March 4, 2011 — An economy gaining momentum and a world economy producing price strains may ultimately drive interest rates higher, but as long as political unrest and the future economic drag of rising oil and gasoline costs remain in play, they remain tomorrow’s problem.
The Fed’s economic tonic — low interest rates and plenty of liquidity — does seem to be having the long-awaited desired effect of boosting growth to more self-sustaining levels. As Spring fast approaches, so does hope for a recovery expanding in breadth and depth. How long these policies can be maintained without fueling inflation remains to be seen, but the Fed maintains that they will be able to effectively deal with it when it returns. Fed Chairman Bernanke said as much in his testimony before Congress this week: “We have all the tools we need to achieve a smooth and effective exit at the appropriate time.”
Whether markets will feel that way or not remains to be seen, and interest rates will surely rise even as the Fed employs its measures.
HSH.com’s overall mortgage tracker — our weekly Fixed-Rate Mortgage Indicator (FRMI) — noted that the overall average rate for 30-year fixed-rate mortgages eased again by five basis points (.05%) starting March at an average 5.18%. A key component of the first-time homebuyer market, FHA-backed 30-year fixed-rate mortgages slipped a little less, declining by three basis points to land at 4.81% for the week. Hybrid 5/1 ARMs, often the most viable alternative to the traditional 30-year FRM (especially for jumbo buyers) split the decline of those two products, losing four hundredths of a percentage point (.04%) to close the period at 3.87%
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The Fed’s own survey of regional economic conditions, called the beige Book for the color of its cover, reported that “overall economic activity continued to expand at a modest to moderate pace in January and early February” in all twelve Federal Reserve districts. Looking at the characterization of residential real estate markets over the past few reports does leave a sense that there is an inkling of an improving market. Back in October, the Fed noted “Housing markets remained weak”; by December, it was “Activity [...] remained slow”, but the latest observation seemed a little more positive, stating “Recent activity in residential real estate varied…”. If credit conditions don’t continue to tighten and the economy continues on an upward path, we may just find a housing market which can contribute to the recovery before too long.
Although construction Spending declined by 0.7% in January, all the decline was caused by weak commercial and public spending. Outlays for new residential project climbed by 5.3% for the month. That there have been increases in four of the past five months is an indication, albeit small, that a more lasting improvement is forming.
Personal incomes rose by a full 1% in January, goosed by the withholding changes designed to power consumer spending. Given wicked winter weather during the month, much of that gain seem to have gotten banked instead, as personal consumption expenditures expanded by just 0.2%, while the nation’s rate of savings moved to 5.8%, a pretty healthy clip. Income has climbed by 4.6% over the past year while outgo has risen by a flat 4%, and the healing of recession-battered balance sheets continues.
Consumer borrowing, though, has been on the rise again of late, as there are certain expensive things which wear out over time and must be replaced. The recession kept at least some of those items in service longer than might otherwise have been the case, but a beneficial replacement cycle continues to get more fully underway. Automobiles are one of those kinds of things, and the latest report from AutoData put the annualized rate of sale of new cars and trucks at a 13.4 million level, easily the best in several years. Automakers are in better position to offer incentives and support financing than they were a few years ago, and strengthening consumer finances are starting to support more sales. General Motors, although propped up by the government, has become so lean they actually managed to turn a profit, even though sales remain well below levels seen before the recession hit.
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.
Concerns about inflation are of course focused on commodity and energy prices at the moment, but “resource slack” in form of soft labor markets are a strong counterbalance to those price pressures. That said, worker output per hour expanded at a 2.6% rate in the fourth quarter, and the labor cost per unit produced by that worker declined by 0.6% during the period. That balance gives businesses more leeway to absorb rising input costs and perhaps even pay workers more without passing those increase onto consumers, keeping inflation in check.
It is hoped that this resource slack doesn’t last forever, since that would mean a soft economy for a protracted period. However, if it comes sooner than later, it might exacerbate any inflation problem, or at least expectations of inflation, which can drive interest rates higher. Thankfully, that should be off into the future, but there are now growing signals that the labor markets are turning more favorable. First-time unemployment claims dipped to 368,000 during the week of February 26, the lowest weekly figure since May of 2008. Layoffs abating is a great sign of a healing job market.
However, somewhat more layoffs were noted by the outplacement firm of Challenger, Gray and Christmas. In February, some 50,702 jobs got the axe, up from 38,519 the month prior. A sizable portion of those were layoffs of government workers, those at non-profits and even the postal service, while private cuts remained at pretty low levels.
After January’s puny figure, some forecasts called for as much as a 250,000 increase in new hires in February. While we didn’t reach that lofty level, some 192,000 new jobs were filled during the month, and upward revisions to January (+27,000) and December (+49,000) rounded out the good news about labor markets. The unemployment rate was expected to rise as more workers enter the fray, encouraged by increases in hiring, but that didn’t occur, at least so far, so the unemployment rate ticked down by a tenth percentage point to 8.9% for the month.
Manufacturers even added jobs for the month, reflecting an unexpectedly good climate at the moment of rising demand and improving exports. Localized purchasing manager surveys in New York and Chicago both pointed upward during February, while the national indicator from the Institute for Supply Management continued an upward climb, reaching 61.4 during February, the highest figure since 2004. Orders, production and employment sub-indices all rose, as did the ‘prices paid’ indicator. Contributing to the multi-year high reading no doubt was a 3.1% increase in aggregate factory orders in January, a much higher than expected figure.
While factories were first to press the economy’s “go” button, non-manufacturing (service) businesses have been late in joining the party. This largest segment of the economy was mired in recession or just cautious expansion until just a few months ago, but has caught fire of late. The ISM’s non-manufacturing indicator came in at a strong 59.7 during February, its best showing since August of 2005, and as with the ISM’s factory index, orders and employment indicators both put in solid showings.
Consumer moods held pretty steady during the week ending February 27, with the weekly Bloomberg index of Consumer Comfort coming in at 39.3, just a tenth of a decline from the week prior.
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Sources: FRB, OTS, HSH Associates.
We’ve been through a few recessions, recoveries and expansions, and this one does have some similarities to others but some differences, as well. The markets seem to have taken to heart Mr. Bernanke’s promises of a benign Fed policy for some time into the future, and might even be said to be expressing a growing confidence in the Fed’s ability to manage the inflation it is and hopes to foster. At least for the month, it also seems to us that the market is expecting that the effect of expensive oil offsets the increase in incomes, keeping the economy on a slow-growth path for a longer period of time.
This may be the case, but the Fed’s record of managing inflation problems when they do come is spotty at best, and the effect of more expensive oil may not overwhelm the positive effects of more people getting back to work. Certainly, these items should be given the benefit of the doubt, for at least a while. However, we believe that higher interest rates are a far more likely occurrence as we look toward spring than are lower ones, and borrowers in the markets need to be wary of a potential for a flare in interest rates as we move forward. It is worth noting the recent experience of rates rising from 4.32% to about 5% in just about two month’s time last fall and early winter.
The drift downward in interest rates over the last few weeks, a cumulative move of better than an eighth percentage point on average, represents and opportunity for those in process to grab a slightly lower interest rate, and perhaps a reason for some potential homebuyers to step into the market ahead of the Spring homebuying season. There is a lighter economic calendar next week, but we’ll see some important reports on Consumer Credit, Retail Sales, Inventories and trade to move the markets around. If the nudge higher in underlying interest rates at week’s end was any indication, the decline in rates may halt next week, and we might take back this week’s small dip.
For an outlook which will take you up until early April, have a look at our new Two-Month Forecast.
If you’ve not yet seen it, we’ve written a year-long overview for mortgages and housing markets for 2011. While there are any number of unseen items which will affect any forecast, we’ve boiled it down to the eight that we think will have the greatest impact during the year. You can check it out here.