HSH Market Trends

Mortgage Rates on Extended Life Support

September 25, 2009 — Anyone who believed that the Federal Reserve would flip a switch and exit the mortgage market at the end of this year was proven wrong this week. The Federal Reserve extended the term of its $1.25 trillion MBS purchase program at least until March 31, 2010. Approximately two-thirds of that money has already been spent, and with the rest now being slated to be spread over a longer period of time, it necessarily means that the Fed’s influence over conforming mortgage rates will wane somewhat.

In “normal” times, before subprime mortgage woes spilled over into all “non-conforming” markets, the difference between an average conforming and jumbo 30-year fixed-rate mortgage (FRM) was roughly a quarter-percentage point. Although measurably wider at times during the crisis, the present gap stands at 81 basis points, and if we remove the “normal” quarter-point difference from the calculation, the Fed’s influence means that conforming mortgage rates are about 66 basis points lower than they would otherwise be. Of course, the Fed’s involvement does have some ancillary effects into jumbo prices; originating and selling low-rate mortgages to Fannie and Freddie produces desperately needed profits for banks.

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Those profits not only bolster the bottom line, but coupled with refinancing, allow those banks to free up some cash to lend for other profitable endeavors such as jumbo mortgages. To the extent that rates increase due to the Fed’s waning support, at least some falloff in originations would occur. However, it appears to be hoped — perhaps expected — that improving conditions will see investor appetites improve for mortgage assets, tempering any significant movement. Whether that will be the case or not is unclear, since there is precious little private money chasing mortgage investments at the moment.

The overall average for 30-year FRMs moved just a lone basis point this week. HSH’s FRMI closed Friday with five-day average of 5.49%. The FRMI’s 5/1 Hybrid ARM counterpart shed two basis points, landing a 4.82%. Thirty-year FRM jumbos nudged closed to the 6% mark, a level last breached in September 2005.

Other support programs for rates have differing expiration dates, and may inject their own influences into the mortgage and real estate markets. The Fed’s program for purchasing $300 billion of Treasury debt has only about four more weeks to run, and the lack of a Federal Reserve to act as a sponge during times of oversupply could boost underlying interest rates which would in turn goose mortgage rates. The program for Fannie and Freddie to purchase certain “high-balance” conforming loans may or may not be extended past the end of the year, and to some degree could pressure the jumbo mortgage market. We should note that the $8,000 “first time” homebuyer tax credit will expire in November, and the end of that program may cause some falloff in home sales.

While certainly firmer than earlier this year, home sales are a long way from robust. Existing Home Sales eased back in August to a 5.10 million annualized rate of sale, down from July’s 5.35m rate. The available supply on the market downshifted to just 8.5 months, the lowest such rate since April 2007, but with many foreclosures still in the pipeline, continuing improvement in supply may be difficult to come by. That overhang of supply continues to pressure prices downward; although there has been some firming on a month-to-month basis of late, prices remain 12.5% below year-ago levels.

With so much supply and ‘bargains’ galore in the used home market, new home sales are finding it difficult to get much traction. In August, brand new homes were sold at an annualized rate of 429K, a level slightly below July and short of expectations for a modest increase. Despite the slower sales pace, inventory levels eased to just 7.3 months of supply, nearing normal for the first time in quite a while. With only 262,000 units built and ready for sale — less than half the August 2006 peak — homebuilding will need to resume before too long. Those unsold remainders are likely to be among the properties most difficult to sell for any number of reasons; new inventory more reflective of today’s market will probably need to be built long before they are sold.

As the year progresses and the economy slowly heals, we can expect to spot signs of a production-led pickup in the economy. Still, any recovery is likely to feature some periods of fits and starts, and this one probably won’t be any different.

The index of Leading Economic Indicators posted a 0.6% rise in August, its fifth consecutive upward move. The August figure was the weakest of the five, but the firmly positive trend which began in April seems to have some momentum and does represent a considerable reversal of fortune from the pace of early this year. The LEI is said to suggest what growth will be in the quarter or two just ahead, but seems to better reflect activity in the month in which its components are measured.

Durable goods orders slumped by 2.4% in August, but that came on the heels of a 4.9% rise in July. In recent years, this indicator has swung from negative to positive and back again repeatedly, and the last few months have started again to exhibit this ‘normal’ sort of pattern, and in that way, this is welcome news. Inasmuch as August was a somewhat slower for factories, September seems to be picking up again, at least in the Kansas City Federal Reserve district. Its indicator moved from -7 in August to +16 in September and even signaled some increased hiring activity. Over in the Richmond district, a third consecutive month of identical +14 readings (plus two smaller positives in June and May) suggest a still-firming platform for the fourth quarter of this year for at least some manufacturers.

That the KC index saw at least some hiring was good news. Weekly unemployment claims now appear to have finally settled into a regular declining pattern — though, like other indicators, one of fits and starts — since March’s peak week of 674,000 claims. The week ending September 19 saw 530,000 new applications filed, and the trend has generally been a diminishing one. We remain a fair distance from levels which not only suggest solid hiring (perhaps the 300,000 level), but where layoffs are low enough as to start to absorb some of the people who lost their jobs during the downturn. Still, prospects in this regard are brightening.

Without job growth, the recovery will continue to be a slow grind, and that will continue to affect consumer psyches. Optimism may ebb and flow, a pattern seen at various times this year across all of the indicators which track the moods of households. At present, the final September reading for the University of Michigan index of Consumer Sentiment found a reasonable improvement, as the index rose from August’s 65.7 to 73.5, its best showing since January of 2008. On a higher-frequency note, and although it didn’t break out of its recent range, the weekly ABC News/Washington Post poll of Consumer Sentiment did rise three ticks to -46 during the week ending September 20.

Mortgage rates largely flattened out this week, and to be fair, there isn’t much reason to expect any kinds of continued or sustained declines. With all the talk about “exit strategies” for the Fed and Treasury, it’s probably a good idea for potential homebuyers or refinancers to also plan strategies of their own. Time is running out for tax credits, and trends for mortgage rates are likely to become more muddied and uncertain as the influence of various programs disappears. All the while, an improving economy (if, when and to the degree it occurs) could begin to pressure rates to some degree by itself, and that’s leaving out any resurgent concerns about inflation.

If nothing else, an interesting period lies ahead, and we hope you’ll continue to follow it along with us. Next week comes the end of the third quarter, a period in which the recession may or may not have come to a technical end. It is a week chock full of both end-of and first-of-the-month data, topped of course by the September employment report. Can’t help but being struck by the feeling that improving economic numbers are going to foster higher rates before too long, but at least any bump which comes will start from a low, low level.

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