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Saturday, January 28, 2006

Mortgage Credit News - January 27, 2006

This has been a big week in the markets, and painful for mortgages. Next week will be bigger, and the odds favor additional discomfort. Mortgages are decisively out of the 6.00-6.125% range; now 6.25%, threatening 6.50% as early as next Friday. The headlines in the last 48 hours have been a maximum-volume garble, guaranteed to confuse clients. The bottom line beneath the noise: rates are rising because the economy is hotter than thought, the market is weary of Treasury borrowing, and the Fed is not as close to being done as hoped. The garble. 4th quarter 2005 GDP grew by a meager 1.1%, less than half the forecast. In what way is that “hotter than thought?” Sales of existing homes plunged 5.7% in December, roughly four times the forecast decline. Hot, huh? Mark Twain said of Wagner’s music: “It’s better than it sounds.” Thus, the economy. The GDP number was suppressed by a string of statistical curiosities: a vestige of Katrina, a decline in business investment not appearing in any other data (December orders for durable goods soared 1.5%), and a bookkeeping “decline” in government spending. The housing market’s overheated regions are slowing, but the link to consumer spending is more theoretical than in evidence; and, this morning’s report of sales of new homes gained 2.9% versus the 1.5% forecast decline. The soft news was suspect, but all the strong data looked real. The market gave great weight to a positive change in a job-market indicator. Each Thursday brings the count of people who filed new claims for unemployment insurance in the prior week. The series is wildly volatile and subject to calendar quirks: you can’t file a claim on a holiday, or during a hurricane, but the line is long afterwards. However, the four-week moving average is reliable, and in January has phase-shifted downward: new claims are running at the lowest level since 2000. If claims are down, layoffs are lower and hiring is stronger. In the bond market, the most-watched single economic datum is the first-Friday-of-the-month payroll report for the prior month. If these declining claims show up next Friday as a surge in January payrolls, we will have a modest explosion in all long-term interest rates. Even if the payroll number is tepid, the financing of the budget deficit will exert upward force. The Treasury does its borrowing in clumps during the year, and during the next two weeks will borrow $112 billion in new cash. Many Republicans are fond of repeating the slogan, “deficits don’t matter”, or advocate “starving the beast” of revenue, or pretend that a deficit-controlling plan is in place. I cannot describe the quiet rage at bond-trading desks (heavily populated with Republicans) when one of these official lines scrolls across screens. Then there’s the Fed. Whee. Inside the GDP report lies the definitive measure of inflation: the “core personal consumption expenditures deflator.” The 4th quarter PCE jumped from 1.4% to 2.2%, which $65 oil will do to you. Aside from all that eyewash about Mr. Bernanke having to prove how tough he is, the Fed must err on the side of fighting inflation. The only thing separating us from a very bad bout of oil flu has been globalized labor keeping wages under control. Hopes that the Fed would stop at 4.50% on Tuesday are gone, and 4.75% in March and 5.00% in May are better bets. Now the perverse part. In the traditional slowdown cycle, housing is early to fade, and employment is the last to let go. Tradition is shaping up nicely. The more resilient the economy, the tougher the Fed has to be, and the more likely and deep the slowdown ahead -- and a downward reversal in long-term rates. Later... later. There is a chance that the Treasury’s borrowing is the strongest force in play right now, and will abate during the concluding week, about February 8. In the meantime, duck.

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