Fiat Rates Falling, Market Rates Rising

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September 13, 2019 -- Reasonable economic date here in the U.S., rising optimism that some sort of trade deal between the U.S. and China will get at least worked on (if not necessarily worked out) and new or (or new and) expanded stimulus by central banks around the world are having predictable effect. While rates set by fiat (defined as a formal authorization, proposition or decree) are being cut by central banks, market interest rates are moving in the other direction.

Why would this be the case? Several reasons. First, perhaps the largest cause of the global economic slowdown has been the continued escalation of tariffs between the U.S. and China, which has disrupted supply chains and slowed economies that heavily depend on such trade for growth. If any sort of deal may get done, or even simply instituting delays and using softer rancor (as is the case at the moment) has seen investors shift some funds out of the safe haven of bonds and back into riskier (but potentially more profitable) equities. As such, these moves put upward pressure on yields.

Second, the European Central Bank announced this week an essentially "all-in" stimulus package. It lowered its key policy rate by another 10 basis points to -0.5%; restarted a QE-style bond-buying program at a rate of $20 billion Euros per month; eased terms for its long-term bank loan refinancing option and provided "forward guidance" suggesting that a) the bond-buying program is an open-ended affair and will run until it looks likely that conditions will warrant an interest rate increase, and that b) interest rates will remain at present levels (if not lower) until inflation runs routinely close to their 2% desired mark. The last time it was close to that level was more than 10 years ago. Welcome to what may become a near-permanent stance by the ECB unless member countries with financial space (Germany and others) begin to at least try to help lift their economies with new fiscal measures. There is certainly no assurance that the ECB's programs will lift the economy there any better than did the last series of efforts, but at least attempts are being made.

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Third, the Fed is expected to follow suit next week with a 25 basis point cut in the federal funds rate to help offset the growing drag on the U.S. economy from business uncertainty. President Trump continues to complain that the Fed is falling behind other central banks and that rates should be slashed to zero or below, but the reality is that the economy here, while slowing, isn't near a recession or facing an emergency that requires emergency-level policy responses. Yes, growth could be stronger, but a record-long economic expansion, near 50-year low unemployment rate and inflation that seems to be gradually firming don't suggest any need for drastic monetary measures... or any measures, for that matter.

Unfounded or not, optimism is rising that business and economic conditions might improve and current and expected actions by central banks make this somewhat more likely to happen. It bears remembering that the lowest market-generated interest rates and mortgage rates come when conditions seem most bleak and central banks are doing little (or simply standing idly by); that's not been the case for many around the world of late, and has not been the case here in the U.S. since July at least. With prospects brightening, interest rates tend to rise, and this is where we find ourselves at the moment.

A resilient U.S. consumer is a cornerstone to this optimism, and this week we learned that despite some rough-and-tumble stock markets and concerns about trade and tariffs that they will continue to spend and power the U.S. economy. Retail sales for August rang in with a gain of 0.4%, a figure rather stronger than forecasters expected and the latest in a six-month string of increases in spending. So-called "core" retail sales (outlays outside of gas stations and spending on pricey new vehicles) did cool from the recent trend but still managed a 0.1% increase for the month. Whether top-line or core, the annual rate of increases for retail sales has been uptrend for the last several months, lessening the chances of a broader economic slowdown.

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Also, in a sign of confidence that future incomes will be available to pay for today's purchases, consumer borrowing on installment and revolving credit expanded smartly in July, with outstanding balance collectively rising by $23.3 billion. As usual, installment borrowing drove the figure, with $13.3 billion in new debt taken on for things like new cars and education. However, a surprise leap in balances on revolving credit (mostly credit cards) of $10.0 billion was a stark rebound from a decline of $0.2 billion in June. This was the largest one-month increase since November 2017, and it looks like there was a vacation and back-to-school spending spree in mid-summer.

While persistently low inflation has been the case for a while there have been gentle signs of firming, and this of course will color the Fed's thinking when they meet next week. The Fed's preferred measure of prices (core Personal Consumption Expenditures) rose to 1.7% in the second quarter from 1.1% in the first, and the monthly reckoning of PCE for July put it at 1.6%. That said, the Consumer Price Index report for August was out this week, and showed that prices rose by 0.1% overall to a 1.8% annual clip, but core CPI (excludes volatile energy and food components) rose by 0.3% for the third consecutive month, bringing the annual run rate for core CPI to 2.4%, the highest figure in more than a years' time. There are key differences in how PCE and CPI are calculated but underlying trends in prices will affect both, if to different degrees.

Prices upstream of the consumer were also still pretty mellow. The Producer Price Index did increase by 0.1%, a little warmer than the "no change" which was expected, and headline PPI is running at 1.8% per year in a softly climbing pattern. However, core PPI did come in unchanged for the month, and at just a 1% annual clip is in a cooling trend. With more tariffs kicking in on consumer goods (some on Sept 1, some on October 15, more in December) it is likely that we'll start to see some greater effect on both producer and consumer prices rising input costs are at least partially passed along.

Increases in levies on imported and exported goods are captured downstream from the official measure of import and export prices and so aren't reflected in the monthly tally. That said, prices of imported goods actually declined by 0.5% in August, mostly due to lower energy costs (prices were unchanged when those are excluded). The headline decline helped perpetuate a five-month string of declines in the annual rate for import prices, which are now actually falling at a 2% annual rate. Prices of goods heading away from the U.S. saw a decline of 0.6% last month and have been retreating for four months in a row. Currently prices of exported goods are falling at a 1.4% clip. Given the pattern, it may be that business concerns on both sides of the trade dispute are working to lower prices to help offset the effects of tariff-generated final costs for customers and to help keep the trade flow going. Whatever the reason, it doesn't look as though import costs are contributing to any upward trend for prices at the moment.

Just as there was an significant increase in mortgage applications when rates first moved below the 4% mark back in early August, expect to see a nearly like-sized decline when rates bump higher next week. In the data week ending September 6, the Mortgage Bankers Association reported that mortgage applications rose by 2%, popping higher after a Labor Day-related stall. Applications for purchase-money mortgages rose by another 4.5% after a 3.6% gain the prior week and are likely to be less affected by the coming increase in rates. That said, applications for refinancing are highly rate-sensitive and have been on a flat-to-downward trend after the early-August surge. The 0.4% increase in refi apps for the week of September 6 was the first gain in three weeks but will prove short-lived given the shift in the mortgage rate climate.

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Levels of inventory holding up and down the supply chain don't suggest that there will be any imminent pickup in manufacturing activity. Overall stockpiles of goods at manufacturers, wholesalers and retail concerns expanded by 0.4% in July, with manufacturing and wholesalers adding 0.17% to holdings and retail adding 0.76% to inventories. The overall measure of inventory holding relative to monthly sales held for a third month at 1.40%, so there wouldn't seem to by the kind of drawdown anywhere that would necessitate the placing of sizable new orders for goods. For the month, overall sales across all stations rose by 0.3%.

Employment trends remain solid, with weekly initial claims for unemployment benefits slipping to just 204,000 in the week ending September 7. The decline of 15,000 was likely distorted downward by both Hurricane Dorian's glancing blow to the southeastern U.S. and the Labor Day holiday. A clearer picture will return next week but the trend of low claims will remain intact.

A trade-and-tariff tumble for Consumer Sentiment in August has partially reversed. The University of Michigan's initial review of consumer moods for September posted a 1.1 point gain, edging back up to a flat 92 so far this month. Assessments of current conditions improved modestly, rising 1.6 points to recover a piece of August's 5.4-point drop and landing at 106.9 in the interim report. The forward-looking expectations component of the index recovered 2.5 points of a 10.6-point fall, rising to 82.4 for the month to date. A rising stock market, low gasoline prices, solid labor market and perhaps some respite from the trade war should help to improve moods a little more, provide that the trends for these continue in a positive direction for a couple more weeks. Even just a quiet period (no tweets, headlines or crashing stock prices) would likely help sentiment to move higher.

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Current Adjustable Rate Mortgage (ARM) Indexes

IndexFor The Week EndingYear Ago
Sep 06Aug 09Sep 07
6-Mo. TCM1.88%1.97%2.30%
1-Yr. TCM1.72%1.78%2.50%
3-Yr. TCM1.42%1.54%2.74%
5-Yr. TCM1.38%1.54%2.78%
10-Yr. TCM1.52%1.73%2.91%
Federal Cost of Funds2.260%2.297%0.941%
FHLB 11th District COF1.155%1.141%0.687%
Freddie Mac 30-yr FRM3.49%3.60%4.60%
Historical ARM Index Data

We've cautioned in the past that there can often be a change in the interest-rate pattern when the first full week past Labor Day comes along and business activity begins to quicken after the summer lull and we head into fall. That seems to have happened with a vengeance this week. considering the third of a percentage point rise in the yield on the 10-year Treasury.

Given the present situation, odds favor that there will be rather a bit of consumer confusion next Thursday morning. By then, the Fed will likely have cut interest rates by another quarter of a percentage point, pledged to support the expansion as needed and provided a Summary of Economic Projections that will likely point to subdued growth and moderate inflation... and Freddie Mac will announce that mortgage rates have moved up considerably. For those that don't follow the market closely, this will come as a complete surprise.

The effect on mortgage rates from the abrupt move in interest rates this week are difficult to fully reckon at the moment. To preserve the flow of refi business, lenders may not fully pass along the considerable bump in rates and hope that a partial reversal in the bond rout will come, so we might see only some of the leap in yields be passed along. At the moment, it would look as though we'll be looking at a 12 or so basis point increase in average conforming 30-year FRM that Freddie Mac will report next Thursday morning.

For an outlook for mortgage rates that carries until the early stages of the holiday season, check out our latest Two-Month Forecast.

See our mid-year review of our 2019 Outlook , where we provide updates to our speculations for ten topics that are in and around housing and mortgage markets.

For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".

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