Mortgage Rates Manage Modest Decline

May 2, 2008 -- Fixed rate mortgages moved just a bit lower this week, according to HSH Associates' weekly survey of mortgage lenders. HSH's Fixed-Rate Mortgage Indicator (FRMI), which tracks 30-year fixed rate mortgages of all sizes -- conforming, expanded conforming, and jumbo together -- pegged the final national average at 6.55%, down five basis points. Mortgage rates have been mostly firm, nudged higher by concerns about inflation but pulled lower by some renewed "risk appetite" by investors.

Conforming 30-year FRMs eased by three basis points (.03%), and remain just a tad over 6% on average, while their jumbo cousins dipped by six basis points and remain well over 7%. That disparity persists despite any number of attempts (TAF, TSLF) to help close the gap in rates and new GSE and FHA- backed offerings to compete with that private market. Presently, investors remain disinterested in mortgages, and demand by investors is the only thing which will appreciably close the differential in rates.

Five-one Hybrid ARMs, often a viable alternative for a long-term FRM, saw an increase of just one basis points, closing the weekly survey at 6.36%. In the present market, these products may be most viable for jumbo borrowers, given the 29 basis point difference between jumbo 30-year FRMs and Jumbo 5/1 Hybrid ARMs -- much wider than the .18% seen between conforming varieties.

The Federal Reserve trimmed key short-term interest rates this week, moving the Federal Funds target rate to a flat 2%, the lowest level since 2004. The move was widely expected, but the language in the release which characterized the reasons for the move failed to provide much clarity as to the Fed's intentions for monetary policy down the road. There was only the slightest hint that the Fed would pause in their campaign to spur the economy -- the Fed omitted a statement that "downside risks to growth remain" -- and with inflation concerns at the forefront, two voting members preferred to leave rates unchanged.

A crush of top-tier economic data neither set off any new alarms nor confirmed any allegations that the economy has fallen off a cliff. Gross Domestic Product (GDP) expanded a meager 0.6% in the first quarter of 2008, according to the "advance" report from the Bureau of Economic Analysis. That was the same rate of growth as seen in the 4th quarter of 2007, and, while weak, remains on the positive side of the ledger. Although the overall GDP price index nudged higher to 2.6% (annualized), consumer inflation managed to retreat a little during the period, with "core" personal consumption expenditures rising by 2.2%, down from 2.5%. Even with the decline, inflation remains above the Fed's desired levels; should it persist, it will eventually be the spark for interest rate increases down the road. Futures markets have already started to muse that November's Fed meeting might be the first to see an interest rate increase.

Although prices for energy and certain goods are pressing higher, that hasn't translated into a wage-based price spiral so far. The Employment Cost Index, a measure of the total cost of keeping an employee on the books (wages and benefits combined), moved only 0.7% higher in the first quarter of 2008, a reduction of 0.1% from the last reading. Salaries rose by 0.8%, while benefits -- usually a source of employer inflation -- rose by 0.6%. With workers now paying more just to get to work, they may begin to press their employers for raises to help offset those costs. It would be helpful if benefits costs remain muted, freeing up cash to help address those needs.

Of course, that's presuming that employment doesn't deteriorate. According to the latest employment report, some 20,000 jobs were lost in April, the fourth consecutive month of job losses. The loss of only 20,000 workers was an improvement over the recent pattern as well as market expectations of losses of as many as 75,000 jobs during the month. Generally, the report was considered good news, as the economic downturn so far has been shallow but broad, but fears that it may become both wide and deep remain, with little to suggest any upswing on the horizon as yet. The nation's unemployment rate, derived from a different survey, put the official jobless rate at 5.0% for the month, also better than expected.

Contrasting that, online "help wanted" ads climbed for the third consecutive month, according to Monster Worldwide. The increase left the index about 6.5% below year-ago levels, but it's now declining at a much flatter trajectory than during the period from November through January.

With hiring non-existent and layoffs mounting, those numbers do seem likely to worsen. The outplacement firm of Challenger, Gray and Christmas counted some 90,000 firings in April, up sharply from March's just-under 54,000 number. About a quarter of those let go were in finance-related businesses. Not too surprisingly, weekly state unemployment claims bounced back up to 380,000 during the week ending April 26, a level consistent with a mildly-declining labor market.

For those folks gainfully employed, Personal Incomes rose by a fair 0.3% during March, down a little from February. Spending, though, kicked 0.4% higher, largely due to higher costs for food and energy, with inflation-adjusted ('real') spending up just 0.1%. Of course, spending outpacing income meant the nation's rate of savings was pressed downward, and now stands at 0.2%, about half the level of February.

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Although the nation's manufacturing base is still struggling, the broad measurement of Factory Orders for March rose by 1.4%, considerably better than forecasts and a nice rebound from February's 0.9% decline. However, the gauge of business spending declined by 1%, its third consecutive reduction, and stockpiles of unsold goods have now increased (albeit mildly) for seven months, suggesting that a slowdown in new production may be at hand.

That's pretty much what the Institute for Supply Management had to say. Their tool for measuring activity among the trade group's members remained in mildly-declining territory in April. The 48.6 reading was identical to that in March, and three of the last four months have been below the breakeven level of 50, but only slightly below. Prices paid by members continue to rise, and the index which tracks prices hit 84.5 during the month. More localized looks at manufacturing health were varied: a New York area group saw another mild decline, while a Chicago regional report ticked just barely higher. For the moment, at least, manufacturing is weak but not recessionary.

Even as manufacturing is being dragged down by the continuing decline in housing, it's facing the added exertion of pressure from falling auto sales. Vehicle sales slumped to a 14.4 million annualized rate of sale, led downward by light trucks (aka SUVs). With the rising cost of gasoline it's little wonder that consumers are shunning purchases of big vehicles, but even car sales edged downward, a likely casualty of the more general retrenchment in the economy.

Construction Spending slumped in late winter, with March outlays diving by 1.1%, pushed lower by a 4.6% decline for residential projects which overwhelmed increases in commercial and public construction projects. With the continuing inventory overhang for new homes, fresh building projects probably won't be seen for some time.

Unsurprisingly, bleak news, waning prospects and high prices continue to batter consumer moods. The Conference Board's measurement of Consumer Confidence declined by another couple points in April, with the 62.3 reading the lowest since October 1993 (sans a single month five years ago). As well, the weekly ABC News/Washington Post survey of Consumer Comfort failed to find any comfort again, and the -41 level for the week ending April 27 marks a new low for the cycle. As gas prices have risen there has been a corresponding downturn in this series, and the traditional "driving season" price hikes still await us.

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On a more technical note, the Fed announced on Friday considerable expansion in both their Term Auction Facility (TAF) program and their Term Securities Lending Facility (TSLF). The TAF provides loans against collateral on a short-term basis, and in conjunction with other central banks is intended to provide competition for LIBOR. The Fed's initiation of the TAF in December served to drag down LIBOR several percentage points -- a huge boon for holders of subprime and other ARMs -- but it has remained stubbornly high relative to other short-term interest rates. The announcement today makes $25 billion per month available to banks who need cash to put to work.

The TSLF is a little different in its approach, and has been available to financial firms who also need cash but can't find it in the open market (or find it at a price which fosters profitable lending). The TSLF, originally intended for leveraging mortgage assets, was expanded to allow for borrowing against AAA-rated asset-backed securities, such as those backed by credit-card receivables or auto loans.

Collectively, the two moves should pump additional fresh cash into gummed up areas of the financial markets, theoretically (and eventually) making more loans available to potential borrowers and at lower rates.

Given the above, there's little reason to expect interest rates to move strongly in either direction. Presently, there is some mild upward pressure for mortgage rates but even more so for other market interest rates. That has caused a slight compression in the very wide spreads for mortgages relative to other instruments. Spreads have retreated from their worst levels of mid-March but remain considerably higher than those seen for much of the year. It is these markets the Fed seeks to address with their maneuvers, but this will be a process, rather than an event.

Mortgage rates likely tick a little higher next week, with probably a couple basis point move in the FRMI.

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