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Fed's Less Aggressive Message Relaxes Markets

March 17, 2017 -- For at least a little while longer, and pending plenty of new information in the coming months, the Federal Reserve still only expects to lift the federal funds rate a total of three times in 2017. The central bank got one of those moves out of the way this week, lifting their benchmark interest rate target by 0.25 percent to a range of 0.75 to 1 percent. After weeks of advance set-up by the Fed, markets widely expected the move.

In recent weeks, financial markets had become concerned that the Fed would release new projections that would reveal that a more aggressive tightening was in the cards for this year, and interest rates had been ratcheted higher in recent days to prepare for this possibility. However, the statement that closed the meeting provided no suggestion that a faster pace of rate hikes was in the offing, and the summary of member's economic projections about the future path for the federal funds rate was largely unchanged from December. As such, investors relaxed their hedging a bit, and interest rates settled lower on Thursday and Friday.

Unlike the last two years, this year's Fed policy won't be "one and done." Despite some clues that economic growth in the first quarter of 2017 remains lackluster, employment markets have remained solid and inflation pressures are firming. For the Fed's purposes, it's far better to move while financial markets remain upbeat and stable than try to justify a move later should inbound data not appear to directly support such an action.

Whether opportunism or for whatever the reason for this week's move, the Fed is likely done for a while, and any "damage" as a result of the move is minimal, at best. Despite the increase, interest rates across the spectrum of borrowing remain highly favorable, and the effect on even directly loans impacted by the move (e.g. some credit cards, home equity lines of credit, etc.) isn't enough to change the financial picture to any great degree. Also, since there is presently little chance of a move at the May 2-3 meeting, the market's focus will center on the mid-June affair, when an updated set of projections is revealed, but concerns about that won't show in rates for many weeks yet.

As such, if the recent pattern holds true, we're more likely to see mortgage rates settle back a bit in coming weeks as we wander into the "valley" between meetings.

What's happeing with home prices? Which markets have recovered... and which still lag behind? Check out the 4Q16 update to HSH's Home Price Recovery Index, covering price changes in 100 metropolitan areas -- and see our Home Value Estimator tool to reckon changes in your market during your ownership period!

Aside from the Fed, there was still plenty of other data to chew on this week. On the inflation front, we got a chance to look at current price trends in the form of the Producer and Consumer Price Indices. In February, overall PPI rose by 0.3 percent, rather more than forecasters expected, but a deceleration at least from a 0.6 percent rise in January. So-called "core" PPI rang in with the barest possible increase of just 0.1 percent, and if prices are beginning to level here that would be could, as there has been a stark acceleration in recent months, driving the annual rate of PPI to 2.2 percent for the overall figure and a flat 2 percent for the core. Six months ago, those rates were 0 percent and 0.8 percent, respectively.

Consumer prices tell much the same tale. Headline CPI rose by just 0.1 percent in February (analysts expected no change), and "core" CPI, a measure that excludes items like food and fuel) moved 0.2 percent higher. Like its PPI sibling, CPI is running much warmer of late; the annualized CPI is now 2.8 percent (just 1.1 percent six months ago) and "core" CPI at 2.2 percent (2.3 percent a half-year ago).

It's true that the Fed follows a different measure of prices, but movement in one will likely presage movement in the other, if perhaps to a differing degree. Regardless, inflation is no longer fading, and a statement by Fed Chair Janet Yellen seemed to indicate that the Fed's preferred annual rate of 2 percent for inflation isn't to be considered a hard ceiling (and subsequently considered a hard trigger for a rate hike) but rather instead as a target. "Symmetrical" is how Ms. Yellen characterized it, suggesting that the Fed would likely tolerate price pressures running above (or below) 2 percent for a time, suggesting that markets need not steel themselves for faster increases in rates if prices meander higher for a time.

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Retail sales edged 0.1 percent higher in February, the smallest increase since last August and a downshift from a stronger recent pattern. Sales were a little stronger when the effects of high-priced autos and the vagaries of gasoline prices are excluded, rising by 0.2 percent, but the weaker pace of sales was broad-based. Some of the slowness was laid at the feet of anti-fraud-based delays in the IRS releasing tax refunds this year. If so, we might expect to see a bump down the road, but like other measures of varying activity, it just may be a settling back to trend after a post-election spurt. Still, there are reasonable job-gain and income supports in the economy as to help keep retail sales on track as we move forward.

Home builders have turned positively ebullient of late. Solid and steady demand, coupled with prospects for mild interest rate increases over time, and amid an economy that may be poised to grow faster (and one with possibly a lighter regulatory burden) is more than enough to boost enthusiasm. In fact, the National Association of Home Builders index of member sentiment rose to a value of 71 in March, the highest such reading since June of 2005. A sub-indexes covering sales of single-family homes powered higher by 7 points to 78; it was late 2004 the last time such a height was achieved. Expectations for activity in the coming six months leapt by 5 points to 78, regaining a post-crisis peak, and the measure of traffic at showrooms and open houses rose to 54; mid-2005 was the last time such a level of activity was tallied.

Tight inventories of existing homes will likely continue to see potential homebuyers exploring the option of buying new instead, giving builders plenty of reason for optimism, not to mention reasons to continue to expand supply.

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Reflecting this (and probably the result of good weather, too) housing starts rose by 3 percent in February to 1.288 million (annualized) units started. Starts of single-family homes bounced 6.5 percent higher to 872,000 (annualized) units begun; multifamily projects eased by 3.7 percent to 416,000 for the month, but generally tend to be the more volatile sector, often posting large swings from month to month. The single-family figure was the strongest number in nearly 10 years; contrast this against a 2009 low of just 353,000 annual starts and you can nearly draw a steady uptrend for starts since then. Better still, there is plenty of upside yet for both building and home sales, providing ongoing support in what is now one of the longest economic expansions on record. Permits for future activity did ease back a by 6.2 percent, but this was concentrated solely in multifamily; permits for single-family homes rose by 3.1 percent.

A couple of looks at regional manufacturing activity revealed a modest slowing in March. Reports from the Federal Reserve Banks of New York and Philadelphia both retreated from high levels. In NY, the Empire State Manufacturing Index shed 2.3 points to slip to a reading of 16.4, still a figure that can be counted among the best of the last five years. Components that track new orders and employment metrics both moved measurably higher, so more positive news is likely yet to come from this region. In the Philadelphia Fed's region, a larger step-back was seen, but as the fall came from February's 33+ year peak it's unconcerning. The headline indicator slid by 10.5 points to 32.8, but measures of orders remained very high and employment moved considerably higher as well.

The February measure of industrial production came in flat, but this masked underlying strength. During the month, manufacturing output rose by another 0.5 percent, notching a sixth consecutive month of rising output. Mining activity climbed by a stout 2.7 percent, as recently firmer prices for oil and other commodities has improved activity in this sector. The laggard, and the reason for the flat overall reading was a sizable drop in utility output; the 5.7 percent decline was due to widespread warm weather in February. This also followed up on the heels of a 5.8 percent slump in January, so utility output has been soft for a bit even as the other news is quite cheery. The overall percentage of industrial floors being used for active production remains stuck in low gear at just 75.4 percent.

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Claims for new unemployment benefits came in at a trendlike 241,000 in the week ending March 11. The last couple of weeks have been unencumbered by seasonal holiday adjustments and probably better reflect the true level of claims than some we've tracked lately. Despite being a little above 40-odd year lows, the message here is that the labor markets continues to remain tight, if not continuing to tighten. That's good news for the economy as we go.

The Conference Board's index of Leading Economic Indicators rose by 0.6 in February, the third such rise in a row, and suggesting that the economy is both doing well and can be reasonably expected to continue to do well in the period just ahead. Month-to-month, the LEI isn't a great forecasting tool, as it better reflects activity in the month its components were gathered. However, a string of solid readings does at least suggest that there is economic momentum, and that's probably good enough to expect more growth just ahead.

Consumer moods brightened a little bit in early March, according to the University of Michigan Survey of Consumers. Their preliminary measure of consumer sentiment added 1.3 points to last month's final figure, moving the figure up to 97.6 for the month to date. Nearly all the boost came from an improvement in the assessment of current conditions, which moved to its highest level in about 17 years. Expectations for things to come were little changed and remain rather subdued, at least compared to the post-election euphoria we saw in the November to January period.

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Current Adjustable Rate Mortgage (ARM) Indexes
Index For The Week Ending Year Ago
  Mar 10 Feb 10 Mar 11
6-Mo. TCM 0.87% 0.63% 0.49%
1-Yr. TCM 1.02% 0.80% 0.68%
3-Yr. TCM 1.64% 1.44% 1.09%
5-Yr. TCM 2.08% 1.86% 1.42%
FHFA NMCR 4.00% 3.66% 3.85%
FHLB 11th District COF 0.616% 0.599% 0.655%
Freddie Mac 30-yr FRM 4.21% 4.15% 3.73%

All in all, the economy is doing pretty well, and the move by the Federal Reserve this week was both a reflection of this and a vote of confidence that economic gains are likely to continue. Still, there are plenty of reasons for the Fed to express caution; the thorny Brexit mess has yet to be sorted out, economies across the globe are just beginning to show semblances of growth and steadier prices, and there may or may not be significant fiscal stimulus anytime soon to change the current climate, so a measured approach to changing short-term interest rates remains warranted. However, if we do continue to see strong labor markets in the next few months and/or prices that continue to uptick, we may see a fourth move late in the year start to come into focus. For the moment, we should expect to see generally stable mortgage rates, and at lower than recent peak levels, too.

As is more common than not, interest rates overshot the Fed's intentions; As such, some easing is on the way. At present, and based on activity in bond markets on Thursday and Friday, we would expect to see a seven basis point or so decline in the average conforming 30-year fixed rate that Freddie Mac will report next Thursday. There is even a chance that we might erase the full nine-basis-point rise we saw this week.

For a interim forecast for mortgage rates and the economy, one which runs through late March, have a look at our Two-Month Forecast. For a year-long review of expectations, see our 2017 Outlook.

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