The HSH Two-Month Forecast for Mortgage Rates
Read the latest HSH Market Trends - and get it via email.
March 21, 2008
Before you read our latest forecast, we recommend that you read this article,
which serves as a preface to the crazy markets we've been experiencing.
Recap
Erratic investor demand amid dysfunctional mortgage markets left our previous forecast in tatters. We expected that the 30-year FRM would range from perhaps 6.45% to as low as 6.10%, but the wide swings in pricing left the actual top and bottom for rates a wider span of 6.05% to 6.72%. Worse still was our expecation for average 5/1 Hybrid ARMs, as our forecast 6.08% - 5.75% gap was broken on both ends with in a range from 5.45% to 6.31%.
Much has been made over the difference in price between conforming and jumbo loans. That wide gap remains, but loans of both sizes traveled the same path during the forecast period. Each sported a 70 basis point high-to-low range, with 30-year conforming topping out at 6.31% and 30-year jumbos at 7.28%.
Forecast Discussion
It's hard to know which market to address for this forecast. It does seem that conforming (and some former jumbo) borrowers will become more well served in the spring of 2008, but markets still remain far from functional at this writing. Pricing for the new "expanded conforming" loans are just starting to make it to market, while short-term rates are low enough as to obviate the ARM reset problem for many homeowners, but concerns over falling home values have left many borrowers with insufficient equity to successfully refinance, even if they could meet today's tougher underwriting standards.
The economy may have slipped into negative territory during the first quarter of this year, and the Fed has lowered interest rates to try to address that. However, inflation concerns are standing front and center in the markets and at the Fed; two Fed Governors dissented at the March vote to lower interest rates. We'll not know the reason until the meeting's minutes are released in a few weeks, but presumably it was the size of the move which caused concern, not the direction. At the moment, the Fed's primary concern is preventing a broadening downturn in the economy, but firming inflation pressure means long-term rates generally have less space to decline.
At least a few indicators suggest that the fall in housing markets is slowing, if not at a bottom. New and existing home sales remain challenged, but signals such as builder optimism do seem to have plateaued, albeit at low levels. Before improvement can occur, a bottom must be found. If -- a big if -- news of lower mortgage rates can make it into the market just as the traditional Spring homebuying season gets underway (and hold, unlike January's refi flare), the combination of lower home prices and lower fixed mortgage rates might produce enough of an affordability mix to provide some support to flagging housing markets. Although enthusiasm will probably be muted, we think there may just be a spark of hope in housing this Spring. The old mortgage-lending machines -- the ones which fostered such a huge housing financing market and the resulting bubble -- remain broken and likely irreparable. However, with new market structures in place, there's a much better chance of measurable improvement.
Forecast
All the machinery put into place since our last forecast should get more fully up to speed during this one. There is no doubt that mortgage markets will remain challenged, or that the former subprime and Alt-A markets will continue to remain "former." True jumbo rates will likely remain elevated relative to their conforming counterparts, and the gap between them may widen more (as a result of a decline in conforming rates, not necessarily a rise in jumbo ones). The new "expanded conforming" loans should provide at least some new liquidity to parched jumbo markets, while FHA-backed lending should help those more on the fringes of traditional lending.
For the rest of the world, we think that mortgage money may become available at lower rates -- perhaps much lower rates -- as Fannie Mae's and Freddie Mac's newfound purchasing power begins to hit the markets.
The overall combined average for 30-year fixed rate mortgages should probably decline during the forecast period. We are presently at an average 6.72% for jumbo and conforming rates combined, and expect that this fixed-rate indicator will move down to as low as 6.27% during the period, dragged down by lower conforming interest rates. Hybrid 5/1 ARMs -- in fact, all ARMs -- have been suffering from even more erratic demand, bouncing up and down by sizable amounts. We start the forecast at 6.31%, and do expect rates to settle back but perhaps only to 5.75%.
We don't usually forecast conforming or jumbo loan price ranges, but if we're correct in that rates will decline, and if much of the decline is in conforming rates, we could see conforming 30-year FRMs with average rates close to 5.50% -- low enough to spark a fair refinance boomlet.
It'll be mid-late May when this forecast comes to an end. Drop back by and we'll see if we're closer to the mark this time than last.
January 18, 2008
The meltdown of the subprime market dominated mortgage-market news over our forecast period. Accompanied by plans to "freeze" initial interest rates for some small percentage of subprime borrowers, regulators and central banks around the world invested a considerable amount of time, effort and money to stabilize and relubricate financial markets. So far, these moves seem to be doing some good for the mortgage market. Lenders continue to report losses from yesterday's loans, but tighter underwriting standards and cheaper costs of input funds make today's loans more profitable, a key element in keeping mortgage money flowing to the masses.
Although price spreads between conforming and jumbo mortgages remain wide, and there has been little discernable change in the availability of high-LTV, no-doc or subprime offerings (and probably won't be, for a while), lenders have stepped up their promotion of conforming and FHA loan offerings. Lenders in our editorial mortgage market surveys have even started to re-offer some jumbo products which couldn't be easily sold since last summer's credit market mess.
While the market mess isn't over by any means, there have been at least a few scattered signs of cautious hope. New and Existing Home sales have been mostly holding steady (albeit at low levels for the past few months) and with lower interest rates and home prices in the headlines, borrowers may begin to show some additional interest this spring.
Recap
Our November 9 forecast called for the overall (conforming and jumbo
combined) average for 30-year fixed rates to range between a high of 6.70%
and a low of 6.35%, and we were fairly close. The actual range for these
rates was a high of 6.60% and the low of 6.31% came at the end of the
period. For 5/1 Hybrid ARMs, we expected brackets of 6.40% to perhaps 6.08%,
and for the most part, the 6.37% to 5.92% we experienced was pretty close to
the mark. In fact, a 23 basis-point decline in the final week of the period
was responsible for breaking the bottom of the range.
Swings of pricing for 30-year conforming mortgages were again much wider than for jumbos. While conforming prices wandered in a 42 basis-point window over the nine-week period, jumbos meandered in a tight 14 basis-point range. Still, the 6.80% for the 30-year jumbo FRM noted at the end of the forecast period was the lowest such average rate since mid-June, when the market crisis began to first show itself.
Forecast Discussion
As we ponder the next forecast period, we'll note that the strident
calls for the Federal Reserve to again lower short-term interest rates have
been joined by stumping presidential candidates calling for various forms of
economic stimulus. For the Fed's part, they're in a bit of a tight spot:
although economic growth has measurably slowed, price pressures remain firm,
and lower interest rates can't fix the problems already on the books. Worse,
goosing growth could serve to exacerbate that inflation problem, and
persistently high energy costs are making their presence felt and will
probably continue to do so. It's a fair bet that the Fed will lower rates
during the forecast period, perhaps by a substantial 50 basis points (at
this writing, 25 seems a sure thing).
The Fed's Term Auction Facility auctions of cash have been going well, but liquidity at lower rates can only have so much effect. At present, mortgage-price spreads relative to underlying costs of funds and other benchmarks are very high, and we'd bet the Fed may begin to elbow lenders to lower prices on loans more quickly so that more borrowers can be served. Of course, for lenders, only time, the reassessment of the value of loans,and the continuing re- establishment of trusted trading relationships will rebuild these markets. We're now several years into the subprime mess, and there is still a sense among some that the other shoe has yet to drop. It yet may.
That being the case, we closed 2007 on a decidedly softer economic bent than the near-5% GDP we enjoyed in the third quarter. Some estimates put fourth quarter GDP in the low-to-mid-1% range, which seems about right to us. That means there's little energy to kick-start 2008, and a soft tenor for economic activity will probably hold through the forecast period. Whether inflation continues to present a troublesome stance is unknown, but the Federal Reserve's most recent signals suggest that spurring economic growth may be more important to them at present.
Employment growth seems likely to continue to be meager over the next nine weeks. The nation's unemployment rate gapped higher by 0.3% in December, landing at a multi-year high of 5%. Given the weeks of generally rising first-time unemployment claims prior to the December employment report, it shouldn't have been as big a surprise as it seemed to be, but it did startle the markets. We may see a minor improvement in hiring and a slight retreat from the 5% unemployment level during the forecast window, but uncertain times make it unlikely that employers will be adding to their payrolls.
The combination of slow economic growth, additional liquidity and lower interest rates between now and mid-March bodes very well for a don't-miss-it refinance opportunities -- for good credit conforming borrowers with equity in their homes.
This forecast begins with rates for conforming loans at better than two-year lows, and barely a half-percentage point above the now 46-year-low of 5.24% seen back in June of 2003. Plenty of homeowners have enjoyed with rates above 5.75% in the past few years and may benefit from the lower payment provided by a lower rate and a new term. Borrowers with adjusting jumbo ARMs may need to consider a new jumbo ARM, as fixed-rate jumbo loans will probably remain elevated.
Forecast
While we do expect rates to be lower, on balance, through the forecast
period, we are starting at a fairly low level already. Rates could flare
higher on better economic news or worse inflation news. That being the case,
we think that the overall (combined) 30-year fixed-rate mortgage will wander
in a range from 6.45% to as low as 6.10%. We see 5/1 Hybrid ARMs ranging
between 6.08% and 5.75%.
At the end of the forecast period, it'll be mid-March and daylight savings time will be kicking in on the cusp of Spring. That sounds pretty good in the depths of Winter. Why not check back to see how we did, and we'll see if it will be another "silent spring" in the housing markets?
November 9, 2007
Significant market turbulence is now behind us, but unsettled financial markets will be the rule for a while yet. The Fed has made measurable moves, but may be "two and done" as the economy outside of housing and mortgages holds up OK. That has been the case, but inflation and slower growth both seem to be headed our way -- the result of near $100 per barrel oil and rising commodity costs.
Although mortgage rates declined during the last forecast period, little of the decline could be attributed to any influence by the Fed. In the period just after the Sept. 18 cut in the Federal Funds and Discount Rates, mortgage rates largely trended upward before settling back mildly. In late October, a spate of poor economic news related to housing and reinforced by some softer factory orders spread economic disappointment, driving money out from stocks and into Treasury bonds, pushing up prices and dragging down yield and mortgage rates.
Recap
Our September 7 forecast looked for the overall
30-year fixed-rate mortgage (FRM) to trend between 7.02% and 6.70%
during the nine-week period. We did track as high as 6.82% and eased
only slightly before a 14-basis point drop during the week ending
October 26 put us below our bottom limit. The actual bottom for rates
was 6.55%, which came during the last week of the period. Our expected
range of movement (about 32 basis points; actual move, 27) was good,
even if our scale of rates was not. For five-one Hybrid ARMs, we
forecast 7.00% to 6.60%, but rates fell and ended in the lower range of
6.61% to 6.26%.
It's worth noting that the greatest influence in that 5/1 number came from jumbo mortgage pricing. At one point during the forecast period, 5/1 jumbos had shed nearly 60 basis points from their forecast-period starting level. We attribute this to the return of at least some jumbo mortgage buyers and portfolio lenders to the markets during the past nine weeks. By comparison, conforming 5/1s moved about half that much.
This was also the case for FRMs: conforming rates moved down by about 22 basis points, while jumbos declined by more than double that. All that said, while improving, the gap between conforming and jumbo markets remains abnormally wide, a condition which seems likely to persist well into next year.
Follow daily numbers here and weekly numbers on this page.
Forecast Discussion
While the economy has performed
remarkably well over the second and third quarters -- averaging about 4%
GDP growth during that time -- we can't help being struck by a sense of
fading momentum. Housing markets remain in terrible and perhaps
worsening shape; exports may be gaining momentum, but measures of
factory activity don't seem to reflect any sort of enthusiasm for
growth. Consumers may already be retrenching their spending habits, if
the October news from prominent retailers is any indication. Gasoline
and heating oil prices are rising and will rise more, and if recent
history is any indication, those increases tend to slow economic
activity and put upward pressure on prices. Employment levels remain
fair, even good, once recent revisions to hiring are taken into account,
but the nation's unemployment rate has slowly but steadily ticked higher
since March, rising from 4.4% to the present 4.7%.
Presently, the best guesstimates are that we will skirt a recession absent any new or unforeseen economic shock, but a period of slower growth and perhaps rising prices does seem to be forming. As it is usually accompanied by a declining inflationary threat, waning growth generally brings lower long-term interest rates, and that is largely the case, particularly to risk-free investments such as Treasuries. Mortgages, however, are not risk free, and may not benefit as much from any declines in underlying interest rates brought on by economic disappointment.
Providing some tempering to any downdraft in rates are inflation concerns. Price pressures do seem on the increase, and it is reasonable to expect that our weak dollar at some point will serve to firm up the prices of imported goods. Should inflation does move higher, interest rates will have trouble declining, soft economic growth or not.
In this environment, both good and bad news can be found for refinancers and homebuyers. For good-quality conforming borrowers, interest rates are close to 2007 lows as we write this -- providing a real opportunity for refinancers to escape from resetting ARMs to manageable fixed rate mortgages. Jumbo borrowers, especially homebuyers, will mostly find improving conditions and access to credit. Although the price of that money remains elevated, a jumbo borrower with an adjusting ARM may be able to trade in that ARM for a fixed rate for virtually the same rate, presently in the mid-to upper six percent range.
For all other borrowers -- those with no equity, those with no ability to document their income or assets, those with high debt loads, and those who can cover little or no increase in their monthly payment from present levels, those with poor credit -- lending windows remain closed, particularly where any combination of these issues intersect.
Forecast
Downward pressure for interest rates seems to be the dominant theme
for the end of the year and into the new. However, it's our guess that
the downtrend will be limited due to rising concerns about inflation and
a ongoing low level of investor demand for new mortgages. The Fed
trimmed interest rates twice in our last forecast period to modest
effect, and there are some expectations of another cut in December. As
is often the case, fixed rate mortgages can rise even as the Fed is
trimming short-term rates, particularly if inflation isn't subdued.
We think that the overall average for the 30-year FRM will run in a range from about 6.70% to perhaps as low as 6.35% as we finish 2007 and wander into 2008. For Hybrid 5/1 ARMs, we think that 6.40% to as low as 6.08% is a likely gap.
Have a happy and healthy holiday season. If you're inclined, refinance! Come back and see us again in early 2008.
September 7, 2007
The Summer of 2007 can be described in a number of ways, but you can be certain that 'tranquil' isn't among them. Increasing signs of credit trouble in fringe lending markets spilled over into good credit quality non-conforming markets. Subprime mortgage troubles have begun to show up more regularly in investor holdings around the world. More mortgage lenders suddenly shut their doors, and overall, the shunning of risk by investors caused a once-mighty river of mortgage money to dry to barely a trickle, leaving some borrowers with more expensive financing options, and others with no recourse at all.
While the housing boom recedes in the rearview mirror, the housing bust continues to roll along in front of us, and no one can tell how wide the valley is. Dire predictions about the effects on the economy abound, but at this writing it seems to be holding its own, with the latest estimate of GDP growth above 4% (Q207). How much additional drag we'll experience from housing's falloff has yet to be seen, and the earliest estimate of broad economic growth in the present quarter isn't due for about eight weeks yet.
No matter what the response by regulators, Congress, or even the Fed, housing markets are going to take a bit of time to straighten out and improve, and will likely have to do so minus all of the budget-stretching mortgage products which served to artificially inflate it.
Recap
Forecasting is among the most humbling endeavors, so
we're always happy when we're more right than wrong. Back in June, we
offered an extended two-month forecast (this one actually covered about
eleven weeks instead of the usual nine), where we expected the average
30-year FRM to range from 6.70%
to about 7.02%. At the same time, we thought that 5/1 ARMs would wander between 6.36%
to 6.60%.
The actual range of rates for the 30-year FRM covered a 6.80% to 7.02% spread, which was skewed higher by leaping prices for Jumbo mortgages; Hybrid 5/1 ARMs, a "riskier" product, blew past the top end of our expectation, covering a range of 6.47% to 6.85% during the eleven week period as investors turned away from anything but plain-vanilla loans.
Let's call it a split decision for the last forecast.
Forecast Discussion
Although the broad economy seems to be
OK at the moment, there's a fairly loud drumbeat from many credit-market
players for the Federal Reserve to trim short-term interest rates, with
some strong expectation that this will occur at the next FOMC meeting
later this month. The summer flight-to-quality buy of risk-free
Treasuries drove yields for all instruments down to very low levels,
with even the 10-year Treasury far below the 5.25% stated Federal Funds
Rate. With lower rates already in place, pushed there by the market,
this begs the question: "What good will a lower Fed Funds Rate do?"
It's a valid question. For first mortgage rates, the answer is very little, if anything; despite marked declines in the yields which influence mortgage rates, mortgage rates have remained pretty steady. For fixed-rate mortgages, the difference (spread) between the 30-year FRM and the 10-year Treasury has widened to five-year highs, and is running some 80 basis points (.80%) above normal. The increase in differential represents the investor demand for higher returns for investing in mortgages, as all mortgages are being tarred with the same "risky" brush at the moment. Even lower input costs for capital may or may not translate into lower mortgage costs for borrowers, especially those outside the rigid boundaries for conforming loans. Pricing for ARMs is even more distorted at the moment, but in differing ways; while Jumbo ARMs are priced lower relative to their fixed rate counterparts, Conforming ARMs are back into a mostly-inverted pricing curve, at least partially due to balky Wall Street conduits.
Economically, we'll probably come though the forecast period in OK shape, but the number of housing-related job losses from the construction and financial services sectors does seem to be finally showing in employment reports. The Fed has all but explicitly stated that a higher unemployment rate will be required to relieve inflationary pressures in a more meaningful way, and downgrades to hiring (a net 4,000 jobs lost in August) seem to have us setting our feet on that path. Of course, inflation remains the Fed's top priority, and in that regard, signs point to a gentle cooling of price increases, but inflation generally remains above the Fed's implicit targets for now, making a cut in short-term rates less of a likelihood.
To be sure, it is a very tenuous time for the economy, the markets and the Fed. Summer's market maelstrom seems to have quieted a little, and the same could be said for both inflation and the economy. Lower rates are here, Fed moves or not, but mortgage and other debt markets remain in a largely dysfunctional stance at present. As well, the global reassessment of risk continues to keep investors on edge.
While we don't forecast what the Fed will do, we still think that despite all the credit market troubles, there is a reasonable likelihood that investors hoping for a cut in short-term interest rates will be disappointed. The economy is performing, even if segments of it are not. Tightening access to capital does seem likely to trim growth somewhat, but a 4% GDP rating is already above what is thought to be the economy's "potential" (ability to grow without generating inflationary pressure) so some additional slowing could be endured. At 4.6%, the unemployment rate remains low as we hold near what could be considered "full employment". In this way, if a quarter-percentage point cut will do little to loosen the credit market logjam - at its core, a disconnect between holders, buyers and sellers of debt rather than an issue of the price of money - and if the economy is growing above potential, and if such a move could increase the potential for inflation, where is an overarching benefit that the Fed could cite as a reason for such a move?
Forecast
For this forecast, our accuracy level will likely
be dictated by where you look. After spending a fair chunk of the
summer traveling in different directions, conforming and jumbo mortgage
prices finally moved in the same direction again during the week ending
August 31. While they didn't move with the same velocity - jumbos fell
less than conforming - this is the first glimpse that markets are
beginning to function somewhat more normally again, even if there were
disparate improvements. We think that during the next nine weeks, the
overall 30-year fixed rate mortgage will run in about the same space we
expected last time, covering 6.70% to our recent high of 7.02%. For 5/1
Hybrid ARMs, that range will probably be about 6.60% to 7.00%; of late,
hybrids have had more volatility to the upside, so perhaps they will
exhibit some to the downside during our forecast period, as well.
It'll be well into November for our next forecast. Drop by and we'll see how this all played out.
June 15, 2007
Tepid GDP growth through the winter months seems to have given way to stronger activity in the Spring. Housing and mortgage markets remain challenged, global inflation concerns have reappeared, and the reassessment of risks and assets is ongoing. Hopes for lower Fed-led short-term interest rates have faded while $3 per gallon gasoline sapped consumer dollars. In some ways, this Spring looked a lot like last years did.
One key difference between then and now, though, is that instead of the Federal Reserve, other central banks are raising interest rates this year. Better investment opportunities in other parts of the world has slowed the wash of money into US Treasuries and mortgages, while stubborn-if-slightly declining core inflation adds some upward pressure to interest rates.
Recap
Back in April, we postulated that rates would likely
have an upward bent during the nine-week forecast period, with the
average 30-year FRM running
between 6.28% to 6.55%. We were fairly close, as rates ranged from 6.38%
to 6.65% over that time. Our forecast of a 27-basis-point window proved
to be true, even if the nominal rates didn't quite match our
estimation.
For 5/1 Hybrid ARMs, we expected the average rate to wander between 6.06% and 6.26%, but it surged past the top end of the range during the last week of the forecast period, so the actual range ended up being 6.22% to 6.46%.
Forecast Discussion
At the close of the April 13 forecast period, the partial "inversion" in
the yield curve -- a situation where short-term rates are higher than
their long-term counterparts -- was in the process of disappearing. By
June 8, the close of the forecast period, the yield curve was almost
completely normalized. That inverted/partially-inverted curve meant that
mortgage rates were virtually identical regardless of the length of the
fixed-rate period, whether it was one year or thirty. To the borrower,
there was little advantage to accepting an ARM, as there was little
initial reward for having done so, and fixed-rate mortgages offered zero
interest rate risk at very little premium for all that stability.
The phenomenon of long-term rates lower than their short-term counterpart was called a "conundrum" by former Fed Chair Alan Greenspan. His replacement, present Fed Chairman Bernanke, proffered that the situation was caused by a global "savings glut", a situation where other countries are awash in cash and looking for a profitable place to park it, notably US-denominated assets which include mortgage-backed securities. With the fallover in subprime mortgage bonds, and in light of growing opportunities elsewhere, those investors who were formerly sending money here seem to be having some second thoughts. That corresponding lack of demand for bonds means that offered yields (returns) must be higher to attract investors to come back, hence the rise in interest rates toward the end of the last forecast. Rising rates also means less need to use Treasuries as a hedge against refinancing, contributing to slack demand.
What's uncertain is whether or not this situation will continue. Certainly, with other central banks raising interest rates, investment opportunities in home markets may be more compelling for those investors; even several hard selloffs this year in Asian stock markets failed to produce any flight-to-quality buy of Treasuries sufficient to push yields back down.
Domestically, the slump in business-related spending so evident in the fourth quarter of 2006 and early 2007 has given way to at least a mild uptick, and the "inventory correction" for manufacturers seems to have at least mostly run its course. The result is that growth has moved notably higher from the anemic 0.6% seen in the first quarter of 2007, and GDP growth seems again only restrained by still-stumbling housing markets. The pick-up in growth comes at a time when labor markets are quite tight; unemployment remains low, substantial housing-related layoffs don't seem to have occurred (at least not yet), and concerns that the Fed may have to raise interest rates have resurfaced in the markets.
The question for the Summer forecast then becomes: Does the upward pressure for interest rates persist, or do things flatten out again? History can be a rather poor guide in matters economic, but a similar run-up last year saw rates get to within a whisker of 7% before spending the summer on a lazy downward drift. In a wider view, that near-7% represented the top of a longer range we traveled from a June 2003 low of 5.37%; the last time we cracked the 7% mark was April of '02.
There's a reasonable chance that we'll crack it again this summer, an unwelcome position for homeowners looking to refinance out of costly ARMs, and for homesellers holding fast to inflated prices.
Forecast
As we write this, mortgage rates are still
climbing toward that psychologically significant 7% slot, but the rout
in Treasuries has stopped for the moment and some yields have eased back
a bit. The new levels for interest rates do seem likely to attract at
least some money back into the bond market, but that might prove fickle.
The 50-basis-point lift in 10-year Treasury yields during the last
forecast period is unlikely to be duplicated during this one, but there
may be an upward flare or two in the wings. That said, the see-saw of
interest rates probably went a little too far to the upper side than was
warranted in the past few weeks and may level a bit.
Over the next nine weeks, we think that the average 30-year FRM will wander within a range from 6.70% to 7.02%. Rates at these levels seem likely to enforce the quiet real estate markets seen during the Spring, but any additional downward pressure on home prices which result may better be viewed as a buying opportunity.
The more normalized yield curve may make products other than the 30-year FRM relatively more attractive to homebuyers and refinancers. We expect that the 5/1 ARM should cover a range of 6.36% to perhaps 6.60%; not exactly cheap, but nominally better.
This forecast covers us through September 7. Have a good Summer, and check back after Labor Day to see what happened.
April 13, 2007
Spring, cold and dreary though it is this year, is upon us. If some forecasts and expectations are to be believed, 'cold and dreary' will also describe housing markets this Spring, as the sunshine of easy mortgage credit is diminished by the murkiness of regulators, Congress, and ongoing credit quality issues. Hopes for some assistance from the Federal Reserve in the form of lower rates aren't likely to come anytime soon, as inflation hangs tough at unacceptable levels.
The economy continues to stumble in a low-growth pattern, but overall it seems to be holding up well. Recent signals have been mixed, with the slowdown in housing and autos joined at least for the moment by sluggish spending for business investment. First quarter GDP growth is likely to be no better overall than was 4Q06, which rang in at 2.2% for the period.
Recap
Our expectations for mortgage rates for the forecast period just past
looked for perhaps a little upward tick, then some settling. At that writing, growth was still estimated at well above 3%
(since revised downward) while inflation pressures remained above the Fed's
preferred range. On January 31, we called for 30-year fixed rates to run
between 6.28% and 6.55%, but they never tested the upside to any degree, but
drifted downward amid a strong flight-to-quality purchase of US Treasuries.
That happened due to an almost 9% one-day decline in a major overseas stock
market index and near daily revelations of losses in the subprime mortgage
market. The actual range for rates during the period was 6.45% to 6.26%, so
we were pretty close. Also, we thought 5/1 Hybrid ARMs would range from
6.30% to 6.09%, but we saw 6.24% to 6.03% instead. Still, that was within a
reasonable margin of error.
Forecast Discussion
At its last meeting, the Fed removed its explicit 'bias' toward higher
interest rates. Although the markets interpreted that to generally mean an
interest rate cut might now be more likely, we took it to mean that the Fed
no longer felt the need to state any bias if it really didn't believe that
(in this case) a rate hike was the most likely course of action. In our
view, no change, perhaps for a long while yet, is the most likely course for
the Fed, but explicit bias or no, the possibility of a rate hike cannot be
erased from any longer-range forecast. The subsequent release of the minutes
of the Fed meeting largely bore out our reading of the change to their
wording.
It's a tenuous time for forecasting this spring. Credit markets have become creaky lately, as the well-oiled machine for all forms of mortgage credit are running less fluidly than in recent years. The mess which has developed in subprime lending has many observers wondering whether greater contagion to better credit grades can be contained, or whether a market-dooming round of foreclosures will derail real estate to a greater degree than that already happening. Certainly, either circumstance would lead to a diminishing of available credit, as investors would probably pull back further from even pretty good quality paper. Moreover, any spate of foreclosures will likely bring the wrath of Congress and Federal Regulators armed with missions to 'protect' the public. Already drying streams of credit would likely dwindle to less than a trickle, at least for a while.
Amid what seems likely to continue to be a stumbly economic time with stubborn inflation -- a continuation of the recent pattern -- this becomes perhaps the key feature of this spring's forecast. It's still unclear how investors and markets may fully react to increasing losses, how well any loss mitigation programs will soften the effects of poorly or non-performing loans, and whether or not "regulation risk" will become the latest risk mortgage lenders will need to manage.
An already-underway pullback in credit availability -- tougher underwriting, higher rates -- would be exacerbated by any new layers of regulation or 'guidance' which might come. More oversight means higher rates and fees at an inopportune time for the markets.
Expectations for an increasing amount of slack in the economy simply haven't materialized yet. Employment levels are quite high, job growth remains firm, and the unemployment rate for March matched cycle lows of 4.4%. From a Fed standpoint this should serve to keep a floor on interest rates, and unless inflation begins to decline anew, rates seem poised to hold pretty firm for the period just ahead, pulled between slow growth and persistent inflation. However, the wild card remains the markets themselves.
Forecast
From an economic standpoint, mortgage interest rates seem likely to have
an upwards bias of their own during the forecast period. We haven't been any
higher than 6.5% in over 30 weeks, but we'll probably approach that level
again before the nine-week window of this forecast comes to a close. We
think that the average 30-year fixed rate mortgage will manage to hold the
same range in our last forecast, running between 6.28% and 6.55%, while
Hybrid 5/1 ARMs wander between 6.06% and 6.26% between now and the time of
our next forecast, due just about a week before Summer begins. Hope for sun,
but plan for rain, as the saying goes.
Enjoy your Spring, and drop back in June to see what weather prevailed.
January 31, 2007
Nine weeks have passed since our last forecast, and we're now one-twelfth though 2007. Estimates of economic growth have been moved considerably higher during the period, while inflation remains fairly firm. Hopes for a cut in short-term interest rates by the Fed continue to be pushed deeper into the year, and a growing number of analysts are starting to suspect that we may be into 2008 before any significant rate cuts occur. Mortgage rates have spent the last nine weeks adjusting to the new landscape, and seem likely to be as firm as the economy appears to be.
There's no precise period in which a change to the Federal Funds rate has an explicit effect on the economy. It's generally thought that the full effect from such a change isn't fully felt for between six months and a year from the date of the change. It's now six months since the last rate hike, and the economy is doing very well -- even accelerating from a periodic "soft patch." If the time window is as long as a year, though, some additional throttling of economic growth might be expected, but that seems increasingly unlikely.
Expectations, though, play a large role in what happens to interest rates. As the economy slowed last year, the stock and (especially) bond markets began to expect that the Fed would need to trim rates fairly quickly, before the economy slipped toward recession. As we now know, the Fed didn't and the economy didn't; in fact, interest rates have risen.
Recap
Our November 28 forecast turned out to be pretty close. At that time, we
expected 30-year fixed rate mortgages (FRMs) to run in a range from 6.15% to
6.45%, and we actually managed 6.16% to 6.38%. That's about as good as it
gets. For five-one Hybrid ARMs, our expectation of 5.95% to 6.30% was also
on target, with the popular alternative mortgage product featuring average
interest rates of 5.99% to 6.20% during the forecast period.
Forecast Discussion
We seem to be entering an interesting, muddy time for interest rates.
Falling energy prices in late fall seem to have goosed the economy back to
life, as the initial estimate to 4Q06 GDP came in at an 'above potential'
3.5%, up from a flat 2% in the third quarter (when oil touched $77 per
barrel). From a broad perspective, and for people and businesses, that's
generally great news. Employment growth is solid, and this should ultimately
help to revive housing and automotive industries most affected by the
slowdown last year.
It's all great news -- unless you happen to be a central banker. The Fed's campaign of lifting interest rates was comprised of a substantial 425 basis points (4.25%) in two years through last June. At that time, in conjunction with cash-sapping energy costs, the economy slowed sufficiently to allow the Fed to come to a least a temporary halt.
At the turn of 2006, oil prices pumped up by hurricanes fell sharply, and GDP revved up to over 5% in the first quarter. A similar effect seems to be in play here, as the break in oil costs back to $55 a barrel in December and January is serving to enhance economic activity. Lower energy costs tend to lessen inflation over time, but stronger economic activity can worsen it.
Since core measures of inflation are still fairly above the Fed's desired levels, resurgent growth probably wouldn't be welcome right now. Growth below 'potential' -- about 3% GDP or so -- should eventually help to slow employment growth, lessen demand for resources, and ultimately drag inflation back down (or at least keep it steady). We saw just two quarters of sub-par growth in 2006, enough to get that process started, but here we are again above potential, at a time of full employment and firm inflation. Even with the rise in interest rates in the past nine weeks, the market remains in a stance that the Fed is likely to lower rates sometime in the future. Presently, we're not convinced that that's likely to occur in 2007 as the economy is doing fine and needs no additional stimulus. In fact, absent drag from high(er) energy costs, the Fed may need to raise interest rates again if growth remains above potential.
The market seems presently unprepared for such an event, and in order to avoid disruption, the Fed would need at least a meeting -- perhaps two -- to signal its intentions. It's still too early to think that any rate increase will come anytime soon, but it's not too soon to consider that it might .
Forecast
During the next nine weeks, we'll close out the winter and begin Spring.
Another two-day Federal Reserve meeting comes at the end of March, and if
present conditions hold -- solid employment, firm core inflation and above
3% growth -- we'll be unsurprised if the Fed signals that higher rates may
be in the offing at some point. There's nothing wrong with strong growth,
but it's more welcome when there is resource slack in the economy. The
unwinding of Fed rate-cut bets has moved interest rates higher, but to us,
there still seems to be some upside potential. Over the next nine weeks, we
think that the average 30-year fixed rate mortgage will range between 6.28%
and 6.55%, while the average 5/1 Hybrid ARM drifts from 6.09% to about
6.30%.
Stop back in early April and we'll see where we're at. Will we have laid an (Easter) egg?
November 28, 2006
Over the past nine-week period few new trends seem to have started up, but we now appear to be following a path which may promote fair economic growth while inflation gradually wanes. Should this happen, it could be considered a "soft landing" -- a feat engineered on rare occasions. The back-to-back quarters of low-to-mid 2% GDP growth are only mildly subpar, but may prove sufficient to ease considerable inflationary pressure which has built up over several years.
Engineering a soft landing starts with solid, vigilant, transparent monetary policy. With increasing clarity, the Fed continues to communicate its goals as well as its concerns about the risks involved with achieving them. While the Fed is careful not to proclaim a formal inflation target, it has made it known that it prefers 'core' inflation to be approximately 2% per year or less. While core inflation remains above those levels, it's easy to conclude that interest rate policy will tend to be steady to firm. At the moment, both inflation and policy should be expected to remain so, as (housing excepted) only a gentle drag on the broad economy seems to be the result of short-term rates at multi-year highs.
Recap
Our last longer-term musing saw us call for 30-year FRMs to range between 6.25% to perhaps as high as
6.60%. The actual low and high point for the benchmark fixed rate mortgage
was 6.30% at the bottom to 6.50% at the top. We'll call our forecast a
success in that regard. For five-one Hybrid ARMs, we expected a 6% to 6.35% spacing, and the market
obliged with 6.12% to 6.29%.
We noted at the time of writing that we thought mortgage rates might have room to rise from then-existing levels, but they never did move higher than the 6.5% at the start of the period, but instead touched it twice. After the second minor flare-up at the end of October, rates have largely been on a downward slope.
Forecast Discussion
The twin exertions of high energy prices and accumulated monetary drag
have undoubtedly trimmed the sails of the economy. The most pronounced
effects have been in the housing arena, where significant declines in sales
and building have slashed 1% or more off the GDP numbers. The advance
estimate for GDP in the third quarter was an anemic 1.6%, revised this
morning to a preliminary 2.2% for the period. The effects of lower energy
costs in August and September no doubt contributed to the upward revision,
and absent housing's drag, growth would be at about 'potential', or the
ability to grow without producing undue inflationary pressure. Headline
inflation has begun to ease, a welcome sign.
Slower economic growth is necessary if reductions in "utilization rates" are to be achieved. Utilization isn't simply one of commodities such as steel or oil, but also "human capital," also known as workers. Slower growth should see falling demand for steel, for example, as production of things like cars and washing machines decline, and softer manufacturing means less demand for energy. As such, the wax-and-wane cycle for commodities is more or less immediate.
Human capital is a bit different, though. Not only can demand for certain skills exceed available supply, the best-qualified workers can produce longer-lasting, more intractable costs to a business though higher wages and benefit packages. Worse, thin labor pools mean that less desirable, perhaps less productive workers are available to fill certain slots, all the while at higher costs to the company which hires them. It just may well be that this is where we are at the moment, which becomes a source of concern for the Fed to reach its goals.
With an unemployment rate at 4.4% -- a low for this business cycle -- the pool of available workers is low. Productivity, a key component of keeping wages growing without sizable effect on final prices, has been on the decline, registering no change for the third quarter of 2006. The combination of tight labor markets and falling productivity can produce a baseline for inflation which can be tougher and more painful to wring out, a situation the Fed would prefer not to have to face. As a result, while headline measures of inflation caused by energy costs and tight supplies of basic commodities may be on the wane, elevated core measures of inflation seem likely to persist until economic cooling serves to replenish the labor pool -- that is, until the unemployment rate rises somewhat from these levels and inflation slips below... perhaps meaningfully below... the 2% threshold. Until then, the Fed not only will be content to sit and watch and wait for data, but remains more likely to raise interest rates than to lower them.
Forecast
Over the next nine weeks, we've got the typically-dull holiday period
where market activity slows (almost in progress already, now that
Thanksgiving has passed). If Black Friday is any indication, consumer
spending will be fine this holiday season. If history is any guide, once we
pass the holidays and business resumes after about January 5, new patterns
for rates typically form (last year, we were on the cusp of a longish period
of rates rising, for example). From where we sit today, though, rates have
little room to decline with any vengeance, but may slip a little below
present levels before bouncing back upward again. As a result, we expect the
average 30-year FRM to wander between 6.15% and 6.45%, while 5/1 Hybrid ARMs
range from 5.95% to 6.30%.
We'll check back along about the last week of January. Here's wishing you and yours a great holiday season, and Happy New Year.
