7.24.26 One-Year Look Back; Morgan Stanley’s Matthew Hornbach on Risks; Stagflation Creeping

Robbie ChrismanWelcome to the Chrisman Commentary, Daily Mortgage News Podcast. I'm your host, Robbie Chrisman. Topics on today's episode include what were we talking about a year ago? Are we seeing more inflation with a slowing economy? And my interview with Morgan Stanley's Matthew Hornbach on identifying the risks that investors in the mortgage industry may be underestimating as the economy transitions into its next phase. Here, take a listen, do a little preview. For mortgage lenders or mortgage backed security investors trying to separate signal from noise, which economic indicators do you think deserve the most attention today? And which do you think are over-emphasized? Obviously, people say, oh, payrolls and then CPI or PCE inflation or retail sales, personal spending. But but your thoughts on on what to pay attention to out there? It doesn't have to be just economic release, it could be anything. Matthew HornbachWhat should people be paying attention to? I think, aside from the geopolitics of the current world that we in which we live, I would say people should be paying attention to what's happening with with pricing, either in their businesses or in their communities, and not focus just on the things that are easy to focus on, which are things like, hey, the iPhone price is going up. Because oftentimes you can get hypnotized by things that at the micro level are important to you as a consumer of cellular technology, but at the macro level, actually don't really move the needle. And you know, if iPhone prices defined inflation, things would be a lot different today than what we actually see in the overall numbers. So I think paying attention to the bigger picture of inflation, and there's lots of ways you can do this. The Federal Reserve published what's known as the beige book, which is about as boring a read as the color beige. Robbie ChrismanThat's what AI is for summarizing that down into one paragraph. Come on. Matthew HornbachThat's right. Um, well, the good news is they already summarized it for you on the website. And if you you know, if you actually read the section on inflation, it it reads relatively benign, you know, and and so I think again that that's really good information for for people to pay attention to. And then the other thing I would I would focus on is the competitive landscape for AI. I I presumably you know people are using some combination of Claude and Chat GPT and Google's model, Gemini Copilot, so on and so forth. Robbie ChrismanYeah. Matthew HornbachExactly. But but but really focus on like the competitive landscape of of AI. Because those of you, for example, who are using um you know Claude and have access to some of the higher tiers and and their latest models, will see that that they've been extending the deadline for you know for their frontier model. Then ChatGPT just came out with its frontier model sold. And and so capital markets are you know, kind of operate off of this principle of capitalism, competition. And that's the beauty of that's the beauty of our economy, that's the beauty of the of the global economies, it's it's a competitive marketplace. And I think just paying attention to how competition evolves in AI is going to be really important. And not just competition within the US ecosystem, but global competition in AI is a fascinating thing to pay attention to. Robbie ChrismanLooking for the first true end-to-end AI platform built for mortgage? Look no further than JazzX. From application to closing, JazzX is a new operating model that helps you scale growth, boost productivity, and transform how your team performs. Learn more at jazzx.ai. Do you ever buy anything? I used to, but that's become too expensive. And the U.S. Federal Reserve can't do anything to fix it. Kidding. Of course. I buy food. The odds are anything you buy was transported using diesel fuel, the price of which has shot up after Russia banned exports of it, impacting farmers, trains, trucks, kind of nearly everything. Today is Pie and Beer Day in Utah, aka Pioneer Day, and having parades is costly. It was also celebrated last year, and the year before, and the year before, and the year before. What were we talking about a year ago? We were interested in how FHA and VA wanted early payoffs when loans traded below par. At that point, JP Morgan Chase was very active in MBS issuance, and most banks preferred short duration products like HELOCs or ARMS while offloading 30-year mortgage-backed securities. There was a lot of talk about how IMBs were increasing production of non-agency loans. Things haven't changed too much, like Pie and Beer Day. As technology becomes more complicated, competitive advantage is shifting away from simply having better tools toward making better decisions with them. AI can accelerate analysis and uncover patterns, but it cannot fully account for changing investor sentiment, borrower behavior, regulatory shifts, or market context that ultimately drive execution. Recognize that models should inform decisions, not replace them, and that experience remains essential in distinguishing temporary market noise from meaningful structural change. A rare policy window is opening for the mortgage industry as regulators and policymakers appear more willing to revisit long-standing rules that affect origination, servicing, affordability, and compliance. But meaningful reform will depend on whether the industry can provide clear, coordinated, and practical recommendations rather than broad complaints. Simultaneously, mortgage companies must navigate an increasingly complex risk environment shaped not only by federal regulators, but also by aggressive state-level oversight and a growing plaintiff's bar that is often driving industry behavior as quickly as formal regulation. In this environment, participation matters. Policy priorities emerge from real-world operational challenges raised by practitioners, and the organizations that engage constructively today will have the greatest influence on tomorrow's regulatory framework. Even before markets learned of President Trump imposing new tariffs on imports from most major U.S. trading partners, U.S. Treasuries extended their sell off as surging oil prices and escalating U.S. Iran tensions intensified inflation concerns, pushing yields on the 10-year note and shorter maturities to their highest levels since early 2025, while the 30-year yield approach levels not seen since 2007. The markets are increasingly pricing in the possibility of a September Fed rate hike, reflecting rising expectations that energy-driven inflation could delay the path toward policy easing. Mortgage rates, already the highest in almost a year, rose for a third week. The average for a 30-year fixed loan climbed to 6.58%, according to Freddie Mac. That rate was 6.74% a year ago. For today's interview, I wanted to welcome to the show Morgan Stanley's Matthew Hornbach to talk about identifying the risks that investors in the mortgage industry may be underestimating as the economy transitions into its next phase. He's managing director at Morgan Stanley, global head of macro strategy, and one of eight members of the Global Investment Committee for Morgan Stanley Wealth Management. As you know, this is a podcast for residential mortgage industry professionals who are a cyclical bunch. Maybe they're a cynical bunch, but they're used to the cyclical nature of markets. Because the more mortgage market, as much as any, goes through these clear patterns. Obviously, the economy goes through cycles as well. And the last several years. Not necessarily so much Russia and Ukraine anymore, but a lot of the stuff dealing with the Strait of Hormuz. What do you believe investors are still underestimating about the next phase of the economic cycle? I don't I don't know if I want you to speculate on what the next phase of the economic cycle will be. You're welcome to go there if you'd like, but what do you think people are still kind of underestimating about what's going on? Matthew HornbachYeah, well, you know, if I could choose one theme that's really dominated markets over the past year, aside from the geopolitics that we encounter from time to time, it's it's AI, right? It's the large language models that I'm I'm guessing most people are using, and all of the investment that is being made and that is expected to be made in this theme for several years to come. And in what I think is kind of just an interesting aspect of this AI-related theme is it's all it's all really being driven by a very simple idea, which is that the demand for computational power, I'll use the word compute. The demand for compute is greater than the supply of compute. I mean, it's very simple. It's economics 101. Supply is greater than demand. And so the way in which, you know, corporate America, at least, is trying to deal with this supply and demand imbalance is they're trying to address the supply side of the imbalance. They're saying, okay, if there's more demand for compute, right, or tokens, there's more demand for tokens than our ability to supply them, we have to increase the supply of tokens and or a compute. And we're going to do that by investing a lot of money in building data centers, um, in building energy infrastructure to power those data centers. And that makes perfect sense, of course, right? If you have that type of supply-demand imbalance, that is a perfectly reasonable way of trying to fix it. What maybe a lot of people aren't considering, and maybe because it's not worth considering at the moment, is isn't there another way of trying to solve the supply-demand imbalance? And isn't that way focused on the demand for compute? Now, I'm not saying, you know, won't these companies try to reduce their user base? Well, of course not, right? And chances are very high that over the next many years, the number of users of these tools is only going up dramatically, probably. But, you know, what if per user you can build a model that uses far less compute, far fewer tokens? And it seems at the moment that you know the part of the world that is focused on solving this problem in that way is China. The models that China is putting out are seemingly focused on efficiency. How do we build a model that has similar, if not the same, performance as the frontier models in the US, but at some fraction of the cost? And so, you know, for example, I was in I was in Mexico City earlier this week, aside from the food, I love going there just to learn from from clients. Uh, and one of the things I learned when I was in Mexico City is how many Chinese electric vehicle manufacturers are selling cars in Mexico. I mean, the number is is is 30. 30. Wow. Who would have thought, right? And and and and they're selling you know cars that compete with electric vehicles in the US for a lot lower cost. And I just it made me wonder, well, what if like that's going to happen in AI at some point? And so anyway, that was a very long-winded answer, Robbie, to your question about what might people be missing. Maybe it's that. Robbie ChrismanCertainly, I've seen here recently that there's there's a confluence of a lot of different things. And so trying to parse out one thing is is always difficult here. And we and we've seen uh some of the the underlying assumptions that have historically been true, those have shifted and things aren't acting fundamentally like they should. Anyways, let's let's talk about the yield curve a little bit because we have seen longer-term yields rise of late, and a lot of that is the expectation that inflation will seep back into the picture. Obviously, the most recent CPI and PPI reports are pretty benign, which is good news. However, straight of hormous once again closed. Mortgage rates are uh are toward the long end of the yield curve. They remain elevated despite moderating inflation. In your opinion, what are the structural forces that are keeping these longer-term yields high? What would it take to meaningfully change that dynamic? Matthew HornbachYeah. So, I mean, the the the short answer is it's inflation, right? We have inflation that's running kind of roughly 100 basis points above the Fed's target. And it's been running above target for some time now, but it's inflation. And so then the next natural question is well, well, why is inflation elevated today relative to the Fed's target? And you know, the the answer is tariffs, a combination of tariffs and uh what's happening in the Middle East. We estimate that tariffs added about 70 basis points or 0.7 percentage points to inflation in the US uh over the past year. And if it if you strip that out, you actually get reasonably close to the Fed's 2% target, maybe not all the way there, but certainly a lot closer than where we are today. And and probably close enough where investors in the markets wouldn't be speculating on the Fed increasing interest rates over the next nine months. Um, they'd probably still be speculating on the Fed decreasing interest rates at some point over the next nine months. And so that would be worth a fair bit on longer-term bond yields. So that's kind of one factor are you know, tariffs, you know, the other factor, of course, is what's happening in the Middle East. And energy prices, of course, are up a lot. That you know has started to creep into the price of energy-sensitive goods that we consume or services that we consume. Um, and airline fares are like the number one thing to highlight there. Gasoline, crude oil goes up, one of its distillates is jet fuel. Jet fuel prices go up, cost to airlines go up, they pass on some or all of those costs to us as consumers. So, you know, that that has kept inflation high as well. Now, you know, the good news is you know, we think that at some point the straight of hormous will open more permanently, let's hope. And, you know, the way inflation is measured, it's measured in rates of change. So it's not, we we don't measure inflation as a price level, but we measure price levels to calculate the rate of inflation. And and because that those rates change over time, you'd expect naturally that the further we put tariffs into the rear view mirror, the further we move away from the Strait of Hormuz being closed, the the the better the chances are that inflation rates come back down to the Fed's target. And in that case, you'll get lower interest rates. Now, you ask me, how do you get significantly lower rates? Robbie ChrismanAnd I think what a pandemic or a economic collapse. Come on, Matthew. Matthew HornbachWell, yeah, like I'm not going to go there because I don't want to be the person that everybody blames for having you put that put that out into the world. Um, but what what what I would say is is that the thing that we started off our conversation talking about, like what might people be missing, if if you did have, and I'm not saying this is going to happen, by the way, just to be clear, but if if you did have a a correction in the equity markets, because people have to readjust their expectations about what's the most efficient way of solving this problem of more demand for compute than supply of compute. And people come around to the idea that actually it's cheaper and more efficient and better for the bottom line to solve this problem through the demand side, and you get a correction in the equity market, in addition to underlying inflation continuing to come down. You know, just imagine a scenario in which inflation is actually back at 2%. So everybody's happy, including people at the Fed, and then you get a bear market in equities. All of a sudden, you're not just talking about a couple more rate cuts. You could be talking about a fair number of rate cuts, and that would get yields significantly lower than where they are today. Robbie ChrismanI'm glad you brought up the Fed because that's where I want to talk for a second. There, there's obviously expectations for what the Fed's next move will be. And I think we've gone from a couple rate hikes down to one rate hike. We saw with the benign inflation reports, maybe some of that has dropped off, at least for the July meeting. They're not expected to do anything. The Fed has as much data at its fingertips as any institution or individual out there, yet they've seem to be very reactionary here. And and I'm wondering your thoughts on kind of misconceptions that markets might have about the Federal Reserve's reaction function over the next year or so. Matthew HornbachYou know, the way that I would describe the Fed's reaction function during Powell's 10 year as chair was one that showed a fair bit of skepticism about economic projections, and and as a result, tended to overweight actual economic data that was coming in month to month. And so when that data changed and said something concerning to the Fed, it would then observe, it would double check, it would wait for three or four or five or six months of that type of data to actually be in hand before deciding to respond to it. Um, so a very backward-looking reaction function, in my estimation. Understandable given how difficult it is to forecast economic activity, right? If you're basing a policy decision on a forecast and the forecast is not very accurate, you you can understand the problem there. But I think you know, the the new chairman of the Fed, Kevin Warsh, will want to take a bit more of a forward-looking stance. You know, maybe not put all of his eggs in the forward-looking basket, but also not put them all in the backward-looking basket. That's going to be a change. Now, the other big change, of course, it with the new Fed chairman is communication with the market. For the better part of my career, I've been at Morgan Stanley for 26 years. I joined the firm when Alan Greenspan was still chair, chairman of the Fed. And under Greenspan, communication policy changed and it became more communicative. But then his predecessor, his successor, Ben Bernanke, and Ben Bernanke's successor, Janet Yellen, communication with the public became a whole new thing, really. It became very transparent. Like the philosophy there is fairly simple. The more the Fed communicates with the public, the more the public understands the Fed's reaction function, the better investors are able to look at what's going on in the world, understand how it feeds into the reaction function, and then move markets accordingly. And if they do that successfully, the markets do a lot of the work for the Fed. I think the incoming Fed chair has a has a has a different perspective. And I think that perspective is okay, but that assumes that the 19 people that gather in Washington, D.C. every six to eight weeks who are informed by a very a lot of very smart people within the Federal Reserve System, right, that that information ends up being filtered up the chain into this committee. Maybe that's just a bit too much hubris. Isn't it better if The Fed stays quiet. Investors who care about their investments do their own homework, figure out what's really going on, invest accordingly, move the markets as such. And then the Fed gets to sit back and look at this collage of information come together in the form of market prices. And actually, the Fed might think, okay, but that's telling us this thing that's very concerning to us. And so we're going to respond to this thing that's very concerning to us. I think that's where it's going, rightly or wrongly. I'm not going to sit here and opine on that's better or worse. It's different. And I think reasonable people could disagree on whether it's better or worse. Robbie ChrismanWe did see with the most recent minutes that were released that there is still the transparency in the minutes, it's just not in the dot plot and the immediate aftermath of the meeting. And I would say as well, bond markets are pretty good at sniffing out things on their own without a bunch of fed chatter or yap, as Gen Z would say. Thoughts on what's emerging that maybe we haven't talked about to this point? Any risks to the outlook out there, things, things that because obviously we're discussing what's happening in AI and tech and ComQ, all that's kind of happening. Anything people aren't really thinking about that you could see coming to the fore? Matthew HornbachSo, you know, we have a midterm election in the US coming up. And not that I necessarily see that at the moment as being a particularly risky event on the calendar. Um, but it is certainly, I think, going to be an interesting event. Um and depending on how smoothly it goes, and of course, depending on the outcome, and you know, whether that outcome, you know, is accepted as is, or whether other perspectives enter the fray, you know, that that can potentially have an effect on, let's say, for example, the value of the US dollar, you know, because you know, we uh a feature of our of our economy, of course, is that we have elections often. And so we kind of have this refresh in our in our country every two years, which is I think a huge benefit to the country as long as things go smoothly. The the rest of the world looks at it with, I think, a fair bit of envy. Smoothly is a very important word there. Robbie ChrismanIt is a very important word. We haven't seen much go smoothly, quotes, here as of late, but uh hopefully it does. Matthew, I really appreciate the time, man. This is really good stuff. Glad we got connected, glad we were able to make it happen, and hopefully we'll have you back on talk soon. Matthew HornbachYeah, my pleasure. All right, take care. Robbie ChrismanToday's economic calendar kicks off later this morning with Flash July SP US Global or Global US manufacturing PMI and services PMI. The report is forecast to show modestly slower growth as customers added less to inventories and the re-escalation of the Iran conflict weight on new orders. The surveys will likely report input price inflation picked up from June as prices rose for crude oil, gasoline, diesel, jet fuel, and other refined products. That will be followed shortly thereafter by June new home sales, which are expected to post a modest rebound of 620,000 in June, after two consecutive monthly declines, and a May reading of 580,000. The housing market remains hampered by elevated mortgage rates, deteriorating affordability, and subdued buyer demand, leaving sales well below year-ago levels and pointing to another disappointing year for residential activity. Buyers continue to rely on price cuts and incentives to support demand. We begin the day with agency MBS prices slightly improved from Thursday's close, the two-year yielding 4.33, and the ten-year yielding 4.68, after closing yesterday at 4.70%. Rates being lower on the thoughts that more tariffs will lead to a further slowdown. Let's wrap up with a joke and some housekeeping. Josh and his wife lived in Arizona where the summers were very hot. He woke up one day when they were having a heat wave and decided to cool off in the shower. As he stepped out of the shower, he complained to his wife, saying, I'm just too hot to wear any clothes on a day like this. What would the neighbors think if I mowed the lawn with no clothes? To which she replied, that I married you only for money. Looking for the first true end to end AI platform built for mortgage? Look no further than JazzX. From application to closing, JazzX is a new operating model that helps you scale growth, boost productivity, and transform how your team performs. Learn more at jazzx.ai