calabria said his internal model forecast around 6%, and actual peak was slightly higher. Nonbank servicing share of Fannie/Freddie burden: About 25% - Calabria said only about a quarter of servicing advances were borne by nonbanks. Fannie/Freddie servicing responsibility: About 40% - He noted the GSEs themselves carry a large share of servicing advance obligations. Nonbank servicers under contract with Fannie/Freddie: 346 - The number of nonbank servicers in the GSE book at the start of COVID. Largest servicers contacted: 30 firms - FHFA reached out to the biggest servicers, which represented most of the market. Market coverage of largest 30 servicers: About 90% - Illustrates concentration in mortgage servicing. Forbearance exit behavior: About 15% took forbearance for one month; about 25% for three months or less - Calabria used this to show many borrowers used the program briefly and recovered. Credit quality tail risk: 5%-10% - Calabria estimated a small but meaningful vulnerable tail in the mortgage book, concentrated more in FHA than GSE loans. Estimated FICO inflation: 20-30 points - His rough estimate of score inflation relative to pre-2005 norms. Average mortgage rates in the discussion: Near 7% - Used as a sign affordability remains strained and housing demand could weaken further. Likely normalized mortgage rate range: High 5s to 6% - Calabria’s view of where mortgage rates may settle long term. 10-year Treasury normalization assumption: Around 4% - His mortgage-rate framework assumed a roughly 200 bps spread over Treasuries. Great Recession fiscal response: About 10% of GDP - Used as a comparison for pandemic stimulus and policy scale. Pandemic fiscal response: About 25% of GDP - Calabria contrasted the much larger COVID response with 2008.

Pivotal Quotes: "We're headed towards three here towards the end of the year, 3% year over year, and going into next into the twos." — Mark Sandy: On the expected path of CPI inflation as vehicle prices and shelter cool. "The dot plots are really about sending a message." — Chris Toritis: On why the Fed projected two more rate hikes despite pausing in June. "If you get job loss, this is why I get back to Earla's point. A lot of this rides on the job market." — Mark Calabria: On which borrowers and mortgage segments are most vulnerable if the labor market weakens.

Implications: Listeners should expect continued disinflation but not an immediate Fed pivot. In housing, the key risk is a weaker job market hitting fragile nonbank servicers and lower-quality borrowers, which could expose structural problems in mortgage finance.