Mortgage Rates: Best of Summer '07

September 14, 2007 -- Adding a shakier economy to an already jittery credit markets has helped push mortgage rates down to levels seen since just before summer began. While the disparity between conforming and jumbo mortgage rates hasn't narrowed, both series managed a decline this week. Conforming 30-year fixed rates slipped slightly more than did jumbos (a 13-basis-point decline compared to 10). It was the second week that these numbers moved in tandem, suggesting at least some investor interest in non-conforming mortgages. Overall, the average for a 30-year fixed-rate mortgage slipped by 15 basis points (.15%) to 6.77%, while the five-one Hybrid ARM shed 13bps to land at 6.57%.

Come Tuesday, markets are now fully expecting at least a quarter-percentage point decrease in the Federal Funds Rate, and perhaps some additional liberalization of the terms of borrowing from the Fed's own discount window. Some corners are hoping for a half-point cut in the Funds Rate. To date, and despite all the credit market troubles, we've not been convinced that a lower Fed Funds rate will do any good, at least not directly. The issue at present isn't the price of money, but a perception of creditworthiness and a broken trust between buyers and sellers of debt; these are conditions that cheaper money can't solve.

After the rising level of mistrust washed across markets in August, many different markets which function on trust have been affected, including Commercial Paper, overnight loans between banks (including LIBOR), non-conforming mortgages, and Treasury markets. Because they didn't trust the quality of the assets being pledged, those firms and banks which would put up money on a short-term basis against assets in the Commercial Paper markets stopped doing so, crimping the availability of credit to businesses (including those which make mortgages). This became the case in overseas markets, where the short-term cost of borrowing money (LIBOR) began rising to cover perceived risks. Also, investors who would buy mortgages pulled back, as they could not trust the quality of the assets or that a market to resell those loans at a profit would exist when or if they wished to unload them. Finally, money roared into the most trusted assets, namely US Treasury obligations, whose prices soared and yields plummeted over the past few weeks.

But are those markets beginning to repair themselves? Rumor has it that Commercial Paper markets have begun to loosen somewhat this week, even as the Fed has been lending more money though its discount window to help provide liquidity at a competitive price. If not improved, mortgage markets do seem to have stabilized somewhat. LIBOR markets are still upset as evidenced by rising costs of money, while yields on Treasuries have risen from the panic levels seen at times in recent weeks, as at least some money has returned to riskier assets, including stocks.

It's also apparent that some of the money which was formerly going into mortgages and Treasuries seems to have found a home in oil and gold, prices of which have risen strongly in the past two weeks (with oil hitting all-time records). Word of a slowing economy in the US would normally bring lower prices, but supply issues and a wash of cash into the sector seems to be preventing that from occurring. Gold, of course, is also said to be a classic hedge against inflation.

And what of inflation? Price pressures remain fairly constant, if slowly declining. If recent history is any indication, pricier-than-ever oil will push up inflation pressures here before long. By some measures, we're still working through the issues caused by the $50 to $70bbl increase of the past couple of years, as those prices worm their way though the economy. The latest reckoning of import prices actually noted a decline of 0.3% during August, driven down by falling energy costs, an influence which is now gone. Prices of exported goods, aided by a weaker dollar, expanded at a 0.2% clip for the month, and our nation's imbalance of trade narrowed just barely to 59.2 billion during July. Exports rose by 2.7%, while imports rose just 1.8%.

If at least part of the cause of our present troubles was easy money and rising energy costs, more of the same seems unlikely to be the proper medicine.

Economically, things were a little slower in August than July. Retail Sales edged just 0.3% higher, goosed by rising auto sales, but pulled back by falling gasoline costs. Exclusive of those, "core" retail sales slipped by 0.1%, as it appears that back-to-school bargain hunters ruled the markets. July retail sales were moved higher, however.

Borrowing by consumers expanded by $7.5 billion in July, mostly on credit cards. Auto sales were soft during that period, but borrowing on plastic has mostly run higher this year since borrowing against home equity has fallen, along with flat home prices.

Fairly flat, too was the measure of Industrial Production, which increased by 0.2% in August, all on the strength of a 5.3% lift in utility output. Manufacturing and mining concerns retrenched a little during the month, and the percentage of factory floors actively being used remained unchanged at 82.2%.

The falloff in hiring for August -- a net loss of 4,000 jobs, according the Bureau of Labor Statistics -- has caused great concern that the economy is faltering fast. Whether or not that is the case, or perhaps just a temporary stasis in hiring related to the credit mess, remains to be seen, but new claims for unemployment benefits have been very steady, and came in at 319,000 new applications during the week of September 8.

Measures of consumer attitudes have leveled, as well. The weekly ABC News/Washington Post poll of Consumer Comfort remained at -17 during the week of September 9, while the preliminary reading on Consumer Sentiment from the University of Michigan survey sported a reading of 83.8, up a hair from August's 83.4 final mark.

A Fed hoping to reduce inflation would probably prefer not to lower interest rates at a time of $80/barrel oil and while inflation already holds just above desired levels. That said, a small cut may provide some psychological lift, although markets are simply likely to demand more. Despite that, we think that the Fed will give in to a 1/4 point cut. While it won't help mortgage borrowers to any great degree, we think that the Fed will do so only because it will likely do little harm, as well.

Mortgage rates moved a fair bit this week, rather more than we expected. Based upon that, and with regards to how the Treasury market performed this week, it does seem likely to us that no improvement in mortgage rates should be expected next week. The 10-year Treasury yield started this week at very low levels, rose by about 15 basis points by Thursday, and essentially settled there, which should put a floor on rate declines for the moment. That said, next week is all about the Fed, and what they do and say will probably overwhelm the reports due for Producer and Consumer Prices, Housing Starts, and more.

A thought: How disrupted would the markets become if the Fed chose not to change interest rates (which we would prefer, given inflation concerns)? Of course, even if the Fed does cut rates, a curiosity might take place, too: If the inflation reports are worse than expected, long-term rates might rise even as the Fed is cutting short-term rates. Simplistically, short-term rates worry about the economy; long-term rates are concerned with inflation.

For more in-depth commentary, see our latest two-month forecast. And for today's top stories, see our daily news column.

Are You a Subprime Success Story? If you're one of the majority of subprime borrowers who's not in financial trouble, we'd love to hear from you!