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Friday, November 18, 2005

Mortgage Credit News - November 18, 2005

Big doings this week. The tentative signs last week of a top in long-term rates this week turned into a brass band blaring the news.
The 10-year T-note fell as low as 4.45% yesterday, down from the scary top just short of 4.70% only ten business days ago. Yes, mortgage rates are supposed to follow the 10-year, but this time for technical reasons involving hedging of rate risk, fixed-rate mortgages are stuck just north of 6.25%. And, don’t confuse a top with the prospects for a decline, the latter not good.

The change at hand is the shift from fear that the Fed would continue to raise the cost of money from its current 4.00% up to 5.00% or more, open-ended into 2006, to the belief that the Fed is very close to being done. The bond market is telling the Fed that neutral is nigh.
The Fed meets next on December 13, and all still expect 4.25% at that meeting, and most expect 4.50% at Mr. Bernanke’s first meeting on February 1st. This week’s trading has removed thought of the Fed going beyond 4.50%, and has called into question the wisdom of going any further at all; the pattern of rates across all maturities suggests that if the Fed does go to 4.50% it will not be able to stay so high for long.
Pay no attention to prognosticators in this situation because few have done well. Instead, pay attention to the market, the cumulative vote by $30 trillion invested in bonds. Pay attention to two changes in the market: the drop in the ten-year is a big deal, but two other things are bigger. First, the crucial, Fed-predicting 2-year to 10-year spread; and second, the behavior of the 2-year T-note itself.
The 2s-to-10s spread last week broke inside .20% for the first time in this tightening cycle (except for that misbegotten Katrina scare), and this week inside .10% -- at the narrowest, .07%. Mr. Greenspan obscured the importance of a narrow spread with his “conundrum” fog, but traditional analysis is winning out over the Chairman’s this-time-it’s-different: a narrow spread reflects a tough Fed and portends a slower economy. Narrow spreads have always done so, and still do.
The key data this week causing the spread to narrow was cumulative testimony that the housing market is slowing, perhaps abruptly. October housing starts and permits for new construction fell 5.6% and 6.7% respectively; a survey of home builders sank in November to levels of two years ago; surveys of real estate brokers show a sharp decline in contracts written; and several regions report deterioration in the listings-to-sales ratio. Throw in some benign inflation numbers and a visible topping in energy prices, and the-Fed-is-going-to-the-moon psychology has broken for the first time this year.
Really broken. The most extraordinary market move has been the outright decline in the 2-year, down .10% to 4.36%. The 2-year T-note must pay a yield higher than the Fed funds rate because it has two years of risk; the only time the 2-year pays less than the Fed is when rates are on the way down. Specifically, when it’s clear that the Fed has overdone a tightening episode and will have to retreat. The 4.36% 2-year is the brass band: it says the Fed will not go to 4.50%, and if it does will soon wish that it had not.

So far, so good, but we’re a long way from the economic weakness that would cause a Fed reversal, or mortgages back in the fives. Industrial production, capacity utilization, and the job market are all doing fine.
There is a better than 50-50 chance that Mr. Greenspan’s final circus act will be to deliver a reasonably stable economy and rate structure to his successor, inflation risks waning, and housing cooling. He hasn’t been called Maestro for nothing.

© Boulder West Financial Services, Inc.

Friday, November 04, 2005

Mortgage Credit News - November 4, 2005

Long-term rates have risen in a straight line since Labor Day, now more than one-half percent. The 10-year T-note, 4.67% today, has taken out several technical stops without pause, and 30-year low-fee mortgages are at the doorstep of 6.50%.
Bonds were hurt by some fairly strong economic data, and by inflation discussions shifting to a how-bad-is-it competition, but the real damage to rates is coming from the Fed. The light has dawned that wherever neutral was before oil hit sixty bucks, it is higher now. Further, the location of neutral is passing into historical curiosity as the Fed will likely have to tighten past neutral, going as far as necessary to intercept inflation pressure... going until the economy visibly slows.
The Fed’s fingerprints are on the crucial Treasury 2-year to 10-year spread: it’s been steady at a very narrow .20% for four months. Long-term rates are rising because the Fed is bulldozing the whole rate structure upward from underneath; if the bond market thought the Fed wasn’t tough enough, 10s would be pulling away from 2s. However, this .20% 2s-to-10s spread says nothing about high the Fed will ultimately go. The stop signal would be 2s converging on 10s, or rising above.
The first data from October show an economy if anything accelerating from the pre-Katrina pace. The twin reports from the purchasing managers association show manufacturing running hot, above the 59 level, and the service sector in a strong October rebound, to 60 from 53 in September. Same-store retail sales (the measure removes distortion from new openings) soared 4.4% in October.
There is no sign whatever that consumers have been hurt by high energy prices, rising interest rates, or by anything else.
In modest good news for inflation, labor productivity in the third quarter increased at double the forecast pace. However, news this morning that price pressure is moving into wages overwhelmed everything else, including weak growth in the big-company payroll survey.

The fingerprints may be the Fed’s, but mortgages are doing the heavy lifting. The big selling in the bond market this week was mortgage-related: the proud owners of $5.5 trillion-worth of fixed-rate mortgages have to go short bonds to hedge their positions. As one result, this was one of the rare weeks in which mortgage rates rose more than long Treasurys’.
Fixed mortgage rates are now about even with the highs in each year since 2001. How high they will have to go to cut into home purchases... we won’t know until we are there. Classically, a 2.50% rise is necessary to clamp the housing market: in recent examples, from 9.00% to 11.50% in 1989, and 7.00% to 9.50% in 1994. In the Fed’s last cycle, ’99-’00, mortgages went from 7.00% to 8.50%, but the technology bubble-burst collapsed the economy before housing broke.
So far, mortgages are only 1.25% percent above the cycle low, and on theory might have to rise to 7.75%. I doubt it. The anomaly in this cycle (among many) is the role of the adjustable-rate mortgage. In recent real estate expansion phases, ARMs were not important housing-market propellants: short-to-long rate spreads were narrow, and ARMs were no great advantage over fixed loans.
Contrariwise, in the four-year super-cycle now concluded, short-to-long spreads were the widest in a half-century, and ARMs for home buyers bordered on free money. No longer. Rates on five-year hybrid ARMs have almost doubled in eighteen months. Construction money has doubled. Piggy-back seconds, essential to the low-down payment market, have gone from five-something to eight-something.
Especially in the hottest housing markets, these adjustable and innovative products have accounted for more than half of all purchases, and suddenly have no utility at all.



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