Two-Month Forecast: May 30, 2008
Preface
So far, despite a continuing slow period, the US economy has skirted an actual recession. Housing markets remain moribund, as bloated inventory levels and stiffer underwriting standards for mortgages are the order of the day. At some point, perhaps even later this year, when lower home prices and fiscally-prepared borrowers intersect, sales will firm and housing inventories will begin a slow process of reduction. For their part, credit markets have largely stopped deteriorating and have achieved a shaky stability as the process of raising capital and rebuilding loan-loss reserves continues.
Recap
In our last forecast, we expected a much greater improvement in rates than that actually occurred. We called for rates to decline, and they did, but less than we hoped.
Back in mid-March, we forecast that the overall average for 30-year fixed-rate mortgages (HSH’s FRMI) would slip from the 6.72% at the time the forecast was written to perhaps as low as 6.27% by the end of the period. The actual range was much narrower than that, with the 6.72% giving way to a bottom of 6.46% back in April. Rates have been slightly firmer than that on average since then, hovering around 6.5% or so.
We believed that lenders would show a greater appetite for Hybrid 5/1 ARMs as Spring rolled along; we anticipated a wide range for rates in the forecast, expecting a decline from 6.31% to perhaps as low as 5.75%. That demand never appeared, though, and rates were quite erratic, rising to 6.41% before slipping back to 6.11% at the end of the period.
At one point during the forecast period, the “mortgage yield curve” became quite flat, and all mortgage products were priced very close to or even above the 30-year FRMI. Since then, however, a steepening of that curve — short-term rates falling more than their fixed rate mortgage (FRM) counterparts — has largely been the case, making ARMs somewhat more viable for borrowers.
We also took a flier on a forecast for the 30-year Conforming FRM. We thought, given the right situation, that prices for those good-credit quality loans could plummet to perhaps 5.5%. We offered that item because, back in March, limits on how many mortgages the GSEs could retain in their investment portfolios were lifted, prompting us to speculate that Fannie and Freddie would be urged by legislators and regulators to pump mortgage money out to the markets, even if no investors could be found for the paper. Unbeholden to investors and pressured by Congress, the GSEs would fill their books with new lower rate mortgages.
Unfortunately, that didn’t turn out to be true for “traditional” conforming loans, but this structure of support was actually announced to get new “agency jumbos” into the market at lower costs to borrowers. Perhaps it will yet occur for the rest of the market at some point; mortgage money in the mid-5% range would definitely spark a refinancing boomlet and serve to support home sales and house prices, too. Will it happen? We’ll see. Conforming 30-year FRMs did decline, though, and presently stand at 5.89%.
Forecast Discussion
How best to characterize what we think will be the state of the market for the next nine weeks? If history is any guide, market players will spend some of that time jockeying to establish summer trading positions and then things will generally become quiet. This isn’t always true (see last Summer, when the credit market completely broke in mid-August) but this has been the case over the years. Regular readers of these pages know that there isn’t any reliable seasonality in mortgages, nor any to be expected amidst troubled markets.
As we discussed in the May 23 Market Trends, we think that we’re at a juncture in the economy where rates are being pushed and pulled in two different directions: Upward, boosted by rising inflation and its return-eroding effects, and downward, where slumping economic growth produces additional ‘resource slack’. Skyrocketing energy costs seem certain to pressure economic growth downward in the weeks and months ahead as consumer spending becomes concentrated into less-productive narrow streams for food, gasoline, electricity and such.
So far, despite dire forecasts, the economy has escaped recession. It is true that weak growth remains in place, but there should be some lift provided by stimulus checks hitting bank accounts and mailboxes as we close out the spring. That said, any boost from that will likely not only be muted but short-lived, as well, so a resumption of significantly stronger or more permanent growth isn’t likely during the forecast period. Any revival of growth remains threatened by higher gasoline and food costs, so it’s our opinion that this period of weak growth will persist.
Inflation remains a constant concern. How can it be otherwise when signs on every corner show ever-higher prices, or when the supermarket bill increases with each shopping trip? High and still-rising energy costs lift prices immediately and can also have lagged effects; for example, costs for petroleum-based fertilizer are kicking higher, so the next crop in place will start with a higher cost basis than did this one.
Amid these troubles, though, there are some signs that housing markets are trying to find a bottom. Housing starts, building permits, home sales, builder sentiment and other indicators all suggest a pattern of bouncing along the bottom — minor improvements one month giving way to minor declines the next. Actual inventory levels of new homes for sale continue to decline, but sales are falling faster as buyers who can obtain financing wait for lower prices before acting. For existing homes, inventory levels are rising as foreclosed properties are added back into the “for sale” ranks, but some of the hardest hit markets are starting to see some sales activity as “market-clearing” prices are discovered. Backing and filling for sales does seem likely, and even for those housing indicators which haven’t shown improvement, at least the rate of decline seems to have slowed.
Some boost for sales and refinances may come in the form of GSE reform and FHA expansion. Bills have cleared the House and Senate Committees, and a floor vote is slated in the near future. Despite a strong push in Congress, it’s not clear how many potential homebuyers will be helped (or how quickly), so despite big election-year pronouncements we expect only a limited boost this year.
All this being the case it does strike us that we will remain directionless over the next two months, with no sudden clarity, but rather a slow slog through a still-murky period.
Forecast
The question, of course, is what will exert the stronger pull during the forecast period: inflation or weak growth? It does seem likely to us that the upward pressure on underlying interest rates will remain, but mortgage rates should hold mostly steady or perhaps decline a little at times.
A year ago, the difference between the 10-year Treasury and the average Conforming 30-year FRM was 153 basis points (1.53%); it was 172 for TCM-Jumbo. Despite recent declines from historical highs, those spreads are presently 216 and 326 basis points, respectively. That suggests that with the crisis slowly passing, and as balance sheets are rebuilt and lender recapitalization continues, new loans should be able to be priced at less of a premium relative to other benchmarks.
In such a situation, even if comparable indicator rates do rise, mortgage rates would therefore rise less as lenders look to keep originating new, better-quality loans. These new originations serve to offset the poor loans already on books, or can be sold for needed cash. Of course, we won’t return to normally-thin spreads anytime soon, but we should see thinner spreads as time rolls forward.
We’re not going to venture a forecast for Conforming 30-FRMs this time around, and here’s why: if the GSEs do suddenly decide to use their nearly-unlimited powers to help all “A-quality” borrowers instead of those only in “high-cost” areas, Conforming rates could ease, perhaps markedly, which would be good news overall. Jumbo markets seem to be creaking back to life, too.
For the next nine weeks, we expect that HSH’s FRMI will range between 6.37% to 6.72%, while the overall 5/1 Hybrid ARM average might travel between 6.25% and 5.85%. It’s most likely that both will exhibit choppy or erratic behavior.
When this forecast expires, we’ll be coming up to the one-year anniversary of the big break in credit markets. No celebration is planned, but we will review the forecast here to see how we did.
Popularity: 9% [?]
