November 5, 2010 — After preparing the markets for the last several months, the Fed pulled the trigger this week on its latest plan to boost the economy. “Quantitative Easing II” or QE2, as it’s being called, will see the Fed purchase $600 billion in new Treasury bonds by the end of the second quarter of 2011 — and this in addition to the expected $250 to $300 billion it will also reinvest from the maturing mortgage portfolio it holds from the last monetary stimulus program.
The open question is, will mortgage borrowers benefit, and if so, by how much?
Mortgage interest rates are already at rock bottom. HSH.com’s overall mortgage tracker — our weekly Fixed-Rate Mortgage Indicator (FRMI) — found that the average rate for 30-year fixed-rate mortgages eased by three basis points (.03%), ending HSH.com’s national survey at 4.61%. Important for first-time homebuyers and low-equity-stake refinances, FHA-backed loans are available at an average rate of 4.26%, while the overall average rate for hybrid 5/1 ARMs was 3.51% for the period. HSH.com’s public data series include rates for conforming, jumbo, and most recently the GSE’s “high-limit” conforming products and so covers much of the mortgage-borrowing public.
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In the post-financial-market-meltdown era, investors — particularly institutional and banking concerns — have been quite content to get money in their doors as cheaply as possible, either borrowing it at very low rates or attracting deposits from fearful customers interested not in making money but rather not losing any. Those cheap inbound funds have been plunked into Treasuries or other low-risk investments, and the spreads — even thin ones — between those two cash flows have produced acceptable and important profit streams.
With the American government borrowing money (issuing new Treasury Debt) at a record pace since the recession began, it was expected that the glut of this new Treasury supply would flood the market and outstrip demand; in turn, this would cause interest rates to begin to rise, particularly as the economy emerged from recession. Amid a shaky recovery and overseas market panics, this situation never occurred, and there has instead been a steady appetite for investments which are considered safe.
The Fed’s plan is to snap up so many of these Treasury bonds that they drive up the price of them, which in turn drives down their yields. In this way, investors won’t be able to make money easily by buying these low-yielding instruments, and so will find an incentive to put their money into equities, other bonds, commodities, wherever… but the effect is hoped to be a deconcentration of investment dollars, spreading money around the broader economy… if it works.
Concentrations of money into a single class of investments isn’t healthy. You can see how this played out in any number of bubbles, from tech stocks to mortgages. That said, money now concentrated in Treasuries may simply move en masse into oil, commodities or other narrow channels which too might produce undesirable economic effects.
In hoping to “force” investors to spread their money around, the Fed is trying to bring up the value of other assets, but may also be trying in its way to deflate a Treasury bond bubble which may cause trouble down the road. After all, interest rates will eventually rise, and the firms which found safe but low-yielding investments acceptable today may find themselves stuck with them tomorrow. Holders of those bonds might find that the market to unload them when needed might not exist — or only exists if the instruments are sold at a loss. After all, who wants to buy an old security which yields 2% when new ones are available at 4%? The seller will have to make up the difference in order to make it attractive to a potential buyer — and will lose money in the process. Reducing — or at least trying to reduce — the concentration of investor holdings may serve to prevent future losses.
HSH has several lengthy series of statistics dating back to the 1980s for FRMs and ARMs, Conforming, Jumbo and FHA products. These can be licensed for use — interested parties should inquire here.
Does a lack of desirable Treasuries mean that there will be an automatic shift in favor of mortgage-backed securities (MBS), which would serve to push mortgage rates lower? No. There might be some additional appetite, but the risks of lending to mortgage borrowers remain both appreciable and constant, what with property values still wobbly and the latest foreclosure mess making failed-loan resolution uncertain. Borrowers also need to be aware that the Fed is trying lift the economy, which tends to help interest rates to firm, and also to cause some inflation, which tends to push interest rates up, and these factors may overwhelm any investor-caused downdraft in rates over time.
There’s also no guarantees that the Fed’s program will produce the desired effects. Unlike the QE program for mortgages, where the Fed essentially bought all available supply to keep a market functioning as the buyer of last resort, this is the Fed attempting to manipulate the behavior of a market.
This is also to be considered in the context that the Fed it hoping to create a little bit of inflation, at least enough to make deflation a fading concern. There is a real possibility we could end up with more inflation than desired, and the Fed’s job of managing price stability is much more complicated with the additional hundreds of billions in cash floating around the markets. There is a great deal of uncertainty that the outcomes of these exercises will be as hoped, but we are going to find out.
The economy could of course use some help, and perhaps this will come not only from the Fed but from the new Congress as well. There are a couple of months before the actual changeover occurs from old to new, and there is expected to be much greater focus on job creation and clarifying tax policy than has been the case this year. Two percent GDP growth is better than a recession, no doubt, but we’ll need something greater than 3% on a sustained basis to really start to move forward again.
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There is some indication that, just as September was better than August, that the economy was somewhat stronger in October than September. A key indicator in this regard was the employment report, which found that there were 151,000 new hires which took place during the month, the best figure since census-goosed hiring back in April. This time, however, there were 159,000 private-market jobs created and government hiring was a net drag on the number, and this is very good news for the economy. There were also upward revisions to September and August, producing less negative readings for those months as well. Average hourly earnings and the length of the workweek also expanded, another signal of improvement in the labor market.
Unfortunately, the level of hiring is just enough to keep the unemployment rate steady at present levels, and 9.6% is way too high for comfort. It’s also worth mentioning that the number of workers too discouraged to even bother looking for a job continues to rise, and the “participation rate” of the labor pool continues to fall.
Layoffs continue at a more-or-less constant rate, too. Another 457,000 applications for unemployment benefits were filed at state windows during the week ending October 30, but the pace of new claims on balance was lower in October than September. The outplacement firm of Challenger, Gray and Christmas reported that there were another 37,986 announced firings during the month of October, continuing a fairly low and flat pattern which began in April of this year.
Worker productivity bounced 1.9% higher in the third quarter of 2010, rebounding from a 1.8% decline in 2Q10. While an improvement, the gain is still small enough to suggest that businesses will need to continue to add at least some additional workers, even as they get more out of their existing employees. Profitability should also improve, as the cost of labor per each unit produced slipped back by 0.1% after a 1.3% rise. The last couple of quarters seem to suggest that productivity is settling into a lower level than the huge gains seen in 2009, when workers were pushed harder as jobs were being shed. The new level strikes us as much more conducive to improving labor market conditions going forward.
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The production-led recovery does seem to be slowly shifting toward the service sector even as it shows some resilience. The Institute of Supply Management (ISM) survey of manufacturing conditions found a rise in activity levels, and their indicator rose to 56.9 for the month of October, the highest since May. As well, both orders and employment sub-indexes rose. With a breakeven reading of 50, the latest period is in very solid territory, and the 2.1% gain in factory orders for September no doubt played a role in the October ISM gain.
In October, sales of new vehicles rose to a 12.3 million (annualized) pace, according to AutoData. Even though sales remain quite soft relative to historic norms, it was the best such reading in two years, excluding the short-lived CARS-related boost in sales in August 2009.
The ISM also produces a service-business related index, and this indicator also strengthened in October, rising by 1.1 points to 54.3 for the month. As with the manufacturing survey, orders also rose. Importantly, the employment indicator remained above breakeven at 50.9; the figure was still weak, but sufficient to show the first back-to-back positive readings of the recovery, now some five quarters old.
Some lift in construction spending was seen in September, led by a 1.8% gain in residential outlays and a 1.3% rise in public project spending. The gain in residential spending was the first positive figure since April, when there was a rush of activity trying to beat the April 30 homebuyer tax credit deadline. Since then, activity has been very weak for new homes, but housing starts did nudge a touch higher during the month. Commercial building subtracted 1.6% for the month as those markets are early on in a still-intensifying downturn.
There was no lift in personal income for September. In fact, there was a 0.1% decline, and wages were stagnant for the month. Surprisingly, there was a 0.2% rise in spending, and given the lack of consumer enthusiasm for taking on new debt of late, these outlays obviously came from savings, and so the nation’s official savings rate slipped to 5.3% from 5.6% for the month. Over the last year, personal incomes are up a meager 3.1% and the lack of growth presents a challenge to the recovery.
We begin a different era for monetary policy, one with uncertain benefits, unknowable outcomes and uncertain risks all around. Certainly, we hope that Fed is successful, that the economy revives to better levels, job growth picks up, inflation remains at bay, and the Fed can unwind these unusual methods without long-lasting market distortions. At the same time, we cannot help but remain concerned that there are fairly long odds of all this working out 100% favorably. We are going to walk this path, and may also need to consider that, if un- or only partially successful, we may have to walk it again in just eight months’ time.
Until then, and at least for now, mortgage rates seem to have improved just a whisper, and we have no expectation of pronounced or immediate effect. As the program gets underway we’ll start to know more.
Looking down the road toward Thanksgiving? Take a look at our just-posted-today Two-Month Forecast.
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