Mortgages: Six Months Later

December 29, 2006 -- As 2006 comes to a close, mortgage interest rates edged a little higher, with the average 30-year fixed rate mortgage (FRM) closing the year at an average 6.27%. The nation's leading survey of mortgage pricing also found five-one Hybrid ARMs blipping upward, where the average rate rose two basis points (0.02%) to 6.11% for the week.

Six months after the last increase in the Federal Funds rate, the markets remain uncertain about the direction for the economy, wavering between outcomes of a 'soft landing' or a recession. Bets that a weaker, rather than stronger, outcome is likely have served to press market interest rates lower even as the Fed remained steadfast since June. Mortgage rates peaked about mid-year but have settled considerably since then.

Those who expect a darker outcome have continually pointed to the effects of a slump in the housing markets. It's true that home sales and building have come off their highs in uncomfortable fashion, but it's also true that they powered to historic levels on the backs of record low interest rates and extraordinarily easy credit availability. While we no longer have record low rates or as free-flowing liquidity, home sales and mortgage rates remain well within historically favorable territory.

That realization appears to have put a floor on the housing crash. Sales of New Homes came in an an annualized 1.047 million units in November, up 3.4% from October and above forecasts. Prices, too have kicked up after meager gains (if any) for months, with the median price of a new home sold rising about 5% for the month; this came on the heels of a 4% increase in October. Although still high, inventory levels of unsold homes have begun to decline, and that may help firm up construction opportunities sooner in 2007 than previously expected.

Sales of Existing Homes represent a much larger market. Here, sales have also also stabilized, ringing in at an annualized 6.28 million homes sold. Prices remain flat and inventories continue to be bloated for existing homes, butt the situation here seems to no longer be worsening.

In addition to housing issues, pessimists have pointed to the broadening trouble in manufacturing, largely due to a falloff in auto sales but also influenced to a degree by housing markets. Several new observations suggest that some improvement is starting to show for factories too, and that could also constitute a floor of sorts. A regional survey of purchasing managers in the Chicago area found a reasonable increase in activity during December, with production and new orders rising while price pressures remained unchanged. Changes to this survey can presage those found in the larger ISM survey, and suggest that action is picking up at factories around the country.

Any improvement in the manufacturing sector will probably be uneven, depending upon the mix of industries in a given region. According to surveys in several Fed districts, that appears to be the case. Activity slowed in the Richmond Fed's covered area, where a mild positive reading of 7 for November gave way to a -6 mark for December. However, Kansas City saw just a little deceleration over the same period, slowing to a reading of 4 from 6 in November. In the New York market, activity continues to expand at a good clip, as their local index continues a string of record highs to close 2006.

If manufacturing and housing have found a platform, they only seem to be catching up to labor markets which have been remarkably stable all year. New claims for unemployment benefits were 317,000 during the week ending December 23, about the same as for many weeks in 2006. Employment remains high despite a softer economy, but has little space to improve from present levels; that's actually a good thing, since tight labor markets are surely in the forefront of the Fed's collective mind. Jobs are on the minds of consumers, too, and it's no surprise that employed people are happier and more secure than those seeking work. According to the Conference Board, Consumer Confidence rose to just short of 2006 highs during December, landing at a reading of 109.0 for the month. On a higher frequency note, the weekly ABC News/Washington Post poll of Consumer Comfort edged a little lower, declining to -2 from a positive 1 during the week ending December 24.

In a thinly traded holiday week, underlying market interest rates were on the rise, as the positive news outweighed the negative in the minds of the few players populating trading floors and pits this week. Opportunities have been somewhat better in stocks than in bonds of late, so equity prices have been rising for the most part at the expense of bonds.

Next week is another holiday-shortened one, but don't be lulled to sleep. A pile of significant data is due out, including Construction Spending, both manufacturing and service business readings from the ISM, factory orders and the "biggie", the monthly employment report for December. If there are to be any surprises which will move interest rates to any great degree, this is the week they will probably happen.

We're already expecting a bit of upward pressure on mortgage rates as we turn the calendar, but probably not too much. We'd guesstimate that an increase of a at least couple of basis points is likely next week, as it seems to us that good news is outweighing the bad at least for the moment. In the six months since the Fed's last increase in the Fed Funds rate, things have been pretty fair, and may be poised to even get a little better as 2007 rolls along.

Here's wishing our you -- our subscribers, survey purchasers, clients media supporters and friends alike -- a happy, healthy, profitable and peaceful 2007.

For more pithy commentary, see our latest two-month forecast.