March 22, 2013 — The Federal Reserve held a meeting this week to review the state of the economy, provide some projections about future growth and inflation, and to review the economic supports they are managing. At some point, these unconventional policy tools of purchasing Treasury debt and mortgage-backed securities alike will come to an end, not to mention increases in short-term interest rates, the Fed’s traditional method of manipulating monetary policy. At the moment, though, there is no end in sight.
While that is good news for mortgage shoppers — as is the renewed nervousness over Cyprus’ bank troubles — the Fed faces risks of killing the programs too soon as well as running them too long, with consequences for interest rates in both cases.
HSH.com’s broad-market mortgage tracker — our weekly Fixed-Rate Mortgage Indicator (FRMI) — found that the overall average rate for 30-year fixed-rate mortgages eased by five basis points (0.05%) to 3.83%, backing down from a 2013 high. The FRMI’s 15-year companion slid just three basis points (.03%), falling to 3.05% for the week. FHA-backed 30-year FRMs managed a decline of five basis points (.05%), declining to an average rate of 3.40%, and the overall average rate for 5/1 Hybrid ARMs also fell by five hundredths of a percentage point, landing at an average 2.66%, a basis point above all-time lows.
At the meeting’s close, the central bank provided updated projections for economic growth and inflation, lowering expectations for both when compared against previous estimates. If the economy is on a lower growth and lower inflation trajectory, these creative Fed policies may remain in place for a longer period. The Fed has stated that it will keep short-term rates low until unemployment reaches 6.5% or inflation runs hotter than 2 percent for a period, but these unconventional supports will probably have been greatly diminished (if not totally gone) by that point. This will of course impact mortgage rates.
See this week’s Statistical Release and Mortgage Trends Graphs.
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While a gradual exit is the most likely course — the Fed will slow purchases of Treasurys (presently $45 billion a month) and/or MBS ($40B) — removing even a portion of the demand for these items in the market will cause their prices to fall, and yields (interest rates) to rise. Aside from the immediate impact of rising mortgage rates (which would probably spark a flurry of homebuying as an initial reaction, followed by a slowing of activity due to higher costs), there are other considerations, as well.
To the extent that low rates are supporting economic activity, higher interest rates would tend to diminish it. How much higher rates would need to go to trim economic growth, or to what degree it would be trimmed is certainly a matter of discussion; suffice it to say that there would be some impact. An early exit by the Fed — or slowing purchases quickly — could cause the expansion to stumble, leaving us in a more stagnant pattern at best as the economy adapts to higher credit costs — if it can.
Any measurable slowing would likely necessitate further support by the Fed — a restarting or re-expansion of the support programs — in order to give the economy another boost. Of course, economic trouble in the form of slowing growth would tend to bring lower rates, too, but monetary policy in fits and starts is not something the markets would likely welcome.
So there is an economic risk of exiting too early or too abruptly. There is also a risk of running these programs too long, as the Fed continues to pump billions of new dollars into the economy each month. At some point, these dollars will begin to push their way back into the economy, and that might create an inflation spiral. The Fed has been fighting deflation for the last couple of years, reflating various markets at differing times (first commodities, then equities, and lately, home prices). To complete the circle, wage inflation usually has to join in, but the still-weak labor market does not yet allow for that.
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.
If the Fed continues to pour cash into the economy past the point where the economy needs the additional funds, a bout of inflation may result. In general, the solution for a bout of inflation is higher interest rates, for a time; how high rates would need to rise to quell inflation is uncertain. Regardless, inflation can be tough to tame, as the Fed generally needs to mop up or otherwise lock up all the excess funding it has provided to restore balance.
While these concerns remain in the future, the day when the changes will come are growing nearer with each Fed meeting. Sooner or later we will see a message concluding a get-together which says “The committee has decided to reduce the Fed’s purchases…” and we’ll see how well prepared the stock, bond and housing markets are for the change.
If the economy continues to show signs of improvement, that message may come sooner than you think. Although there wasn’t a lot of top-tier economic data out this week, there were a few updates of note.
Sales of existing homes continued a general upward trend in February; purchases rose by 0.8%, climbing to an annualized rate of 4.98 million units. Despite the increase in sales, more inventory came into the market, and the supply of houses available relative to sales rose to 4.7 months. That is still rather thin, since six months supply is thought to be normal or optimal. Home prices are rising, at least compared against year ago levels, with the 11.6% gain over the last twelve months the result of fewer sales of “distressed” homes. There is also arguably some pricing power afforded to sellers by the increase in demand fostered from still rock-bottom mortgage rates.
Housing starts did also rise by 0.8% for February, climbing to an annualized rate of 917,000. Single-family starts nudged about 3,000 units higher to 618,000 while multi-family added 4,000 units for the month. Permits for future activity also climbed, rising by 4.6% to 946,000, so it would appear that the future for construction and sales of new homes is brightening.
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That does seem a little at odds with the slide in moods of the nation’s homebuilders. The National Association of Home Builders index of member business activity stepped backward in March, easing by two ticks to a value of 44. That little setback took returned us to October-November levels, as did the slump in single-family sales from 51 to 47 during the month. Traffic in builder showrooms and model homes was improved in March compared to February, although it did lag December and January a little. In the NAHB survey, reading above 50 indicate expanding activity; below 50, contraction. In the recovery for new home sales, we have only recently been starting to flirt with these breakeven levels, and to see activity slip is a little disappointing as we begin the traditional spring homebuying season.
Was that slippage a result of higher mortgage rates in February and early March? Could be, as rates have been about a quarter percentage point higher of late than they were when we began 2013. Potential borrowers who might be highly sensitive to rate changes may have stepped out of the market for the moment in hopes of seeing them decline. If that’s the case, could January and February have constituted a flurry of activity for new home sales? Maybe. They were the strongest months of the recovery to date, and are now followed by some diminishment, so we may be seeing a bit of the market reaction we noted above.
Sales of both new and existing homes will be better supported as the job market expands. We won’t get the March employment report for a couple of weeks yet, but present unemployment claims levels suggest it could be a pretty solid month. During the week ending March 16, claims for new unemployment benefits were 336,000 and the trend has begun to move to a level which suggests that additional hiring is happening. Could we ring up a 250,000 or better new hires figure for March? While fewer layoffs aren’t the same thing as actual new hiring, the pattern suggests that we might.
Consumers were less enthused in the week ending March 17. The weekly Bloomberg Consumer Comfort Index slumped by 2.3 points, ending a six week long string of improvement; the easing left us at a value of minus 33.9, a level last seen about a month ago. That said, the future should be brighter, if the latest index of Leading Economic Indicators proves right. The LEI rose by 0.5% in February, fast on the heels of a like-sized gain in January. In fact, the last six months have all had readings of unchanged or better, so the economy should be on a firming path. However, the LEI isn’t necessarily a reliable forecasting tool, but may simply better reflect the month in which its components are accumulated. Regardless, the news is good.
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|Current Adjustable Rate Mortgage (ARM) Indexes|
Good news was also noted in the latest report from the Philadelphia Federal Reserve. Its measure of manufacturing activity broke a two-month losing streak, with enough activity to move the needle from -12.5 in February to a positive 2 for March. While weak, it is a recovery of sorts, with measures of new orders and employment prospects both gaining during the period.
There is little doubt that the Fed will face a very delicate dance as it
tries to remove all of these extraordinary monetary supports. At what point should they be removed, and how will they know when it is tie to do so? How quickly should things be changed, and should the market be prepared in advance for them? Are the Fed’s stated milestones actually triggers, or will things be moving long, long before we hit them? Perhaps more important is the question is “What is the reaction of an economy which has become dependent upon historically low interest rates to function when they are no longer available?”
For housing, we know the answer, or at least one probable outcome. Low mortgage rates promote affordability, as a lower mortgage rate will allow a given borrower to leverage a given loan amount. In turn, and coupled with a downpayment, this allows a potential buyer to buy a home. A higher mortgage lowers the size of the loan the income can carry, and affordability is diminished, unless home prices decline. Given the recent market experience, no one wants to see that happen, and prices have a long way to fully recover for a fair number of homeowners.
That’s still tomorrow’s problem. In the immediate future, we have some fresh data out next week in the form of the Chicago Fed’s National Activity Index, Sales of New Homes, a final update to GDP for the 4th quarter of 2013 and few other items of note. We should also have a new two-month forecast out. Mortgage rates moved off last week’s recent peaks this week, but seem likely to be flat next week.
For an longer-range outlook for rates and the economy, one which will take you up until late March, have a look at our new Two-Month Forecast.