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Friday, October 14, 2005

Mortgage Credit News - October 14, 2005

A coulda-been-worse inflation report today gave us a morning-only breather, rates rising again now, as they will continue to do.
Bonds and mortgages on Wednesday broke through crucial levels: the 10-year T-note through 4.42% to 4.49% (higher today), lowest-fee mortgages through 6.00% to 6.125% (a move which Freddie Mac’s survey won’t “discover” until next week).
The overall September Consumer Price Index rose 1.2%, the largest single-month gain in fourteen years, now a 4.7% year-over-year increase. However, the “core” rate, excluding volatile food and energy prices, rose only .1% -- just 2.0% YOY, down from 2.4% YOY in July.
Some have misunderstood the Fed, seeing it in a jawbone offensive against inflation, but not intending to raise its rate much farther because core inflation is under some control. Many others have mistakenly assumed that high energy prices would do the Fed’s work, slowing the economy. Give that up: September retail sales rose 1.1% excluding the collapse in SUV sales, and despite Katrina/Rita. There is some word of accumulating inventory of homes for sale, but no decline in aggregate sales, nor a decline in purchase mortgage applications.
Bonds and mortgages have not adjusted to the very great likelihood that the Fed will go .25% at each of the next three months’ meetings, putting Fed funds at 4.50% by February 1st. At that point, a lot of heavy lifting will have been done for the new Chairman (hope -- pray -- for Ben Bernanke or Donald Kohn), but any new Chairman faces market doubt about toughness, and the only way to demonstrate fortitude is to raise rates. Any flinch by the new Chairman will be interpreted as timidity, or execution of election-year instructions from the White House.
Fed politics aside, I don’t for the life of me know what is different about our economy now compared to 1994-1998, when the baseline for Fed funds was 5.00%-plus (mortgages 8.00%) and I don’t see any reason for the Fed to stop short of 5.00% unless and until the economy slows markedly. Inherent economic strength aside, the grotesque budget irresponsibility in Congress and at the White House is working to stimulate the economy, not slow it.
There are some signs of an energy top: oil is falling toward $60/bbl, wholesale gasoline is down fourteen cents to $1.68/gal, natural gas off almost two bucks to $12.85/hcf, and gold’s retreat from the $470s confirms the pattern. A sudden drop in oil to maybe $45/bbl would remove some inflation heat, but would also stimulate the economy, and a hot-running economy is the Fed’s fundamental problem.

Lagging behavior in mortgage rates is delaying the full effect of the Fed’s tightening. Fixed-rate mortgages are still below the 6.50% highs of the last three years, but the next .75% coming from the Fed is certain to push mortgages up toward 7.00% by spring. However, 7.00% was the low of the 1990s. Nobody knows or can know the level at which housing will crump.
Consumers are calling us, disturbed by the rate increases on their HELOCs, but are reacting to changes at least 45 days old. It seems to take a month-and-a-half for a rise in prime to make it all the way into payments, and consumers don’t have a clue that prime is already 6.75%, going to 7.50% by Presidents’ Day.
ARM indices are rising, T-bill and LIBOR-based ARMs going to the high sixes right now. However, the lagging indices, MTA and COFI, will take a year to eighteen months to fully reflect the Fed. If the Fed stops as low as 4.50%, the whole ARM universe will adjust above 7.00%.
This lagging mortgage action is one of many reasons that the Fed tends to overshoot its proper stopping point, and likely will this time, too.

© Boulder West Financial Services, Inc.

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