July 17, 2009 — The economy continues to display a ‘fits and starts’ kind of recovery, fostering optimism at one moment only to see hopes dashed at another. While there is a growing consensus that the worst of the downturn is behind us, it increasing looks as though we’ve only moved away from the extreme effects of the financial market collapse to find ourselves in a more ‘garden variety’ recession.
Extraordinary efforts by the Federal Reserve and Treasury have served to ameliorate those effect to a very real degree, but there is only so much the Fed can or will do without causing ‘collateral damage’ to long-established market functions.
The Federal Reserve released the minutes of its June 23-24 meeting this week, and it was clear that the committee members had much to discuss in this regard. The staff reviewed existing programs and some participants noted that “increases in purchases of Treasury securities might have little or no effect on long-term interest rates unless the increases were very sizable” given the volume of issuance by the Treasury. Increasing the size of the purchasing program could also have adverse effects, since doing so “could add to perceptions that the federal debt was being monetized”, and that “public concern about monetization could have adverse implications for inflation expectations.” That, in turn, might cause an unwanted rise in long-term interest rates.
The Fed is providing support to various financial markets, including the mortgage market, with purchases of MBS and Treasury debt alike. Earlier this year, there were rumors pervading the markets that the Fed would engineer 4.5% 30-year fixed-rate mortgages; we never put any stock in them. With the release of the minutes, they revealed for the first time that there is no specific target for rates in mind, but rather the Fed seems to be acting as a sponge to absorb excess supply in those markets when and if it forms, serving to keep interest rates low. The minutes noted that “The asset purchase programs were intended to support economic activity by improving market functioning and reducing interest rates on mortgage loans and other long-term credit to households and businesses relative to what they otherwise would have been. But the Committee had not set specific objectives for longer-term interest rates…”. At the same time, they also revealed a steadfast hold to the objective of the established program of measured buying of these assets, and that there would be no knee-jerk adjustments to try to address short-term fluctuations in market interest rates.
The Fed can certainly claim success in helping interest rates to remain low. Certain stresses in the markets a few weeks ago caused a quick run-up in rates, only to see them retrace that path to a substantial degree.
The overall average for 30-year fixed-rate mortgages — detailed in HSH’s Fixed-Rate Mortgage Indicator — declined by four basis points (.04%) during the week ending July 17. At 5.66% we remain quite near the levels seen before June’s flare in rates sent refinancers scrambling. The FRMI’s 5/1 Hybrid ARM counterpart slipped by five basis points, closing at 5.07% for the week.
The collective tenor of economic data out this week continued the pattern of ‘a better grade of lousy’, more likely showing a bouncing-along-the-bottom pattern than that of any substantial recovery. Some of the data looked pretty good, at least taken at its face, but one didn’t have to look too hard to see the grime beneath the shiny exterior. One such report was that for Retail Sales; in June, a 0.6% increase in aggregate spending looked fairly solid, coming on the heels of a 0.5% gain in May, but virtually all of the increase was due to rising gasoline prices during the month. Excluding them, and spending for autos, ‘core’ retail sales declined by 0.2%. The last positive figure here came four months ago.
Another came in the form of weekly unemployment claims, which came in for a second straight week well below recent trends. The 522,000 new filings during the week ending July 11 followed July 4th’s 569,000 nicely, but that July 4 holiday and seasonal adjustment issues due to regular auto-plant retooling make the number an unreliable indicator at present. Certainly, it looks good, but we are more likely to return closer to 600,000 over the next couple of weeks.
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Inflation concerns continue to bubble. While not specifically today’s problem, there have been somewhat less-soothing numbers revealed at times over the past few months. The Producer Price Index spurted 1.8% higher in June, about double the expected leap. The ‘core’ PPI also put in a fair surge, rising 0.5% for the month; exclusive of energy and volatile food prices, ‘core’ PPI has risen by 3.4% over the past year, while headline PPI has declined by 4.3%.
The Consumer Price Index told much the same story. Headline CPI rose by 0.7% in June, goosed to some degree by rising gas prices, but still managed a year-over-year decline of 1.2%. However, ‘core’ inflation is running on a much firmer pace than that, rising by 0.2% in June and by 1.7% over the past twelve months. Now, a 1.7% core CPI is well within the Fed’s speed limit for inflation, so it’s not yet a worry, and the economy could probably even stand above-trend inflation for a while as growth firms, but expectations for future inflation might become “less anchored”, to use the Fed’s parlance.
Indicators of factory and industrial health continue to remain below grade, but seem to be moving closer to flat-line, if nothing else. Businesses continue to shed excess inventory (the overall measure of stockpiles declined again in June, this time by 1%), but despite the drawdown, no spate of ordering has yet been seen, as final sales growth remains quite weak (see the retail sales numbers above). Two local surveys of manufacturing activity both found sub-par patterns, with the Philadelphia Fed’s index retreating somewhat in June after a leap higher in May. The -7.5 mark took back about a third of May’s 20+ point gain, and while we are well above the -41 low levels notched in February, we haven’t seen a positive reading here since last September.
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Much the same was seen in the Empire State Manufacturing Survey, whose 0.6% reading in July was the best since last September, if still negative. It’s been some seventeen months since the last above-board reading, but the extremes of the downturn continue to fade behind us. The national measure of Industrial Production covers both these areas, and lots more. IP declined by 0.4% in June, the decline only that small due to a surge in utility output, likely related more to the spate of hot weather in some part of the country than to an increase in factory demand.
Consumer moods remain subdued, with the weekly ABC News/Washington Post poll of Consumer Comfort ticking upward to -51 during the week ending July 12, treading water just above record lows of -54. A lousy economy, no job creation and a government itching to spend additional billions it doesn’t have on new programs (bringing new tax burdens) seems certain to keep moods depressed for the foreseeable future.
One brighter spot worthy of note: Housing Starts moved higher in June, rising to a 582,000 level of initiation. Single-family production led the gain while multifamily starts eased. Building has improved modestly since hitting post World War II lows earlier this year, but is still a whopping 46% below year-ago levels (which weren’t stellar by any means). We have postulated at times that builders were running out of the most in-demand homes, that the remainders on the markets were among the most difficult to sell, and that they would need to start to produce at least some new housing to meet the kind of demand which has been forming, however weak. It would appear that that is becoming the case. As well, building permits moved back up to December 08 levels (which were also quite subdued) but may offer some promise for future projects. It should be noted that homebuilders certainly felt a slight bit better, as the NAHB’s index of member sentiment moved up to a reading of 17, a level last seen in September 2008 and double the recent low. In a climate of 9.5% unemployment, and with tougher lending standards fully in place, we wouldn’t expect to see a lot of traction in the homebuilding market, but any upward movement is a good sign.
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The fits and starts pattern is likely to prevail for some time yet. Most sectors of the economy seem to have found their bottoms and are bouncing along at very low levels, but real improvement remains off in the future. In a couple of weeks, we’ll get an early look at second quarter GDP, and we think it might come in in the -2.3% to -2.8% range, a marked improvement from the past two quarters. Still, and while moving in the right direction, that figure will still leave the economy deep in a hole to start the third quarter, a period that some believe will (eventually) mark the end of the recession. We may have to wait for the fourth quarter to see the first positive growth figure, and if it comes it will probably just get us over the zero barrier.
Some positive earnings reports sparked a rally in stocks this week, drawing money out of safe-haven Treasuries and causing a lift in yields. The better than quarter-percent rise in the influential 10-year Treasury over the week has put some upward bias into mortgage rates, as conforming rates rose from 5.22% on Monday to 5.41% on Friday. That momentum will probably carry over into next week to some degree, where a light economic calendar seems unlikely to contain the kind of news which would press rates downward to any great degree. Expect at least a few basis point increase in the 30-year FRM average.
What lies ahead? Read (and let us know how we did on) our new, just-posted two-month forecast.
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