The HSH Two-Month Forecast for Mortgage Rates
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July 23, 2010
Preface
A stumbling economy, the continued influence of euro-zone troubles, and no signs of significant improvement on the horizon have helped mortgage rates drift to 50-plus-year lows. A world awash in capital (and too afraid of financial risk to do much with it) has had some beneficial effect, but still-tight underwriting standards and a largely sated pool of potential borrowers means that even these record-low interest rates can offer only limited benefits.
Housing markets and demand dynamics remain distorted, due to the end of federal tax incentives and existing loan failures. With financial-market overhaul now the law of the land, we are about to enter a new age of re-regulation which promises to muddy up the already-murky waters of calculating risk and receiving reward. Until new clarity about the structure of finance and mortgage markets comes, it will be hard to expect any improvement beyond those at the fringes of the market.
This leaves us in a difficult state. The FHA program is serving as many prime and near-prime borrowers as it can at the moment with pretty liberal underwriting requirements. That said, for millions of potential borrowers, most notably the 25% or so of homeowners who are underwater, low interest rates are little more than an attractive nuisance, as unattainable as selecting winning lottery numbers.
The inability of these homeowners to refinance to lower monthly payments, or to sell and move on, is keeping the housing market from moving forward. Wherever the market goes from here, this is the audience most in need of support -- and not only if a borrower cannot make today's payments. The billions we have already spent and continue to spend to prop up failing borrowers might better have been spent to at least attempt to address this issue. We know of no such program even in the planning stages, and fear that without one, the housing market faces a long uphill climb back to normalcy.
Which alternative is likely to be the most cost-effective: helping a borrower before they fail, incurring a greater loss when a borrower 'strategically defaults', or cleaning up after a borrower's financial catastrophe?
Recap
Back in May, we looked ahead and expected an improving outlook for the economy, and that the late-spring euro-panic would have settled behind us to some degree. Absent a new crisis, mortgage and underlying interest rates seemed most likely to us to be on a firming trend during the forecast period. This did not occur, as we underestimated to some degree the depth and breadth of the mess overseas, and failed to fully account for downgrades to first quarter growth and diminished prospects for a better economic climate.
We expected that HSH's FRMI would trend in a range between 5.17% to 5.5%, but instead got a lower range of 4.98% to 5.17%, with the lowest rates occurring late in the forecast period. We fared little better with 5/1 ARMs, calling for a 4.2%-4.5% run which got pushed aside by a 3.98% to 4.28% gap, but at least our expected 30-basis-point range was right. For conforming 30-year FRMs, we believed that those boundaries would be 4.85% on the low side to 5.35% on the high, but got a 4.69% to 4.93% set of bookends instead.
This last go-round was clearly not our finest forecasting moment.
Of course, this has been a challenging year, so much so that we took a few minutes to update and expand last December's 2010 Outlook. We updated our mid-year review a couple of weeks ago, and we seemed to fare a little better in the longer-range department, at least so far.
Forecast Discussion
With a newly-sluggish period of economic growth upon us there have come questions about the durability of the economic recovery. Much of the initial effect of Federal stimulus will wear off in the next few months, and the rebuilding of stockpiles slashed in the "Great Recession" seems to be nearly complete. This leaves us in a lackluster climate at best for the forecast period and beyond, searching for a mechanism which will promote a transition to a consumer-led recovery.
In addition to the "underwater" discussion above, housing markets rely upon a number of concurrent factors to generate fresh economic heat -- and several are missing from the equation at the moment. Chief among them is steady employment growth, the kind which produces a paycheck which increases over time; as well, and as an expression of commitment against future conditions, a home purchase requires a level of confidence sorely lacking today. It requires reasonable home prices and accessible finance markets with moderate interest rates (affordability). Presently, only some of these conditions exist.
As long as the employment market continues to be weak, housing will struggle to recover, and it doesn't appear that there is a political solution to promoting hiring in the near-term cards. More fiscal 'stimulus' spending is politically unpalatable in the present election-year climate, and the Federal Reserve has few unused tools at its disposal to promote job growth. In fact, the Fed's chief monetary policy tools are fully in play at the moment, and both short- and long-term interest rates are about as low as they can go, but low rates cannot produce much growth on their own. Attaining growth requires those who have access to utilize cheap financing avenues to take risks in expanding production and hiring, which is less likely to happen in muddy regulatory waters.
This being the case, the housing market is about as strong as it is going to get for at least the foreseeable future. Once we get past the tax-induced distortion in demand we'll have a better sense of where we are, but it is unlikely to be anything more than a weak level. To help it move forward, we will probably need a combination of additional supports in the form of "underwater" borrower help, job growth and perhaps even new tax incentives to help foment demand.
Soft growth in both the economy and housing means low interest rates are likely to persist for a much longer time than anyone might have originally expected, and certainly though the forecast period.
Forecast
This forecast takes us though the remainder of the summer doldrums an into a period of the year where activity begins to quicken. Given the starting point for mortgage interest rates, which are at extraordinarily low levels it's even harder this time than last for us to expect measurable declines in rates. That said, we have been wrong before, including last time, and we must acknowledge the possibility that even though at record lows that mortgage rates might move lower still.
For the first time in HSH's 31-year history, our combined FRMI has dipped below the 5% mark, and we recently reckoned rates at approximately 1956 levels.
The economy is weak, confidence is waning and there doesn't seem to be a viable solution to promoting recovery -- except time. This suggests a slow-growth, low-rate period for the remainder of the summer. The flight-to-safety which has fostered low interest rates might wane somewhat, especially if stock markets can find some footing, but probably will not press rates upward by much during the forecast period.
During the next nine-week period, we think that our FRMI will travel in a range from perhaps 4.83% to 5.15%. At the same time, the combined average for a Hybrid 5/1 ARM may run in a 3.72% to 4.15% channel. Conforming 30-year FRMs? As unbelievable at it may seem, we expect a working for rates between 4.5% and 4.88% for the period.
Summer will be closing when this forecast does. To be honest, we'd actually welcome higher interest rates, since this would mean a growing economy and improving prospects for many folks.
A very long-range note: While admittedly well off into the future, we are starting to become concerned about housing market conditions when mortgage rates ultimately do start to increase. How will borrowers, accustomed to rock-bottom rates, deal with rates when they approach five- or ten-year norms which are on either side of the 6% mark for conforming 30-year FRMs? What will become of demand and affordability, and hence, home prices? We won't find out anytime too soon, but inevitably will, in perhaps 2011 or 2012.
May 17, 2010
Preface
Even though explicit Federal supports for the housing and mortgage markets are now behind us, euro-zone financial troubles combined with a slow recovery are serving to keep underlying interest rates low. Coupled with residual benefits of the Fed MBS and Fannie and Freddie buyback program, mortgage rates -- which were already low -- have been driven even lower, and are comparable to the lowest levels the economic downturn produced.
But are low rates durable at these levels? How long can the economy grow before the Federal Reserve feels compelled to begin to raise short-term rates above the emergency levels at which they still stand? How quickly and permanently will the European Central Bank (ECB)'s trillion-dollar support package solve Greece and other countries' debt troubles? Will the austerity measures sure to follow in these economies curtail economic growth here, lengthening the return to a full recovery?
There are always a number of questions which need answering when we write each forecast. The ones above are trickier and more complex than most, and most of the answers are likely to be murky, at best. At the same time, American housing and mortgage markets are in a transitional phase from fully Federally-backed to more private-market oriented, and the uncertainty of financial market reform overhangs everything.
Recap
Back in March, we speculated that rates might move up somewhat as the Fed program came to an end, but that there wouldn't be major effects. As such, we forecast that HSH's FRMI would wander between 5.25% and 5.60%, and we hit the range pretty well, as that overall indicator of fixed-rate mortgages trended between 5.27% and 5.49% during the period.
For followers of 5/1 ARMs, we must offer an apology. Due to an editing glitch, we inadvertently repeated the range for the 30-year FRMI in the slot for the 5/1 ARM. If that was the actual forecast, the 5/1 would have had to rise by nearly a full percentage point! According to our notes, the range expressed should have been 4.25% to 4.60% -- and rates bounced between a low of 4.30% and a high of 4.52% over the nine week period.
We also offered a 30-year conforming-only outlook, expecting a 5% to 5.40% gap between high and low. We got a 5.27% high and a 5.03% low for the period, so we were pretty good in our estimation.
Overall, we'll call the last forecast a success.
Forecast Discussion
We'll try to answer the questions we posed above, starting with the Federal Reserve. Up until the Greek economic crisis exploded onto the world financial stage, we were pretty convinced (if in the minority) that the Fed would lift interest rates mildly as soon as the late June meeting. We believed that this would be the case since June would represent the end of the fourth quarter of positive GDP readings, some of which have been very solid. If the economy is no longer performing at very sub-par levels, there is little need to continue emergency-level interest rates. In fact, doing so carries risks of its own, and the Fed could make an easy case that improving conditions warranted the change. As the Fed Funds target is now between 0% and 0.25%, they could simply formalize the target as a quarter-percentage point, a subtle but clear change in policy. However, in light of the troubles in the world, the Fed's first move has probably been bumped down the road a bit, with August possible but October a more likely date for the first change in "policy" in years. In this estimation, we still remain firmly in the minority, but even with inflation still at bay and plenty of labor market slack, it would be better for the Fed -- and a confirming signal in the strength of the recovery -- to start to adjust policy sooner than later.
However, part of the reason for holding off is that there is no easy way to discern if the ECB (and other central banks') moves to address the euro-zone debt crisis will do the trick. While financial markets can be papered over with enough cash to calm them (at least temporarily), the social unrest related to any government austerity moves makes needed fiscal reforms by those governments a significant challenge. To the extent that the crisis persists, global investors are likely to continue to flock to investments as close to risk-free as they can find, leading them back to US Treasuries as a safe haven for their funds.
t the same time and no matter how marginal, any slowdown in trade will serve to slow the expansion both here and in other economies around the world. Domestic growth has already settled somewhat, easing from a hot 5.6% rate in the last quarter of 2009 to 3.2% in the first of 2010. The present estimated growth rate is certainly a fair pace, but insufficient to engage the millions of under- and unemployed people seeking work. If growth slips further, or fails to accelerate, the expansion will continue to be a jobless one, making it even harder to achieve full recovery here.
All this and the added political uncertainty of financial market reforms, too. On the one hand, rates should be pressured lower; on the other, lending standards seem unlikely to loosen very much, since doing so would expose a lender to both market and political risk.
Forecast
We begin this forecast period at an unexpected place: rates at the lowest levels since late 2009. This being the case, we're hard pressed to find a reason to believe that interest rates might go significantly lower over the nine-week period just ahead. Without a new and even larger global market panic, they simply cannot -- and even that happened, a fresh rush into Treasuries seems unlikely to produce any serious downdraft in fixed mortgage rates.
That being the case -- starting at the bottom -- we do believe that there's only one way for rates to go over the forecast period: Up. However, the issues identified above are a considerable drag on any upward momentum, and it seems likely to us that when they do rise, they probably won't go that far... at least during the period covered by this forecast.
At the same time, the mortgage market will continue to move slowly away from the beneficial effects of the various support programs. So far, things seem to be transitioning about as well as can be expected, but as these lingering effects begin to wane, pressures will ultimately build for rates to rise. Meanwhile, the challenges of a still-flailing housing market remain with us, with soft sales, foreclosures, loan modifications and losses all to be considered in context.
Over the next nine weeks, we think that the overall average for 30-year fixed-rate mortgages tracked by HSH's Fixed-Rate Mortgage Indicator (FRMI) will run in a range from 5.17% to perhaps 5.5%. The 5/1 ARM is expected to find low and high borders of 4.2% and 4.5% between now and mid-July. Conforming 30-year FRMs? 4.85% to 5.35% for the period.
Summer will be nearly a month old when the next review is due. Between the pool and the beach, why not drop back in to see how we did?
March 8, 2010
Preface
We delayed this forecast for a little while beyond its original date, simply because we wanted to have a little more time to think about the shape of the coming mortgage market, especially as it pertains to the coming "spring homebuying season."
The housing market is still seriously challenged, and the expiration of certain supports adds in a number of variables which wouldn't normally need to be addressed in our forecast. However, these supports have become quite material to the recovery of housing and the ability of American households to re-cast their balance sheets. Their introduction produced distorting effects in the market, both beneficial and detrimental, and their disappearance will likely do the same. The question is, "To what degree?"
Nearly 16 months ago, the Federal Reserve announced a program to purchase mortgage-backed securities in the open market which had the effect of driving down interest rates to record-low levels. That program was joined by the Treasury, which also kicked in a couple of hundred billion dollars to reinforce the Fed's work; the Fed also purchased billions in Treasuries and Fannie and Freddie-issued debt to ensure low financing costs all around.
During the last year, Congress provided up to $8,000 in tax credits for homebuyers to help spur demand. Initially limited to "first-time" purchases, the original program expired in November but was revived and expanded to include $6,500 for certain trade-up folks, too.
Recap
Our December forecast called for a working range for interest rates to wander in a range about 35 basis points (0.35%). We expected that the range for HSH.com's Fixed-Rate Mortgage Indicator (FRMI) would trend between 5.10% and 5.45% during the period. The actual range was tighter than that, with just a quarter-percentage point difference between the high and low values. However, that range was biased to the high end of out expectations, with the FRMI running between 5.34% and 5.59%. However, for the second period in a row, our outlook for the 5/1 ARM was fairly on track. The wandering range for the product was actually just 37 basis points (0.37%), with a low value of 4.48% and a high value of 4.85%, both fairly close to the boundaries we forecast.
The high-end bias for both of these kinds of loan all happened at the beginning of the period, when a cascade of new government debt overwhelmed holiday-thinned investor demand for such product.
Forecast Discussion
Since the last forecast, several new mechanisms have been introduced which will significantly influence rates and markets in the coming weeks. Six days after the last forecast was released, a late Christmas Eve announcement came that Fannie and Freddie would essentially be allowed to incur unlimited losses and eased portfolio size restrictions for the two GSEs. The expansion of portfolio holdings and available cash resulted in a program announced in mid-February where up to $200 billion in delinquent loans will be "bought back" from investors.
The combination of these events means several things. First, although the Fed will be moving out of the MBS investment business, Fannie and Freddie can balloon their portfolios of holdings. This means the process of sponging up excess supply of MBS (by the Fed) will be replaced by a process which instead limits how quickly securities come to the market, providing a different (though effectively equivalent) sponge. As such, rather than the process of lenders originating loans, then selling them to the GSEs, which in turn sold them to the Federal Reserve (and any other takers, of course), this new arrangement means that Fannie and Freddie can accumulate loans or securities on their books without needing to dump them into the market all at once; instead, they can mete out supply to the market, providing a stabilizing effect on interest rates.
At the same time, the re-purchase of up to $200B of bad loans from investors should produce some gaping holes in investor portfolios, which will need to be refilled. "Fixed-income investors" -- those who purchase bonds -- may have only a few choices of where to invest funds, with MBS among them. Faced with a handful of cash, it's reasonable to expect that at least some of the funds will buy new MBS from Fannie and Freddie. The repurchase program will spark fresh private demand for securities, which will help to offset the Fed's influence in the market.
As a result of all of this, we think that the transition away from a Fed-dominated mortgage market will be smoother than we expected way back at the end of last year when we wrote the last forecast and put the finishing touches on our 2010 Outlook.
Keeping mortgage rates low is a key issue for the housing market. "Affordability" is the balance between a home's price and the "carry cost" generated by price of financing. If one rises, the other necessarily declines until balance is restored. In this way if mortgage interest rates rise, home prices may need to decline in order to produce the same affordable monthly payment.
While the interest rate isn't the only consideration when buying a home, and a minor rise in rates won't ruin homebuying plans, it could put additional pressures on home prices at a time when they are just starting to find solid footing in many marketplaces. Of course, the other factor which spurs home price increases is rising demand, which has been tough to produce in a difficult economic climate. One bit of assistance has come with the homebuyer tax credit, which has served to produce some additional demand in the market, but created distortions in sales patterns late last year. With that program essentially coming to an end in late April (deals need to be signed by then and closed by late June). We think that there will be significant political pressure to again extend the program at least through the spring season as there is demonstrable evidence that the program is providing important support (see last October and November's spike in sales) and the simple fact that if the program isn't being used it costs the government nothing.
If we are correct, and the above factors come to pass, we should have a Fed-to-private-market handoff with much less disruption for interest rates, coupled with perhaps a bit of seasonally-firming demand for home sales, spurred on by incentives which will be gone at some point.
Forecast
Way back in December, we considered the entirety of 2010 as a whole, and especially the delayed end of the Fed's MBS program. At that time, we thought planning for a half-point rise in conforming 30-year fixed rate mortgages might be a prudent stance. In light of what's outlined above, we think that there will be less disturbance in rates than that. The shift from a guaranteed public influence in the MBS market to one more dominated by private interests will bring some uncertainty, and that uncertainty -- risk -- will influence interest rates to at least some degree. Even a small rise in interest rates will seriously curtail refinancing activity; this means, however, that there will be fewer loans for Fannie and Freddie to accumulate, so less supply of MBS will come into the market at a time when demand should be increasing to some degree... all of which should serve to temper any rise in interest rates. There are a lot of intersecting factors here which need to all occur simultaneously, but we think it will all work out fairly well.
If everything works as planned, we think that the next nine-week period will see HSH's overall FRMI trend between an average rate of 5.25% to perhaps 5.60%. At the same time, the overall 5/1 ARM will likely wander from perhaps 5.25% to 5.60%. Although we don't usually provide an outlook for conforming 30-year fixed rates by themselves, we'll wing it a little this time, and call for a 5% to 5.40% range over the next couple of months.
Early-mid May's the expiry for this forecast. Stop back and see us!
December 18, 2009
Preface
Mortgage rates remain quite favorable, thanks to a gently improving economy and the push-back of the end of the Fed's mortgage-backed securities program to March. Absent that move, we'd probably be talking about very rocky market conditions right now, instead of the smooth and familiar ones which exist.
Economically, we've technically ended the recession, but troubled labor and housing markets remain. The administration is strongly pushing lenders to conduct more loan modifications, but there are concerns that these measures are merely pushing foreclosures, and the associated impacts on home inventories and home prices into next year, additionally challenging the market even as supports for it begin to disappear.
With improving banking dynamics, the discussion in the last forecast about how improving fundamentals means lower risks for lenders -- and lower interest rates as a result -- does seem to be continuing. Perhaps the best reflection of this can be seen in the rates on non-government- supported, private market 30-year fixed rate jumbo mortgages, which moved into four-year-low territory during the last forecast period. As lenders become more solvent, their ability to support the mortgage market should improve. That said, the fully-government-insured FHA program, virtually risk-free to lenders, is garnering a huge amount of market share, so it's clear that things aren't all that great just yet.
Recap
Our October forecast called for a wider range for rates than we actually got, and stable-to-declining rates helped foster a lot of refinancing activity. We expected that the overall 30-year fixed rate mortgage average would trend from 5.60% to as low as 5.15%, and we certainly well covered that range as rates actually held between 5.45% and 5.24% during the period. Our expectation for the overall 5/1 ARM average was right in the sweet spot as well, dead center in the middle of our expected range of 4.85% to 4.40%, and the actual range was 4.69% to 4.56% -- 16 basis points from both the top and the bottom. We'll call the last forecast a success amidst what ended up being a gentle period for rates.
Forecast Discussion
As we write this, 2010 is fast upon us. It occurs to us that 2009 was all about promoting stability for money, mortgages, and financial markets, and we expect to largely enjoy those conditions for a little while longer yet.
As we write this, 2010 is fast upon us. It occurs to us that 2009 was all about promoting stability for money, mortgages, and financial markets, and we expect to largely enjoy those conditions for a little while longer yet.
That said, we can't help think about what lies ahead. This forecast will expire in late February, and we'll likely be starting to feel the nervous effects of the coming expiry of the Fed's MBS purchase program. If the economy is still moving forward at that time, renewed concerns about Fed "exit strategies" and potential inflation may again resurface, adding additional uncertainty to the period. At some point, the short-term interest rate the Fed controls will be need to be lifted, and that day is getting closer, even if it may still be months away.
Between then and now, there are some normal end-of-year and beginning-of-year "seasonal" effects in play, including slowing demand for credit and quieter market activity in general. Of late, rates have firmed a little bit as underlying interest rates have trended higher, most likely due to investors trying to lock up profits for the year, or preparing for new strategies in 2010. As the holidays fade, market activity will again quicken.
As there is already plenty on the regulatory plate, we expect no brand-new government initiatives during the period (excepting perhaps ongoing tweaks to loan modification programs), but previously-enacted reforms do begin to come into play, notably changes to the Real Estate Settlement Procedures Act (RESPA). New, more explicit documentation will be provided to borrowers when they apply, and lenders are scrambling to make sure they are in compliance with the new regulations. We may also see a more considerable battle forming as the new Consumer Finance Protection Agency (CFPA) starts to take shape.
Increasingly, we expect to see the markets act closer to whatever passes for normal these days, reacting to signs of economic health (or lack thereof) and price pressures. The watchful eye and steady hand of the Fed will still be evident, but we're left with the sense of them quietly backing away as we progress forward, like a parent helping a child to ride a bicycle without training wheels for the very first time.
Forecast
In this environment, tethered by the Fed and government support, movement in mortgage rates should remain muted. Conforming 30-year FRMs have been hanging just over or under the 5% mark for months now, and that should largely be the case (although just over 5% seems most likely in the coming period).
From present levels, no potential borrower should expect significantly lower rates, as the economy has largely stopped worsening and there are a growing number of sporadic clues that the economy is actually improving. Even with easing risk premiums being built into rates, those falling rates and an improving economy are at odds with one another, and if you want one you're unlikely to get the other.
We're not prepared to call for the end of record-low mortgage rates just yet. We visited those bottoms during slow-demand or panicky periods a few times in 2009 (most recently due to a technical default of debt issued in Dubai) but absent those kind of unknowable events we will probably remain above the bottom of the bottom for rates.
This being the case, we're pretty comfortable generally working in the ranges described for the October forecast, but, given the expected relative stability of the market will tighten them up a little bit. For the next nine-week period, we expect the overall average interest rate expressed in HSH.com's FRMI to trend from 5.10% to perhaps 5.45%, while the overall average for 5/1 Hybrid ARMs should wander in a range of perhaps 4.40% to 4.75% between now and late February.
If you are considering refinancing or hope to buy a home in 2010, you really should be getting those transactions underway shortly.
It'll be late Winter when this forecast expires. Will markets still be frozen, or will global financial warming be coming into play? Drop back and find out.
October 16, 2009
Preface
We admit to a bit of surprise that Conforming mortgage rates have moved to approximately the lows of Spring, and that they've dragged jumbo rates down to about four-year-low levels. The economy does seem to be in a firming pattern, housing markets have improved somewhat, and government support programs will all contribute to a "technical" economic recovery which appears to have gotten underway in the third quarter.
Perhaps we shouldn't be all that surprised that rates have eased. Prior to the last Two-Month Forecast, we speculated in the August 7 HSH Market Trends that it was just possible that an improving economy would produce lower, rather than the typical higher, interest rates for at least a time. In that discussion, we noted:
Turns out that this might be exactly the case. The minutes from the Fed's September 22-23 meeting noted that "Yields on nominal Treasury securities also decreased since the Committee met in August. A decline in implied volatility on longer-term Treasury yields suggested that some of the drop in yields was due to reduced risk premiums." Further on, they noted that "Given the improved economic prospects, the decline in longer-term Treasury yields and the apparent marking down of the implied path for the policy interest rate were seen as somewhat puzzling" but probably due to excess bank reserves, reduced inflationary concerns and lower term [risk] premiums in a more settled economic environment.
It's worth noting that there are limits to how much improved fundamentals can influence rates downward, especially for conforming loans. Aside from low nominal interest rates, conforming spreads against 10-year Treasuries are near recent historical norms, and jumbos, though still elevated, are approaching spread levels half of their December peaks. To the extent that "spread compression" has run its course, the less excess spread there is to absorb any increase in underlying interest rates. Improving economic fundamentals, coupled with dwindling Federal support programs for mortgages and Treasuries will serve to foster firmer interest rates at some point, perhaps sooner than later.
Recap
For our last forecast, we believed that our Fixed-Rate Mortgage Indicator ((FRMI)) -- an average inclusive of conforming, jumbo and "expanded conforming" loans -- would wander in a range between 5.93% and 5.5% for the period. While our choice of gap was pretty close, it occurred in a much lower interest rate range, as that benchmark rate walked between 5.73% and 5.34% over the nine-week span. The FRMI's 5/1 Hybrid ARM counterpart downshifted even more strongly; we called for a 5.30%-5% range, but the actual was 5.04% to 4.67%. With the significant decline, there seems to be a growing viability in the use of certain ARMs by homeowners and homebuyers seeking good stability at rock-bottom rates.
Forecast Discussion
Amid an improving but uncertain economic period, forecasting is even more of a humbling art than usual. Complicating this particular period is the still-significant influence of government policies into the credit and housing markets. Precisely how will the government extricate itself from private markets, and at what speed? How wide-ranging will be the effects of expiries and discontinuations of certain supports, and what are their influences on the economy as a whole? Are the private markets ready to assume a more substantial role? How much influence does the specter of a potential cascade of new regulations and regulators to govern those markets influence the direction we move in? Frankly, there are far more questions than answers, and that doesn't even include any about the prospects for economic recovery. Some of these questions and issues will likely become recurring themes in the next few Two-Month Forecasts, too.
Perhaps its best to start with some "known knowns." The Federal Reserve's $300 billion program for purchasing certain long-dated Treasury Securities comes to a close at the end of October. The loss of a significant buyer in that market -- a sponge to absorb excess issuance, if you will -- may have only a minor effect on rates, since there has continued to be a strong appetite by investors for 100% guaranteed obligations. Still, the loss of that buffer at times of high supply levels of debt could add some additional volatility to rates at times.
To the extent that the $8,000 tax credit has goosed home sales, we would expect a falloff in sales when it expires in November (as witness "cash-for-clunkers," but to a much lesser extent). This matters in the regard that such slower sales would mean a falloff in the volume of mortgages issued, and in turn, somewhat lower volumes of mortgage-backed securities to be absorbed by another Fed program as well as the market at large (not that demand there is all that great at the moment).
That MBS purchase program was recently extended by the Fed, not in terms of how many securities it will buy but the length of time in which the program will operate. Originally slated to expire at year's end, the program will now run until the end of March 2010. In our view, this is an expression by the Fed that it doesn't believe that private markets will be ready to accommodate the $100 billion of MBS every month which the Fed has been acquiring. The slowing of the amount of MBS purchases by the Fed over the forecast period (and beyond), and the corresponding effect on mortgage rates is a key test for the markets... and a source of great uncertainty.
New financial regulatory structures are in the early stages of formation and won't be in place during the forecast period, but it's reasonable to expect that concerns about them will be on the rise. Uncertainty -- in the form of political and regulatory risk -- influences not only the price of credit but the availability of it as well. Until it becomes clearer how much more stringent the lending environment will become, lenders (and improving capital markets) will probably keep more to the sidelines than they would coming out of a more "normal" recession, tempering access to credit and potentially fostering "defensive" pricing reactions by the market. The recent changes to credit card legislation are a good place to see that happening in real time.
All the foregoing is to simply note that there are many factors which will twist and turn the market, pushing it and pulling in different directions in the weeks ahead, and not all of them are economic concerns. As far as the recovery goes, we expect that it will be a muted affair -- a technical recovery -- as GDP is boosted by some rebuilding of depleted inventories amid a modest recovery of final consumer demand. Jobs and income growth will lag, and that will keep forward momentum at a minimum (all while serving to help keep inflation at bay, for now).
Forecast
With rates at multi-year or near historic "all-time" lows, it's unreasonable to expect that they have considerable space to decline, especially in the face of a modestly improving economic climate. If the near decimation of markets earlier this spring coupled with some truly bleak outlooks couldn't push them much lower, this climate is unlikely to, either. However, improving risk fundamentals and investor appetites, muted economic growth and low prospects for inflation should serve to keep a lid on any serious increases, too. The bleakness of Spring drove rates down; the euphoria of Summer (and inflation worries) drove them back up. The Autumn seems to have a sense of reality about it, and an improving sense of optimism about tomorrow's economic prospects.
Somewhere between those two extremes of Spring and Summer is where we'll probably find ourselves for the remainder of the fall. That being the case, we expect the FRMI to likely wander in a range from perhaps 5.15% to perhaps 5.60% over the next nine week period. Its 5/1 sidekick may probably have some additional room to slide, so we think a range of 4.85% to 4.40% is probably in the cards.
The next forecast is due a little before Christmas. Here's hoping that our view of the future turns out to be a "present."
August 10, 2009
Preface
Growing optimism that an economic recovery is coming soon has served to put a floor under mortgage rates. At the moment, it would be difficult to see a return to average interest rates in the upper-4% to low-5% range unless either a new financial panic breaks out or there is a steep decline in equity values to drive them back down to those levels.
Supports put under the economy and financial markets are doing their job, but there is precious little forward momentum, "stimulus" or not. It is safe to say that things have improved from their worst levels, but whether they can continue improving (or can improve with any sort of speed) is still the big question.
As we grind toward economic flatline (0% GDP), we continue to look for signals that a self-sustaining recovery is forming. Unemployment remains very high, consumer incomes and borrowing continue to decline, and one-time or short-term boosts (increases in Social Security payments, the "Cash-for-Clunkers" program, $8,000 "first-time" homebuyer tax credits, etc) lack lasting impact and may actually damage prospects for future upswings in activity. Additionally, the "stimulus" which has yet to be spent will promote money into narrow channels of the broad economy. Measures of consumer confidence have risen off their worst levels, but remain mired in rather dark territory.
We can't help being struck with the notion that "Just because things aren't getting worse, it doesn't mean they are getting better."
Recap
For the last forecast period, we expected that HSH's Fixed-Rate Mortgage Indicator ((FRMI)) -- an average inclusive of conforming, jumbo and "expanded conforming" loans -- would range from a low of 5.30% to perhaps 5.72%. We marched well above that range shortly after the forecast was released, topping out at 6.04%, only to drift back to a low of 5.66% during that time. Our expected range of movement was pretty good, but rather than moving to the lower end of the scale, we moved to the upper side instead. That was approximately the case with the FRMI's 5/1 Hybrid companion, which we thought would cover a 5.30% to 4.85% range. As with the FRMI, we did blow past the top somewhat (5.44%) and failed to get as low as we expected (5.07%). Almost all of the flare higher was due to a much-better-than-expected May employment report, an optimism which faded in subsequent weeks.
Forecast Discussion
As mentioned above, we keep looking for clues of a building momentum --the sort which would promote what might be called a "V"-shaped recession, characterized by a sharp downturn but an equally fast rebound. At present, it doesn't seem to us that there is any sort of 'letter' forming -- not V, L, W or U -- which describes the sort of recession/recovery we are having or are likely to have.
The economy was in a slow fading pattern prior to the breaking of financial markets last fall. We had been shedding jobs for months, a gentle bleeding which resulted in a 0.5% decline in GDP in the third quarter. High energy prices were sapping consumer spending strength, and housing was in quite a mess. Absent the collapse of capital markets, we probably would have seen a deepening recession in the fourth quarter of 2008 and the first of this one anyway, but far shallower than the -5% and -6% figures which occurred. The additional damage caused by that break continues to vex efforts to stimulate demand, with additional job losses and tighter access to credit chief among the issues.
For all of the noise being made in housing markets, with both new and existing home sales on an upward path, it's instructive to remember that present levels of new home sales are at about 25% of their peak, while existing home sales are at perhaps 60% of their top levels. Since those were unsustainable levels, it's a solid fact that we have a long way to go just to get back what pre-boom 'normal' levels were.
Building forward momentum requires more consumer spending. Trouble is, unemployment remains high and likely will for some time as we trend toward nearly double what is believed to be the naturally occurring rate of unemployment. Until employment moves measurably higher there will be little to foster a steep incline in economic growth, leaving at best a trend of gradual, moderate improvement. There's little more the Fed can or will do to goose economic growth, and present fiscal policies being pursued by the Administration favor government borrowing and spending of funds. This makes the stimulative power of returning money on a widespread basis to consumers (taxpayers) via marginal or payroll tax cuts unlikely; moreover, even without factoring in massive new spending plans, near-term tax increases are much more likely than decreases, which will be a drag on economic growth.
We've also again begun to watch the price of oil, which seems to now be tracking in lockstep with the stock market. Oil prices firming from the mid-$30/bbl to about $70 hasn't had much effect of yet, but rising gasoline and energy prices also act as a drag on economic growth, not to mention fomenting increases in the cost of just about everything should they become persistent.
We're not trying to sound pessimistic, only realistic. With uncertain demand forming, businesses might not hire as quickly as they have in the past, and some of the jobs lost during the downturn won't be coming back anytime soon, if ever. If we can't additionally stimulate via monetary policy, can't better stimulate via fiscal policy, and can't promote widespread consumer spending via tax policy, the recession will end, but improvement will probably be a grind higher... a process, rather than an event. That being the likely case, we may wander on either side of a pretty flat economic line for some time to come yet.
Forecast
The closing of Summer and beginning of fall usually sees a change for rates, from one of a dull pattern to one with more snap to it. For the most part, that has often meant a modest overall decline in mortgage rates, as perhaps the waning optimism of Summer has become the colder reality of Autumn. Even if firmer of late, rates remain well below last year's level at the start of this forecast period.
Economic activity should continue to nudge higher over the next nine weeks. We expect that as moderately better numbers are revealed, discussions of when the Federal Reserve will raise interest rates will begin to surface. They won't feel compelled to do so anytime soon, probably not until very late this year or early next at the very earliest. Even when they do, short-term rates will still remain well below normal for a long while.
Mortgage rates, on the other hand, seem more likely to be driven in a "start and stop" fashion. The backing and filling of rates after the late Spring run up has left us above "credit market crisis" levels, but well below even year ago marks. As we write this, optimism has pushed mortgage rates back toward the top of recent ranges, but it'll take a much stronger economic showing to push us higher.
For the next nine weeks, this recent start and stop pattern seems likely to leave us pretty rangebound. Our guess is that a range of perhaps 5.93% as a high to perhaps 5.5% as a low is the most likely to be seen. The 5/1 ARM should see a tighter window of perhaps 5.30% to 5% or thereabouts.
It'll be just about Columbus Day when the next forecast and recap comes due. Drop back and we'll see if our realism has been upended.
May 29, 2009
Preface
Although there seems to be no imminent turnaround in the economy, the trajectory of the recession has flattened out and perhaps even lessened somewhat. Home sales -- if not prices -- have bottomed and mortgage markets are functioning in a more stable atmosphere. Capital-impaired lenders have found a fair response as they start to raise "stress-test" required capital, and financial markets have stabilized and perhaps are performing a bit better. It is in this trough, from this platform, which we will begin to build out the next growth phase of the economy.
That may yet be a while, since even getting back to even 0% GDP will require a much stronger bit of momentum than the economy seems to have at the moment. Still, an outlook for a recession with waning severity is far better than one where we're still peering into a dark abyss.
However, significant challenges yet remain. It appears that the worst may be over for job layoffs, at least as far as initial weekly claims go, but the ranks of those receiving benefits continue to grow. Real improvement in hiring may not happen for as long as six months to even a year from now, and a high jobless rate remains an impediment to any strong resumption of growth. After the cacophony of crashing markets during the last two, it seems that it is shaping up to be a considerably quieter Summer this year.
Recap
Overall, improving mortgage rates surprised us somewhat. We expected our overall market gauge -- HSH's Fixed-Rate Mortgage Indicator -- to wander between 5.55% and 6%, but actually got a lower and more muted 5.69% - 5.43% range instead. The FRMI's 5/1 hybrid counterpart actually improved rather more than that; we expected a 5.85% to 5.37% range, but got a 5.42% to 5.05% one instead. There's little activity in ARMs at the moment, but as at least some risk appetite by lenders returns, there may be better opportunities for borrowers who might want a shorter fixed rate period, particularly for jumbo borrowers.
While we didn't provide a specific forecast for conforming borrowers, we expected rates to remain below 5.5% -- perhaps even as low as 5.18%. With the Fed weighing into the market with another $750 bilion in MBS purchases and additional supports for Fannie Mae during the forecast period, it's little wonder that rates moved past our supposed bottoms to hang right around the 5% mark. As we thought they might, Jumbos continued to improve, and have shed nearly 160 basis points (1.6%) from their late October 2008 highs amid better levels of liquidity.
Forecast Discussion
While many troubles remain in the economy, it seems to us that for the first time in a while, there is no emergency which needs addressing by the Congress or Federal regulators. That's not to say that substantive changes aren't coming to the financial markets, including sweeping changes for credit cards, RESPA reform enactment, and more, but rather that there doesn't appear a need any longer for a "drop everything to address this new crisis" mentality. The Fed's laundry list of liquidity programs continue to provide important support for the financial markets, "stimulus" is kicking in as we move forward, and consumer optimism, if still restrained, is again on the rise. It may just be that we're starting to move slowly away from the financial issues which triggered the downturn into a more 'traditional' kind of recessive environment... a more familiar path, perhaps.
Of course, the little bit of stability the economy is exhibiting could prove tenuous should new troubles emerge. While painful, the wrenching changes at Chrylser and GM may prove beneficial (or not) in the long run but seems unlikely to dent the economy to a greater degree than it already is dented. Cautious hiring by businesses unsure about demand may prolong the recession, and a lack of income and financing power may make any recovery more muted than it would be otherwise.
Those concerns will likely persist long after this forecast period, and the next... and possibly the one after that. In the interim, it is likely to be a "fits and starts" pattern of economic news which prevails, looking better one month, then not so good the next. For most mortgage shoppers, those typical market-moving numbers should have little effect as long as the Fed remains solidly in the marketplace. Provided they don't feel the need to increase their purchases of Treasuries or Mortgage-Backed Securities, the Fed's program of manipulating conforming rates to low levels should persist until year's end at the least. As well, Jumbo borrowers have enjoyed some beneficial (if indirect) effects of the Fed's conforming program, as conforming refinances have helped to re-liquify frozen books of loans, with at least some of that returned cash being put to work in the jumbo arena.
While the price of money should remain favorable during the forecast period, firmer underwriting standards in place are not expected to loosen to any great degree. Loose underwriting served to get us into this mess, and, once chastened, lenders will continue to err on the side of caution for the foreseeable future. Better underwritten loans promote profits, greater solvency, less need for taxpayer support and ongoing viability for lenders, and are, on balance, an economically good idea.
Forecast
Under what we think will be an economy featuring grudging, uneven improvement, mortgage rates should remain largely favorable. As we mentioned in our May 22 Market Trends: "As we move forward, and as the economy and markets improve, it may be possible to keep rates lower than they otherwise would be, but it is less likely that that will be at or near 50-year lows."
One interesting development since the last forecast period is that there has been some normalization of the "mortgage yield curve," especially in conforming loans. This is to say that shorter-term products are again carrying lower interest rates than are long-term rates, so at least some reward may be available to borrowers again interested in accepting some risk. Although ARMs are, and will remain, well out of favor (especially among those conforming borrowers), it may represent opportunity for jumbo borrowers, even if jumbo FRM rates are at about two-year lows today.
As far as trends go, overall, we think our FRMI will wander in a range of perhaps as high as 5.72% to as low as 5.30% over the next nine weeks. The FRMI's 5/1 hybrid counterpart should sport a high/low gap of perhaps 5.30% to 4.85%. Thirty-year fixed-rate jumbos have seen mild, gradual improvement over the past couple of months and should remain in the lower six percent range as we head deeper into Summer.
With regards to conforming 30-year FRMs, we've spent the better part of the last two months in a narrow band just over and under the 5% mark, and despite a rapid firming trend as we write this, it seems more likely that economic fundamentals will help rates to ease back somewhat, rather than foster any continued march higher.
It is worth noting, though, that as markets begin to move away from recent emergency (and even panicky) levels, that higher interest rates are a natural course of events and may even signal pending economic improvement.
Nine weeks from now it will be high Summer, with school and football season fast approaching. Stop back in early August to see how all this turns out!
March 6, 2009
Preface
Financial markets remain under duress, even as (or perhaps due to?) the government pledges trillions of dollars in economic supports for various facets of the economy. New programs have been unveiled one after the other, joining the expansion and/or resurrection of older ones. At this point, the success of exactly none of them can be predicted with any certainty, and the values of others remain unclear.
Several venerable financial institutions have required new infusions of cash; AIG and Citicorp are the latest, requiring more billions of dollars to keep them afloat. "Stress tests" are now underway for the collection of banks which hold the majority of the nation's assets, and it has become all too clear that "too big to fail" more likely means "too big to manage effectively and requiring government support no matter the price tag." For some institutions, some form of quasi-nationalization is surely on the way, if temporarily, but the long-term future is much less clear.
The markets -- particularly the stock markets -- have not reacted well to these incursions over the past few months. For example, the Dow Jones Industrial Average shed about 15% in the period between Election Day and Inauguration Day, and since the new team has taken over Washington another 18% decline has occurred. This is not sign of confidence in the new administration's plans or any inkling of optimism about the near-term prospects for recovery.
It would seem that a rough road lies ahead.
Recap
Our last forecast expected overall interest rates to wander in a range of perhaps 5.5% to 6% over the two-month period, and we came pretty close. The period's high-water market for HSH's FRMI was 5.94%, while this indicator's low was 5.66%. The FRMI's 5/1 Hybrid counterpart was forecast to trend between 5.6% to 5.95%, and we managed a 5.51% to 5.80% range instead, still fairly on target. During that time, rates for 30-year conforming loans moved upward off flight-to-quality panic levels to settle around 5.25%, while 30-year "true" jumbos have generally improved in price. In fact, rates for jumbos are holding at about one-year lows, a signal of somewhat improved liquidity for those products.
The "expanded conforming" program -- designed to make jumbo mortgage money cheaper for certain borrowers in certain marketplaces -- saw its "maximum maximum" loan amount re-lifted to $729,750, after the original end of the program (at the end of 2008) saw it reduced to $625,500. When talking about these products, the discussion often turns to how "high" true jumbo mortgage rates are, but it's difficult to buy argument that some of the wealthiest homeowners and homebuyers need interest rate subsidies to promote better affordability
After all, and irrespective of their relationship to government- influenced (read: artificially lowered) conforming interest rates, jumbo mortgage rates have been at or above -- sometimes well above -- present levels in the last nine years. These borrowers seem to have found those rates to be quite acceptable over time. Regardless, and for the most part, rates were pretty stable during the forecast period.
Forecast Discussion
As noted above, a slew of new spending initiatives are coming soon to an economy near you. A $787 billion stimulus plan -- derided by many as nearly devoid of any actual private market stimulus incentives -- will start hitting the streets fairly soon, as will the Fed's new $1 Trillion plan to goose auto, student and credit card lending (and perhaps other asset-backed markets) too. Then there's the regular Federal budget, bloated out to $3.55 Trillion dollars, plus the new HASP, with $200 billion in support for Fannie Mae and Freddie Mac, another $75 billion in refinancing chances and outlines to modify possibly millions of mortgages with certain tax-funded incentives to borrowers and homeowners alike.
With regards to the HASP, there is probably some value for borrowers who are lucky enough to have a Fannie/Freddie held mortgage to refinance even if they are mildly underwater. However, we think that claims of 4-5 million homeowners leaping at the chance to be put through today's mortgage underwriting wringer is wildly optimistic, even if a better interest rate can be obtained after all the "adder fees" and all the hurdles can be overcome to obtain financing.
As well, prospects for 3-4 million loan modifications also seem outlandish, even if there are new incentives to participate for various parties. We've heard too many claims already about how concept A or concept B will save the housing market: anyone remember last summer's much ballyhooed Housing and Economic Recovery Act (HERA)? Or how about the $300 billion Hope for Homeowners, which has only completed about 25 loans since it began in October? (We note that the Congressional cramdown bill will revise and extend the HOPE program.
We need to keep in mind that the actual, recent experience for loan mods isn't good at all, with some 55% re-failing after just six months. Call us skeptics, but we'd prefer proof -- or at least some well-thought analysis -- which shows that this is a better avenue to explore than previous attempts or even allowing foreclosure. Perhaps the only thing of actual value is that HASP allows innocent investors to have a chance to share their losses with the Federal government. Contrary to many reports, investors aren't all big, bad banks, but ordinary people putting money into bond funds, 401K and IRA plans who rightfully have been resistant to taking all the blame and all the loss, simply for having been nice enough to lend their money to people who wanted to buy homes. If anything, this is where the real value of HASP may lie.
The $787B stimulus plan may or may not provide much stimulus, and if it does it may be a ways down the road before its effect is felt. Many feel that its government-heavy spending program comes at the expense of private (especially small) business by removing immense amounts of capital that investors could otherwise use to spur new companies.
Still, the only program which can claim actual tangible benefit to a wide group of consumers is the Fed's and Treasury's program of buying Fannie and Freddie debt and mortgage-backed securities (MBS purchases are running at about $4B per day at the moment) which serves to keep interest rates low at a time when the government is literally flooding the market with new debt. Certain of their other programs -- the commercial paper facility -- are working to improve liquidity, but are well upstream of producing any direct consumer benefit. As these are interest-bearing investments, they may actually have no ultimate cost to the taxpayer... but the verdict for that may be years away.
With all the spending and grandiose plans of the new administration, we can help being struck by a line from Creedence Clearwater Revival's "Who'll Stop the Rain":
Caught up in the fable
I watched the tower grow
Five year plans and new deals
Wrapped in golden chains...
The plans and deals are coming, but the golden chains will be our tax obligations, as well as the continuing tax burdens of our descendants in the generations ahead. May they look with a favorable eye toward the decisions being made today.
Forecast
The country remains mired in recession, and we have a pretty deep hole to climb out of before we're in any recovery mode. Fourth-quarter 2008 GDP came in at an alarming -6.2%, the biggest contraction in about 27 years, so we're even a long way from breakeven at this point. Thankfully, inflation pressures have flattened out, even if a fair portion of the benefit of declining energy prices has already occurred.
We remain perhaps more optimistic than many with regards to housing.
Provided there are no more rumors to distort market activity (like those promising 4% or 4.5% mortgage money, or huge tax credits) the combination of low mortgage rates and low prices is creating perhaps the best buying opportunity in decades. To realize that opportunity, we'll need to see some firming in the labor market and consumer confidence, which will hopefully start to happen in time for the traditional spring homebuying season, now just weeks away. Certain markets -- those with high volumes of foreclosures, and thus very low prices -- are already responding (notably markets in California), and sales are firming.
Home prices have not yet stopped declining, according to the most widely published indicators, but that is serving to enhance affordability, if at the expense of the property's present owner (bank or individual). New home sales remain tepid, competing as they are against low cost (and often recently built) homes available. Builders still have too much hard-to-sell inventory on hand and few solid prospects for new developments to become viable anytime soon.
All that said, the current environment should again promote fairly stable mortgage rates. Overall, rates really shouldn't be expected to go too far, too fast, as the private mortgage market continues to try to crawl its way back to health, while the government-backed market is probably supported to extent its going to be, absent any new crisis. Prospects for economic recovery aren't yet coming into view, but at the same time, signs of _some_ solidifying in certain financial markets make a new panic somewhat less likely. The slew of debt supply coming into markets is of some concern, as it might serve to lift interest rates somewhat, but fortunately concerns about inflation are tomorrow's problem.
For the next nine weeks, we think the overall cost of mortgage money as gauged by HSH's FRMI should trend between 5.55% and 6%, while the overall 5/1 hybrid ARM should range between 5.37% and 5.85%. True (up to $417,00) conforming loans probably remain below 5.5% for the period, perhaps dipping to as low as 5.18%, while true jumbos seem likely to drift lower in a gap between perhaps 6.85% and 6.5%.
Check back mid-late May and we'll see where we're at.
January 9, 2009
Preface
It was quite a year.
Since our last forecast, significant portions of the residential mortgage market have been reshaped due to government intervention and -- in some ways -- due to a lack of government action. We've come through an election cycle, seen hundreds of billions of dollars spent trying to comfort financial markets, and heard the promise of hundreds of billions more dollars in various forms of 'stimulus' that may be on the way. For mortgages and real estate, at least one important support is in place; others may arrive under a new administration.
On November 25, the Federal Reserve announced a plan to support the good-credit-quality residential mortgage market like never before: the government offered to purchase up to $100 billion in Fannie Mae- and Freddie Mac-issued debt while purchasing up to a half-trillion dollars of agency MBS in the open marketplace. With a new, deep-pocketed player in the market -- especially one unlikely to turn tail and run at the first sign of trouble -- the mortgage market collectively found a plan it could rally behind and fully support. Conforming mortgage rates (notably 30-year FRMs) enjoyed a substantial drop in rates. At this writing, we're witnessing a real refinancing opportunity; home purchasers seem to be starting to take notice as well.
While this was going on, an ongoing rush to safety and security was fully in place, driving Treasury yields to historic lows. Those influential benchmark interest rates served to push mortgage rates somewhat lower on balance.
Recap
When we wrote our last forecast, we expected interest rates to trend downward. HSH's Fixed-Rate Mortgage Indicator (FRMI) -- an average inclusive of conforming, jumbo and "expanded conforming" loans -- was expected to trend in a range of 6.90% to as low as 6.40% over the forecast period. However, neither we nor anyone else could have foreseen the Fed's foray into the market, and the downward pressure for rates which ensued. The range for the FRMI over the nine-week period was 7.05% to 5.85%, an unusually wide swing. This was much the same for the FRMI's 5/1 Hybrid ARM counterpart; we expected a 6.70% - 6.25% range, but instead got a 6.80% to 5.80% one. Unlike the FRMI, much of the drop in rates here came in the last four weeks along with what seems to be some loosening in the credit markets for products other than 30-year FRMs.
Much of the FRMI's downdraft was due to the drop in conforming 30-year FRMs, which stood at 6.06% the day before the Fed's announcement. The daily national conforming average declined to a low of 5.06% in late December before bouncing off the bottom somewhat. Jumbo 30-year FRMs didn't fare quite as well, as those markets remain more viscous than the better-flowing agency market. Still, the improvement here was substantial; rates had moved down somewhat before the Fed's announcement but remained at a mid-7% level, but the last five weeks have seen some improvement in liquidity, easing to about a 7% level at this writing.
Forecast Discussion
The influence of the Fed's announcement cannot be overstated. The drop in conforming rates opens up a number of possibilities to help move several markets forward. It goes without saying (though many would-be borrowers are finding out the hard way) that the program is aimed only at solvent homeowners with equity and good credit (among other requirements), but a lender with a portfolio of first mortgages will see at least some of those now-illiquid holdings retired, and the resulting cash will allow for a more natural rebalancing of books over time. That's obviously preferable to resorting to a fire-sale-at-a-loss situation to raise desperately needed capital.
This process not only helps a lender to become more solvent, but can also allow for those returned funds to be used in other ways -- perhaps to purchase jumbo mortgages, for example. We suspect that this is part of the reason for the drop in jumbo rates noted above, accompanied by the search for better-yielding investments, given that highly-safe Treasuries now yield virtually nothing.
Of course, the process of rebalancing portfolios will take some time, but that might prove to be a good thing, since that time can also be used to help unwind many of the impossibly complex debt instruments which have tied the markets into near-Gordian knots. As well, the fee income generated from refis produces profits and should help to support mortgage-related jobs. Of course, the layoffs in banking and mortgages over the past two years meant that the industry is quite unprepared for the onslaught of mortgage applications, and unlikely to want to re-hire experienced hands on a permanent basis, so we'll need to see what develops in this regard.
The chance to refinance -- which helps a household to recast its own balance sheet -- also promotes solvency, and may also potentially pump billions into the economy over the next year as lower debt burdens take hold. This is powerful stimulus of its own accord which costs present and future taxpayers nothing, even if investor returns may be lowered somewhat overall.
The Fed also took several occasions during the forecast period to lower short-term interest rates to historically low levels. With present-day interest rates near zero, the effects of traditional monetary policy using the Federal Funds and Discount Rates have fully run their course. The Fed's next moves must all come in the form of "quantitative easing," which is Fed-speak for various forms of direct market manipulation (such as the mortgage-support plan described above).
One influencing factor in the markets -- the Troubled Assets Relief Program, or TARP -- underwent a significant change during the forecast period. Originally slated as a fund to remove bad assets from lender and investor books, the Treasury ultimately abandoned that mission as far too complex and time-consuming. Instead, the Treasury opted for direct injections of capital into troubled institutions through the purchase of preferred (non-voting) equity positions. While this means that these firms still have bad loans on their books, they may now have adequate capital -- and time -- to manage those troubles more effectively.
Aside from those items, the economy continued to stagger along, and late October and early November's financial markets came to a virtual standstill. So deep were the troubles in obtaining capital that auto makers had to go to Washington hat in hand on two separate occasions to ask for assistance, some of which was provided by the outgoing administration.
After months of erratic performance, the economy was declared to be in a recession by the National Bureau of Economic Research. When the announcement came in December 2008, it was unsurprising that the NBER dated the beginning of the downturn to December 2007, since job losses have occurred in each month of 2008 (with perhaps the worst reading to close the year forthcoming in December's data).
In the midst of all this, a historic election took place, and a new administration is slated to hit the ground running in just a short while with as much as a trillion dollars in new spending to hopefully revive the economy. That spending may ultimately serve to bolster economic growth, but history teaches us that the effects of any such spending will come much later in the year at the earliest. More pronounced stimulus may come from the collapse of gasoline and heating oil prices and the loosing of cash through refinancing noted above.
It's expected that one of the new administration's priorities will be to slow the rate of foreclosures through a variety of measures. While this problem certainly does need to be addressed (provided a borrower has both the incentive and capability to remain in the home), we're of the mind that more important to the market would be support for those good-credit-quality homeowners who are now underwater in their loans.
Without equity, these borrowers cannot refinance and cannot sell without either losing money or costing the lender (investor) money though a short sale or foreclosure. Many millions of homeowners are in this situation, and as home prices keep sliding this problem worsens with each passing day. Brighter minds than ours will need to come up with a plan -- grants, insurance contracts, subsidies, whatever -- but with some $350 billion left in the TARP fund, at least some portion should be dedicated to this issue. Presently, the only market incentives for these homeowners are perverse ones; that is, they typically can't get help unless they begin to fail. In finance as in medicine, prevention is the best cure.
(There's also been little, if any, discussion of the effects of high property taxes on the nascent homebuyer movement. We'll have more to say about this, in time, on our blog.)
There is little doubt that the economy will remain highly challenged over the next nine weeks, but we think there is reason for at least cautious optimism.
Even though the job market is weakening, home affordability is rising due to the fall in interest rates combined with sliding home prices. Sooner or later this will begin to stabilize home sales; we are coming to believe that there will be a mild recovery as the spring approaches -- provided no unforeseen economic event occurs.
Lower energy prices will add tens (if not hundreds) of billions of dollars back into the economy, should they hold at these levels. While that cash seems to be ending up in savings at the moment, Americans usually find a way to spend at least some of their holdings, so at least some economic boost should result. Added to what's shaping up to be a massive stimulus package from the new administration -- expected at this writing to be a combination of fairly modest tax cuts and infrastructure outlays, among other ideas -- the economy's decline should stop, even if real improvement may lie in the future. Just the announcement of a actual plan can have wide-ranging supportive effects.
The incredible wash of cash into the financial system with nowhere to go suggests that we should see at least some risk appetite forming. Ultra-safe Treasuries and bank obligations will probably continue to get the lion's share of those dollars, but mortgages do seem likely to get at least some increased interest.
Forecast
It's widely agreed that without the government's influence, the mortgage market would be an even messier place than it already has become. That durable support is crucial to stabilizing the market, at least until private capital again develops an appetite for investments with greater-than-zero risks. With a new administration coming in, any number of plans may come to manipulate interest rates still lower, but that could delay any resumption of private interest, since that paper would feature very low yields. In this way, we find ourselves in a tenuous situation, with one overarching question: Does the good-credit-quality mortgage market need more incentives than the near-50-year-low interest rates already in the market... and if so, who deserves that additional support? (If you've read this far, you already know our answer.)
The Fed's massive November plan moved conforming mortgage rates down to present levels, and it does seem unlikely that any new plan would be of comparable size and magnitude. That suggests that, absent any significant new government influence, there is limited downside for conforming interest rates over the forecast period. However, the refinancing/portfolio rebalancing detailed above could exert some continued downward influence on jumbo mortgage prices.
This being the case, we expect that HSH's FRMI should decline somewhat over the next nine-week period, likely wandering in a range from about 6% to perhaps 5.5% over that time. The overall average for 5/1 Hybrid ARMs will probably be stickier, though, as there's little demand for these ARMs in the market (especially since many are prices above their fixed-rate counterparts, particularly in the conforming market) so we think the rang for them might be 5.95% to perhaps 5.60% over the next couple of months.
If nothing else, it should be an interesting end of the winter. Check back in early-mid March and we'll see how this plays out.
October 20, 2008
Preface
We're a little later than expected with this forecast. Frankly, there's been so much going on in mortgage and financial markets, we forgot the self-imposed deadline of October 10. Oh well.
What's happened since the last forecast? Well, the sweeping housing bill signed back in July has just started to kick in, but has since been dwarfed by other efforts. Fannie Mae and Freddie Mac were put into conservatorship by their regulator, effectively nationalizing their function in the mortgage market (buying loans from lenders to produce liquidity).
The Federal Reserve instituted a new Troubled Asset Relief Program (TARP) to help lenders sell bad assets to the government and clear off their books, and a new Commercial Paper Funding Facility (CPFF) was created to allow the Fed to support asset-backed and unsecured short-term credit markets.
In exchange for equity stakes, regulators directly injected $125 billion in the nation's most significant banks, hoping to spur new lending.
Two global credit market spasms provided the impetus for a full-tilt run by investors to cash and cash-like investments, and central banks around the world have begun to pour cash into their own troubled institutions. Stock markets collapsed and revived (and are still in that sort of mode), oil prices have fallen by half compared to their recent peaks, and the Federal Reserve trimmed short-term interest rates in concert with other central banks around the globe.
And that's only a portion of the headlines. With hundreds of pages of bills signed into law, there are probably any number of nuances yet to reveal themselves.
Recap
In our last forecast, we expressed optimism that we might be seeing some signs of stability in many markets. We were encouraged by moves put into place by the government and lessening inflation threats. Home sales have been a mixed bag, with existing home sales bouncing back and forth over and under the five million (annualized) level, while new home sales continue to touch new lows. New Home inventories are being worked down, albeit slowly, and spending for new residential projects actually revealed a slight spark in August.
Fannie and Freddie's now-explicit backing by the government means that mortgage markets for good credit quality borrowers remain fully open, and there has been at least one signal that the tightening of credit for this audience has come to a halt.
For our last forecast, we thought that HSH's Fixed-Rate Mortgage Indicator ((FRMI)) would travel a range between 6.65% and 7.15%. The actual distance between the low and the high was 6.52% to 7.08% (without the extra week in the forecast period, the top would have been 7.04%). As well, we thought that overall average for 5/1 Hybrid ARMs would trend between 6.45% and 6.85%, and got 6.31% to 6.80% as a response. We'll call our late-July forecast "pretty good" and move on from there.
On a product-specific basis, conforming 30-year FRMs trended in a 63 basis point range, while their jumbo counterparts wandered in a 57 basis point gap.
Forecast Discussion
A year and a half into the credit market mess and new troubles keep emerging. Banks across the globe have exhibited new troubles in borrowing and lending; financial markets essentially slammed shut in August and September and have only recently been pried open a crack by extraordinary efforts. The complete lack of access to credit has taken a fairly mild economic downturn and suddenly made it severe, not only here but in major economies worldwide.
Oddly enough, American mortgage markets are among the best functioning financial markets at the moment, largely because so much effort was expended over the past 15 months (but especially in 2008) to ensure that their operation would continue. Other markets, such as overnight lending transactions, remain troubled, but seem to be responding to the unprecedented level of attention they've received over the past five or six weeks.
How fast they respond, and to what degree, is key to this forecast. Concerns over spiking LIBOR rates, for example, have re-aroused fears of ARMs resetting at less-affordable rates, with the potential for a new spate of mortgage failures as a result. If that spike in LIBOR proves short-lived, if government initiatives to influence overnight and near-term funding markets help them to perform more normally, the damage might be relegated to relatively few unlucky borrowers.
The Treasury's injection of capital into banking institutions and their plans to begin to purchase billions of dollars of mortgage-backed securities should serve to both foster new lending and produce liquidity over time, but again, the question remains "how fast will any impact be felt by borrowers?"
It's important to remember that there are two components of any financing deal: the availability of money, and the price of that money. Virtually all government efforts to date have been intended to ensure or improve the availability of money, but few (excepting the TAF) have been designed to influence any given price of money. For mortgages, and although volatile in this environment, the price of money remains at reasonable levels for borrowers who have access to it (good credit- quality borrowers). However, the availability of money for certain audiences (i.e., subprime) remains curtailed, perhaps severely so.
Risks, of course, influence the price of money. The risks of making a mortgage or investing in mortgages remain quite high (and perhaps rising) as none of the issues which have plagued the market have shown any signs of easing: foreclosures and delinquencies continue to rise, home prices continue to fall, credit quality continues to deteriorate and the economy is showing increasing signs of stress. All but the bravest investors have turned from this market, and those the do remain demand higher compensation to offset those risks.
Throughout these troubled times, access to mortgage money has been largely maintained, at least for the most creditworthy borrowers, but until and unless mortgages become a favored investment again, mortgage interest rates will have a tough time declining by much. Of course, Fannie and Freddie could use some of the $200 billion in capital they got to buy up mortgages at below-present-market rates, but they would probably be stuck with those low-yielding loans in their portfolio for some time since investors wouldn't be very eager to snap them up.
While there are any number of complicating factors which could affect this forecast, it seems to us that at least two considerable opposing forces are in play. On one side are the drags of the economy and falling inflation concerns, which typically serve to pull down interest rates; on the other, troubled property markets and a stumbling economy (especially declining employment) make the risks of investing in mortgages more pronounced, pressing rates higher. The government's backing of the markets means that mortgage money remains available -- that is, liquidity is maintained, even improved -- but the price of money will likely remains stubborn.
Forecast
We've argued for some time that a period of quiet would be of great benefit to the markets. With the whirlwind of new programs, policies and regulatory changes, this is probably even more the case now than before. Too much change, too soon and too broad, even while ultimately helpful, also serves to inject a certain level of anxiety into the market, and can also have unintended consequences (such as the mass-selling of Agency debt in favor of bank debt seen earlier this month).
An opportunity to review what's been done and already in place and what's coming on line now would likely allow for a less reactive marketplace, and perhaps a stabler, more proactive one. That could allow frazzled nerves a chance to calm, and could even foster lower mortgage rates as investors search for yield.
After spiking higher in mid-October, mortgage rates begin this forecast coming off elevated levels. Even though mortgage rates tend to decline much more slowly than they increase, the next nine weeks should feature somewhat lower rates on balance. We think that the overall average rate reflected in the 30-year FRMI should trend between 6.90% and 6.40% during the next nine weeks, and the overall 5/1 Hybrid ARM may travel between 6.70% and 6.25%. The Treasury's plan of purchasing MBS in the market could produce some additional downdraft in rates (we hope), but there's no way to know how much (if any) at this point.
We'll talk again after Christmas, and we'll review how close we were to reality.
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July 31, 2008
Preface
It's been a wild ride since our last forecast A new housing bill has been signed into law, producing new opportunities for lenders to rid their books of perhaps their worst-performing mortgages -- that is, if they wish to realize those losses today, rather than 'bleeding' slowly over time. Fannie and Freddie's mission will continue unabated, and new regulatory frameworks are coming into place. The FHA program will enjoy new prominence in housing markets, and some incentives to buy homes are now available.
All this, plus billions in actual and potential spending, add up to continued pressure for mortgage rates on the upside. New Congressionally-mandated commitments for Fannie and Freddie for affordable housing will likely add 4.2 basis points to your next mortgage, and the need for more government-backed debt to finance these initiatives puts more bonds into a market -- more supply during a period of uncertain demand. Of course, rising prices are evident almost everywhere you look, but the Fed cannot quickly act to quell inflation pressures for fear of upending fragile markets.
Recap
Our last forecast suggested that the downward pull of a slacking economy would prevail over rising price pressures, but the opposite turned out to be the case. The spiralling price of oil was largely to blame; it peaked at over $146 per barrel before backing off, which helped both the Producer and Consumer Price indexes to march higher. Coincident with that, the markets had to deal with new uncertainty about the solvency of Freddie and Fannie, prompting emergency offers of support. Home prices continued to slide, making even solid mortgage investments made over the past few years somewhat more risky. Demands for mortgage credit remained pretty stable, with home sales holding pretty steady during the period, but the supply of credit became somewhat more curtailed as investors extended their 'buyers strike' for mortgage-related assets.
All these pressures moved mortgage rates upward. Overall, we expected HSH's overall Fixed-Rate Mortgage Indicator (FRMI) to range between 6.37% and 6.72%, but instead saw a differential of 6.65% to 7.10% at the close of the forecast period. For 5/1 Hybrid ARMs, we expected to see the average travel between 5.85% to 6.25%, but it ranged from 6.25% to 6.82% during the period.
Interestingly, it was conforming rates which suffered the most from the difficult market conditions. Conforming 30-year FRMs wandered in a 52-basis-point range, compared with only 39 for private-market jumbos. Five-one conforming product trended in a 68-basis-point gap, with just a 45 basis point distance for jumbo 5/1 ARMs. As impaired as jumbo markets have been, they may already be about as impaired as they can get, what with nominal interest rates already well above conforming. Since they are mostly being originated and held by portfolio investors, only concerns about inflation and changes to actual costs of funds -- rather than investors turning away -- seem to be influencing their rates.
Forecast Discussion
As we approach the one-year anniversary of the mortgage crisis (markets first began to crumble in July 2007 before fully breaking in mid-August), we're still not out of the woods. Tighter access to credit has pulled all financially-marginal homebuyers out of the market, leaving a vacuum of demand. At the same time, record foreclosures have caused a swelling in the number of homes for sale. As Economics 101 taught us, too much supply combined with too little demand has pushed home prices lower. New home sales and home building seem likely to begin to show signs of improvement before long (perhaps a couple of quarters), but until then, rough times remain fully in play. Existing homes -- the largest component of the market -- are of course more affected by inventory increases due to foreclosures.
There are few players fully engaged in mortgages at the moment. Wachovia recently left the wholesale ranks, along with IndyMac Bank (which subsequently failed). Fewer players mean less competition among buyers for loans (less liquidity), and less competition means that demands for higher yields must be met in order to complete a sale.
But are we near bottom? Every time it seems reasonable to think that the worst of the financial losses are fading, along comes another announcement of billions of dollars of losses. Still, we are starting to be of the mind that conditions, if not actually improving measurably, have stabilized overall -- or at least the rate or frequency of decline has lessened appreciably.
Our glimmer of optimism is derived from a few sources. Loan books are being improved though the origination of better quality mortgages; access to government-backed capital remains fully in force at near 0% real rates, and further substantial home price declines will probably be contained to a few deeply-troubled markets.
On the more technical side, the new ability for a lender to pull the worst performing loans off their books, refinance them into an FHA-backed loan, and take an immediate 'haircut' in terms of value -- but be able to close out a troubled asset -- could lead to lessened requirements to raise new capital and also reduce the need to hold additional loan-loss reserves.
The ability to shed bad assets means less of a need to raise new capital, which could lessen the considerable competition for those funds in the already-wary (and strained) credit and equity markets. A lessened need for new capital would serve to better balance the demand for those funds with the availability of them, and easing those pressures could help to lower market interest rates.
With less need to build and hold capital, more of the profits from operations can be used to buy and sell more loans, instead of being held as reserves.
As 'bad' loans are pulled off books, they can be replaced by 'good' loans; this will further improve loan books and may serve to increase (somewhat) demand for new mortgages by the firms whose loan books are improving.
The plan is, however, voluntary, and the process for deciding which loans to excise and which to allow to fail will be done on a one-by-one basis by lenders, so it will take time to produce any measurable results.
So we're somewhat more optimistic than many, perhaps. Lower oil prices will hopefully be more permanent than temporary, which would lessen upward pressure on inflation and its associated influence on interest rates. So far, there's been no corresponding increase in wage demands, and the stumbling economy and weak labor markets may serve to trim inflation pressures further.
We also think some of the pessimism surrounding housing will begin to fade once year-over-year comparisons of home sales no longer feature regular double-digit decreases. Failing any additional significant deterioration, we're looking for that to start around September or October.
Although certain things set in motion will take time to realize, and keeping in mind that energy costs could again flare higher at any time, it still lends some hope that we may have found tenuous stability for mortgage rates. Hoping for stability isn't the same thing as achieving it, of course.
Forecast
As we write this, conforming FRMs are near a year's high; fixed-rate jumbos are near eight-year highs. If inflation calms, if demands for capital are diminished somewhat, and if bad assets can be shed, mortgage rates should get no worse and have a good chance to improve, perhaps considerably, from these levels. As such, we're expecting a stable-to-downward trend for mortgage rates over the next nine-week period, where we forecast the overall average 30-year tracked by HSH's FRMI to range between 7.15% and 6.65%, while the erratic 5/1 ARMs (20-basis-point bounds have been all too common this year) should find a home somewhere between 6.85% and 6.45%.
Here's hoping we're right. Refinancing and home buying could use a boost, and cheaper mortgage money would help.
Our next forecast should come in early October. The third quarter will have come to a close, Autumn will be upon us, and we'll look back to see if our optimism was founded or unfounded.
For a weekly outlook, see the latest edition of HSH's Weekly Market Trends.
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