Mortgage Rate Trends: Weekly Market Commentary & Forecast

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Keith Gumbinger    HSH.com Check archives.

Fed Moves, Rates Not So Much

June 16, 2017 -- Another lift in short-term interest rates by the Federal Reserve and no change in the promise of more increases to come had little effect on interest rates, which remain close to levels seen last November. Even a plan to start to reduce the central bank's bloated balance sheet elicited a yawn from markets, but at least that was largely the Fed's intention.

Instead of the Fed's widely-anticipated move, markets instead seemed to focus more on the latest spate of economic news, particularly inflation reports that suggest some cooling in price pressures has taken place of late. The market seems to thinks that slowing inflation might stay the Fed's hand on another lift in the federal funds rate until much later this year, but the statement released at the end of the two-day get together this week didn't seem to bear out this argument, even as the decent easing in inflation was acknowledged. "Near-term risks to the economic outlook appear roughly balanced," said the Fed, and also reiterated that they "expect economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate."

All indications are that the Fed hopes to start to trim its bond and MBS holdings later this year. Arguably, they would probably like to lift rates one more time before 2017 ends, and probably not at the same time as they begin to pull back on reinvesting inbound proceeds from maturing and prepaid instruments. That argues still for a September lift in the fed funds rate (to an upper bound of 1.5 percent, and certainly consistent with earlier statements that "normalization of the level of the federal funds rate" would be "well under way", as this value could be close to half of the final nominal level reached by the time this tightening cycle is complete (2019, perhaps?)

When it does start the process of "quantitative tightening", the Fed will, in steps, trim back the amount of reinvestment it is making. Initially, and then in three-month intervals, purchases of new Treasury bonds will be pulled back by $6 billion per month and MBS and agency bonds at $4 billion per month. After 3 months, the $6 billion and $4B will be turned into $12 billion and $8B respectively; after three more months, this will rise to $18B and $12B and will ultimately end up as $30B in Treasuries retired each month and $20B of mortgage-related debt.

Given a balance sheet comprised of $2.46 Trillion in Treasuries and $1.78 trillion in MBS and agency debt, it will be a long time before these holdings are pared down to what is expected to be a final balance of perhaps around $2 trillion or so, and likely one solely comprised of cash reserves and Treasury bonds. While the amount or Treasuries the Fed holds and maturities can be well graphed -- a fairly predictable reduction process can be plotted -- that's not so much the case with mortgages, at least at the moment, as mortgage rates lower than expected and increases in refinancing may increase for a time the amount of mortgages being pulled out of the Fed's holdings, back into the market and back into new MBS that the Fed will continue to buy (at least when issuance is in excess of $4B (or $8B, $12B, etc) in a given month.

So far this year, the Fed has "recycled" about $142 billion of MBS; if the plan was already in place, perhaps a third of these would have needed to be absorbed by private investors, which might have lifted mortgage rates a marginal amount. The market's calm in the face of this plan is a stark contrast to the "taper tantrum" back in 2013, when then Fed-Chairman Bernanke overtly said that the Fed would need to reduce purchases of bonds and MBS at some point. Markets took this to mean there would be an imminent change for which they were unprepared, and the expectation of massive new supply of these investments at a time of insufficient demand amid still-shaky markets sent interest rates leaping by more than a percentage point in a short time frame. No effect of such magnitude is expect this time, but we'll need to gauge how the market manages the change when it gets underway, possibly in early November (or not until the turn of 2018).

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On a more immediate note, we have the current economic climate to consider. With most data now coming from the second month of the second quarter, the picture that is emerging for the period doesn't seem to show much by way of acceleration, to be sure. As recently as two weeks ago, the Federal Reserve Bank of Atlanta reckoned second quarter GDP to be running at about a 4 percent clip; this week, that's been pulled down to a run rate of about 2.9 percent, part of a general downtrend seen over the last month or so.

As we noted above, inflation seems to be easing a little, pulled down by energy costs as oil remains below levels attained earlier this year, falling from about $55/bbl to about $45 now. In response, the Producer Price Index didn't change at all in May, holding steady, a retreat from a 0.5 percent rise in April. "Core" PPI, a measure that excludes volatile costs such as energy inputs actually rose by 0.1 percent, but this too was a deceleration from April. Annualized headline PPI eased by one tick to 2.4 percent, as did core PPI (to 2.2 percent).

More was made of the outright decline in the Consumer Price Index. For May, headline consumer prices shrank by 0.1 percent, a third decrease in a row, leaving the headline figure running at 1.9 percent. As with PPI, the core measure of CPI rose by 0.1 percent, but even with the gain, now sports an annualized rate of 1.7 percent, a 4th consecutive decline in the annual rate and likely forecasting a downturn in the Fed's preferred measure of inflation, core personal consumption expenditures.

Prices of imported goods fell back by 0.3 percent in May, making it two declines in the last three months, part of an erratic but overall declining trend since early in the year. As in the PPI and CPI figures, lower energy costs pulled the headline down, but the aggregate cost of inbound goods was unchanged even when they were left out of the tally. Import costs are now rising by just a 2.1 percent annual clip; last month, the figure was 3.6 percent and prices are trending downward. That's also the case with costs for goods the U.S. is sending offshore; export costs shrank by 0.7 percent for May, and are now rising by at just a 1.4 percent annual rate, less than half that measure seen in April.

The Fed has consistently looked at these periods of slowing inflation as transitory ones, with underlying metrics suggesting that over time, the goal of a 2 percent rate of inflation will be regularly reached. So far, that has not much been the case, and a slower rate of inflation helps bond investors to demand less of a premium for holding bonds, so interest rates tend to ease a bit as a result.

Consumer spending certainly isn't doing much to push economic growth at a faster pace. Retail sales shrank by 0.3 percent in May, with the overall dollar amount pulled down by lower cost gasoline, but also by less spending on cars and sporting equipment, among other items. Leaving out the most erratic components, so-called "core" retail sales were actually a little better, but only enough to be unchanged from April. The current annual 3.8 percent increase in retail spending is certainly not going to cheer the hearts of struggling retailers, as it is the lowest annual run rate since last November.

Housing markets are struggling with a lack of available supply, and new supply seems to be increasingly difficult to come by. In May, housing starts declined for a third consecutive month, falling by 5.5 percent to land with a thud at a 1.092 million (annual) rate. Overall starts are not only down relative to recent months but May was 2.4 percent a year-ago comparison, too. Single-family construction slumped by 3.9 percent to 792,000 units, the lowest rate since last September, and multifamily starts cratered by 9.7 percent to 298,000 units started. Hopes for a near-term rebound don't seem all that promising, either, as permits for future building fell by 4.9 percent, with declines in both the single and multifamily categories.

With a slower construction month, it's unsurprising that builder moods were a bit more tempered than they have been. The National Association of Home Builders index of member sentiment fell by three points in the June observation, ticking down to 67 from 70, a very healthy level still, even if the lowest since February. Measures of single-family sales eased (73, from 75), as did expectations for the next 6 months (76, from 78 in May). Traffic at showrooms and open houses dipped below a neutral threshold of 50 for the first time in four months, with a two point fall to a value of 49.

Manufacturing seems to be pickup up or maintaining strength, at least as two regional observations are concerned. The Federal Reserve Banks of both New York and Philadelphia reported June conditions in their respective districts this week, and New York found a strong rebound in activity after a three-month decline; May's value of -1 gave way to a positive 19.8 for the June, with a strong uptick in new orders even as employment measures eased back a bit. Just next door, the Philly Fed's regional barometer edged down after a very strong May, sliding by 11.2 points to land at a still-solid 27.6 for the month, but has now put together a string of six strong readings in a row. This month, new orders edged higher from an already strong level, while employment eased just a little to remain quite solid.

Despite gains in mining and utility output, overall industrial production was curtailed by softer manufacturing in May. Industrial production was unchanged in May from April; manufacturing eased by 0.4 percent during the month, even as mining output gained by 1.6 percent and utility output rose by 0.4 percent. The percentage of production floors in active use declined by 0.1 percent to slip to 76.6 percent, and continues to chug along a levels below both historical levels and those that would tend to contribute to inflation.

In addition to opening their pocketbooks somewhat less, consumers have also become less enthusiastic about their situations of late. The preliminary June reading of Consumer Sentiment from the University of Michigan showed a 2.6 point decline, with the yardstick sliding to an interim 94.5 value for the month. Assessments of both current and expected conditions were trimmed, and as the present level (should it hold) is about the same as it was in November, it may very well be that nearly all of the jubilance regarding the outcome of last fall's elections has now been bled out of consumer expectations and outlooks.

In an environment such as this, one with low and perhaps falling inflation, sluggish overall growth and consumer spending, less robust hiring and more, it will continue to be difficult for interest rates to find reliable upward traction. That the Fed is committed to raising rates is a given, but the Fed continues to maintain broadly supportive monetary policy, if somewhat less so. With this week's increase in the federal funds rate and the recent easing of inflation, the actual amount of "real" accommodation the Fed is providing has certainly been pulled back, and with a quantitative tightening policy now in place (if not yet implemented) a longer view suggests that it may be hard to get an acceleration in growth without fiscal changes... and the outlook for those remains very uncertain.

As such, we move a little closer to the end of the quarter next week, and even if manage to hold the 2.9 percent current GDP rate for the quarter (seems increasingly unlikely) we will barely hold a 2 percent GDP rate for the first half of 2017. That's about par for this recovery, and not much to get excited about.

Not much excitement is due in terms of economic data next week, so it would appear that mortgage rates will hold pretty steady next week, most likely declining enough to take back this week's small increase when Freddie Mac reports next Thursday.

For a forecast for mortgage rates that will carry you deeper into the summer (at least until early August), have a look at our Two-Month Forecast. For a year-long review of expectations, see our 2017 Outlook.

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