October 17, 2008 — While we expected interest rates to flare higher this week, the ferocity of the increase was shocking. Chalk it up to the law of unintended consequences: the government changing the structure of markets can cause any number of distortions, and this appears to be among them.
The overall cost of mortgage money measured by HSH’s Fixed-Rate Mortgage Indicator (FRMI) rose by 40 basis points to close the week at 7.08%, while the FRMI’s companion 5/1 ARM was lifted by 28 basis points. The FRMI includes conforming, jumbo and expanded conforming mortgage prices. See the latest trending charts for these and other series.
Conforming 30-year FRMs rose by a significant amount more than did already-high jumbos. The 47-basis-point rise for conforming 30-year FRMs outstripped the .32 lift for true jumbos, which are now within shouting distance of 8%. The week’s 7.84% was the highest jumbo average since December 2000.
The Federal Reserve, the Treasury, and the FDIC called nine of the nation’s most important bankers to a special meeting over last weekend, where they were asked to sign an agreement to sell the government preferred equity positions in each of the firms to help more fully capitalize them, and in turn, hopefully loosen frozen lending markets. At the same time, and in order to not spook investors, they offered to guarantee bank debt obligations for the next three years. An initial $125 billion was spent at the meeting, with another $125B available for any other banks which might voluntarily wish to participate.
The rise in rates came as markets reacted to at least two new factors. The first factor is fairly common: With a truly massive amount of sovereign debt to be unleashed into the markets — hundreds of billions of dollars here and across the globe — it’s fair to expect that supply will outstrip demand for some time to come, causing a rise in yields (see our blog entry A Bond’s Influence on Interest Rates for a simplified explanation of supply and demand dynamics as it pertains to bonds). Second, and perhaps more important, was the government’s full guarantee of bank debt for the next three years. That caused a selloff of “agency debt” (bonds backed by Fannie and Freddie), which, although also guaranteed, do have a greater level of perceived risk due to Fannie and Freddie’s difficulties as well as the uncertain nature of the marketplace. The selloff even extended to Treasuries, which are fairly low yielding at the moment. With higher yields than Treasuries available with no increase in risk, it’s little wonder investors shed other holdings in favor of bank debt.
When all these factors combined, routs in those markets caused the substantial rise in mortgage rates.
The crashing sounds of equity markets gave way this week to the crashing sounds of the economy. The stock market skyrocketed, then plummeted; plummeted again, then spiked higher; fell back and rallied hard, and ended the weak on a slightly softer note. Oil prices continued to downshift, and ended the week at a level more than 50% below the record high price per barrel achieved just about 10 weeks ago. The global economic decline is sapping demand, while speculators have been wrung out of the marketplace — at least for the moment.
That’s producing what may be the only bright light for the economy: a decline in inflation and inflationary pressures. While it will take some time be fully reflected throughout the economy, price indices have begun to decline from recent peaks. The Producer Price Index eased by 0.4% in September, fast on the heels of a 0.9% slip in August. Upstream price inputs at the crude and intermediate stages of production are falling as well, so pressures in the system are waning. That said, though, ‘core’ PPI inflation did come in with an increase of 0.4%, so the path downward for inflation may not be a steady one.
At the consumer level, September’s CPI came in unchanged. That was actually a tenth higher than August, but pressures are easing here, too. Over the last three months, CPI is now rising at a 2.6% annualized rate; in August, that number was a 7.1% annualized rate. Yet despite the decline, prices are still some 4.9% higher than last year at this time. “Core” CPI inflation (excluding food and energy) ticked 0.1% higher for the month.
Of course, the ongoing decline in gasoline prices is encouraging to cash-strapped families, and is now headed toward $3 per gallon on average; in some places it’s already less than that. Those dollars being added back into budgets are crucial, given the proximity of winter’s higher fuel bills and the impending holiday season.
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Daily FRMI rates are available at HSH.com. News outlets seeking daily statistics for conforming or jumbo mortgages should contact HSH for more information.
That holiday season is shaping up to be a grim one, if present trends are any indication. Retail Sales declined by 1.2% in September, the third consecutive monthly decline. There were falling sales in every category measured in the report, and the decline was a pronounced 0.7% even when excluding auto and gasoline sales, which tend to skew the numbers. With credit harder to come by, home equity vanishing, and stock markets not very trustworthy, consumers are feeling pinched from every angle — and it shows.
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for 11 products, including Hybrid ARMs.
Our state-by-state statistics are now here.
That sentiment was reflected quite clearly in the Fed’s regional survey of economic conditions, called the Beige Book. Economic activity “weakened in all twelve districts” according to the report, with real estate markets “weak” and credit conditions “tight,” but also with inflation pressures “moderating.” The economy is in quite a funk at the moment, and it is increasingly uncertain whether we’ll now be able to escape a recession after all. That concept is weighing on consumer psyches, with the University of Michigan’s preliminary October survey of Consumer Sentiment posting its largest one-month drop ever, slumping from an improving 70.3 in September to the 57.5 reported this week. This was also reflected in the weekly ABC News/Washington Post poll of Consumer Comfort, which gave up five points to close the week ending Oct. 12 at minus-48 — and that was before the wild stock ride this week.
The blues haven’t only infected consumers. The National Association of Home Builders index of member sentiment cratered to a new low of 14 in October, down from an already terrible reading of 17 in September. Tougher financing conditions and rising unemployment leave fearful consumers unable or unwilling to buy a new home; moreover, the stock market swoon has probably wiped out any number of potential down payments to boot. With markets already weak, there’s little reason to build new units, so Housing Starts caved in by 6.3% in September, landing at 817,000 annualized units initiated. Building Permits, a measure of hope for the future, came in at just 786,000 annualized units so the outlook remains quite dim for housing at the moment.
The weakness which began in mortgage markets and has since spread to other markets is infecting the broader economy to a much greater degree of late. Manufacturing — already struggling with a rising dollar and an auto industry in retreat — is showing new signs of stress. Industrial Production declined in September by 2.8%, the biggest one-month decline in 35 years. The manufacturing component of the report dipped 2.6%, and the weakness reflected in the report was exacerbated by the ongoing strike at Boeing. Hurricanes Gustav and Ike, which visited the US during the month, added their influence by disrupting some petroleum processes. The percentage of factory floors in active use fell to just 76.4% during September.
That weakness has persisted into October, with sizable declines in regional manufacturing surveys in both the New York and Philadelphia regions, both of which simply fell off a cliff during the month.
Although all these issues may contribute to an ultimate increase in jobless claims, new application for benefits at state windows retreated for the second consecutive week. The 461,000 new claims was largely in line with those seen before the hurricanes disrupted things to a greater degree. Even with the minor improvement, labor markets are weak and perhaps weakening anew at this time.
The markets — worldwide — would surely welcome a period of quiet along about now. All the efforts of central banks, regulators and legislators need time to be put into play and to see whether they will have their intended effects. Even the big housing bill, passed with much fanfare back in late July, has barely got underway; none of the other programs and offers are yet beyond the planning stage. Will next week bring another far-reaching change to the structure of markets, or another program which, even if it purportedly helps borrower or lender, will further distort the shape of markets? Nobody can say for certain, and weekends have been quite busy for the world’s central bankers and market regulators. Here’s hoping that next Monday will feature no new plan, no new initiative — just a normal open for markets on a late October Monday morning. Hey, we can dream, can’t we?
A fairly light spate of economic news is on tap next week. Perhaps mortgage rates will take a cue from the economy and begin to settle back amid falling inflation and a weak economic state. We think that could be the case. Also, although a week late, we’ll review the last and kick out a new two-month forecast for rates and the market. Wish us luck!
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