Wobbly Markets But Steady Rates

August 16, 2019 -- The spillover from slowing major economies and the uncertainty injected into the global outlook from the U.S.-China trade and tariff war spooked the markets anew this week, and at one point, a "classic" sign of an impending recession saw a stampede out of stocks and into sovereign bonds, driving yields down further, and in some cases to record lows.

The near market panic might have been worse except for a clear, simple fact: The U.S. economy continues to do very well, and in fact, may actually be on a steady-to-improving bent in the third quarter. Couple better data with what appears to be firming price pressures, and the Federal Reserve may find itself backed into a corner just a little bit, as while the financial markets are strongly betting on more cuts by the Fed, the incoming data don't strongly suggest a need for them.

Lower-cost money isn't the right tonic for what is ailing developed economies; rather, manufacturing (for good or bad, much more important in other nations than ours) has been battered by the effects of trade and business uncertainty, and only likely cure for that is a return to known or at least-well defined trade policies. Temporary reprieves in the imposition of tariffs on certain goods as a courtesy to American shoppers isn't enough, and at this point, even new agreements between trading partners may still be subject to the unknowable whims of the president and so may not feel very binding or permanent. Still, some agreement -- any agreement -- would be better than none, as markets can work within virtually any set of rules, provided they know what they are.

As noted above, yields on U.S. Treasuries (and German bunds, and Japanese Government Bonds) all were driven materially lower this week, most especially when the yield on the 2-year Treasury fell briefly below that of the 10-year, an "inversion" that is considered a classic sign that economic misfortunes are coming before long. The inversion has since reversed, but just barely, as better data helped calm markets a bit. Still, the 10-year Treasury ended the week down about 15 basis points or so and in the mid 1.5% range, but that was still well above comparables in Germany (yield of -0.684% late Friday) or Japan (-0.237%), the U.K. (+0.468). As well, the U.S. 30-year "long bond", broke below a 2% yield for the first time in its history.

Curious as to what the Federal Reserve is doing, and what it means to mortgage markets and rates? After each Fed meeting, read HSH.com on the latest move by the Federal Reserve. We break down the meeting-closing statement, analyze monetary policy changes and interpret the effects on mortgages and more.

That said, the investors packing money into government bonds aren't the same ones who buy U.S. mortgages, and the effect on mortgage rates was nearly nonexistent, with only what looks to be a mild downdraft as the week cam to a close.

In contrast to roiling global markets, it's hard not to look at the available U.S. data and not get at least a little sense of relative calm. For example, if stresses were showing, it would likely be seen in a retrenchment in consumer borrowing and spending, and we don't see that (at least not so far). Retail sales powered in with a 0.7% rise in July, a gain better than analysts expected and a nice flare higher after a few months of just fair gains. "Core" retail sales (excluding gasoline and auto purchases, which can be noisy) were even stronger, climbing 0.9% for the month, the biggest gain in 4 months.

It's too soon to know, but it is starting to look as though the downdraft in prices the Fed characterized as "transitory" are just that. Prices of imports are still lower by 1.8% on a year-over-year basis, but did rise by 0.2% in July, partially erasing a 1.1% fall in June. Export prices followed the pattern, sporting an increase of 0.2% after two consecutive declines, with a 0.9% annual decline an improvement on last month's 12-month decline of 1.6 percent. These costs don't include tariffs, which are added (or not) once goods arrive at their destination. Whether they are added to final costs or not depends on a host of factors; a company could forego some profit and "eat" the increase in costs, for example.

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But for some companies it is not practical to do this, and they may instead pass cost increases on down to consumers, either partially or wholly. While not directly related to the new round of levies, the effects of earlier rounds may explain the new bump in the Consumer Price Index for July. The "headline" CPI rose by 0.3%, than that on the heels of a 0.3% jump in June, a figure rather warmer than forecasts called for. and the first 0.3% back-to-back readings in a very long time. While core CPI isn't the measure the Fed prefers to track inflation (they use core Personal Consumption Expenditures) the effects of higher costs being reflected here will certainly show up in that measure, and with CPI core starting to step higher its a fair bet that PCE inflation will be moving a little closer to target when the next release comes. At the moment, overall CPI is running a a 1.8% clip; core, 2.2 percent.

If inflation is getting more of a toehold, it's a good thing that worker productivity is also improving, as it can help to give the Fed some cover if it does decide to cut rates again soon. In the second quarter, worker output per hour rose by 2.3%, a nice follow up to a 3.5% gain in the first quarter of 2019. Greater productivity means that workers can be paid more without undue effect on the selling prices of goods, and per-hour compensation has accelerated in the last two quarters amid tight labor markets. At present, the cost of labor per unit produced is running at a 2.4% annual clip, a warm pace but not a hot one.

Applications for unemployment assistance continue to remain low, another signal that the economy is doing well here. In the week ending August 10, just 220,000 new requests for benefits were filed around the country. While that's a small bump from recent weeks (and the highest since the end of June) it's a figure that is still both low and in a well-trodden range.

With the recent new dip in mortgage rates resulting in the lowest 30-year FRMs in about 3 years, it's unsurprising that consumer have noticed. The Mortgage Bankers Association of American noted a 21.7% increase in mortgage applications in the week ending August 9, driven there of course by a 36.9% increase in homeowners seeking refinances, but joined for the first time in five weeks by an increase in borrowers looking for purchase-money mortgages (+1.9%). For the most part, sales of both new and existing homes have been running at merely moderate levels, and lower mortgage rates only offset affordability headwinds to a degree, so we wouldn't expect a big surge in homebuying anytime soon.

The place where sales growth might come from is in the new house sector, rather than the existing side (where tight inventories are the biggest deterrent). According to the National Association of Home Builders, their members are quite pleased with current conditions; the NAHB's Housing Market Index rose by a point in August to 66, creeping closer to an expansion high. A sub-measure covering sales of single-family homes was even more cheerful, rising two points to 73, its highest value since last October, while one covering expected conditions over the next six months eased one tick to 70, even as the measure of buyer traffic at sales offices and model homes moved up two stations to 50, also the highest level since last fall.

Builders are happy despite working somewhat less. In July, housing starts declined by 1.9% to a 1.191 million (annual) rate of construction initiation. However, all of the drag came from the smaller multifamily sector of the market, which tends to suffer from big monthly swings (for example, the last two months saw declines of 16.2% and 16.4%... but came after two months of 10.3% and 11.5% gains). Meanwhile, the all-important single-family component moved higher, rising by 1.3% to 876,000 (annualized) units started, a figure good enough to be the best since January. As well, permits for future building suggested optimism, as they rose by 8.4% for the month, with a mild 1.8% gain for single-family permits but a 21.8% one for multi-family buildings. As such, you can expect more volatile readings and a rebound in multi-family construction in the coming months.

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Manufacturers have been rather hard hit by the trade-and-tariff mess (agriculture, too). That said, at least two regional reviews of factory activity seemed to be holding on fairly well in August. The Federal Reserve Banks of New York and Philadelphia's local reviews of their districts revealed OK conditions; the NY Fed's barometer had a big plunge back in June but has since steadied, with positive readings of 4.3 in July and now 4.8 in August. Importantly, the measure tracking new orders was a positive 6.7 after two months of contraction, but this wasn't sufficient to break a decline in the employment-tracking component of the report, which put in a third month of declines. Meanwhile, down the Jersey Turnpike to the Philly district, things also seemed fair; although slipping by 5 points to 16.8 for the month, this was a figure still high enough as to be the second best of 2019. New orders powered 6.9 points higher to 25.8 for the month, the highest figure in 15 months, while that for employment stalled, falling 26.1 point from 30.0 in July to just 3.6 in August. Collectively, manufacturing conditions in these regions isn't great, but it doesn't appear to be falling off a cliff, either.

Industrial production was a bit soft in July, declining by 0.2% for the month. Manufacturing activity tracked here softened during the period, declining by 0.4%, while mining output dropped by 1.8% (oil production was interrupted by TS Bruce during the month). However, rather hot weather meant strong demand for electricity to power air conditioners, and utility output helped keep the headline figure from retreating further with a 3.1% increase. The overall level of industrial production floors in active use slid by 0.3%, ending the month at 77.5% overall, a figure still rather below historic norms, let alone ones that would serve to foster inflationary pressures.

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Current Adjustable Rate Mortgage (ARM) Indexes

IndexFor The Week EndingYear Ago
Aug 09Jul 12Aug 10
6-Mo. TCM1.97%2.10%2.24%
1-Yr. TCM1.78%1.97%2.44%
3-Yr. TCM1.54%1.83%2.74%
5-Yr. TCM1.54%1.86%2.80%
10-Yr. TCM1.73%2.09%2.94%
Federal Cost of Funds2.297%2.321%0.940%
FHLB 11th District COF1.141%1.144%0.700%
Freddie Mac 30-yr FRM3.60%3.81%4.53%
Historical ARM Index Data

One place we do see the effects of the trade mess is in consumer moods. The University of Michigan's preliminary review of Consumer Sentiment for August showed this quite plainly, with an overall decline of 6.3 points leaving the gauge at 92.1 for the month to date. This is the lowest reading since January, erasing a lot of good feelings built up this year. Present conditions are still seen as largely favorable, with a 3.4-point slide to 107.4, but expectations for the future did turn rather darker, with an 8.2-point fall leaving the outlook component at levels last see at the turn of 2019.

One passage in the summary by chief economist Richard Curtain should give pause to those cheering for the Fed to cut rates faster and deeper: "The main takeaway for consumers from the first cut in interest rates in a decade was to increase apprehensions about a possible recession. Consumers concluded, following the Fed’s lead, that they may need to reduce spending in anticipation of a potential recession."

What we need right now is optimism, particularly among businesses around the world, not lower rates -- and those hoping for them do so at their own peril. We've noted many times before that troubled markets elsewhere are a mortgage borrower's best friend, as they bring lower mortgage rates, but it's also true that a worsening economic climate brings troubled borrowers and homeowners too. We've seen that movie already, and all too recently. Better we should see somewhat higher rates than lower, if it means that economic activity is improving both here and overseas.

Mortgage rates followed Treasury yields down just a little as the week came to a close. Like this week, the economy calendar is back-loaded toward the end of the week, and so it's hard to know how restive markets may be in the first couple of days. We will get the minutes of the Fed's last meeting on Wednesday, and that may shed some light or clarity on the central bank's thinking with regard to the global and local risks, and we'll see if home sales are continued on a moderate pace as the spring homebuying season gave way to summer markets. At the moment, it looks as though we'll see a mild decline in rates of perhaps a couple of basis points in the average 30-year FRM reported by Freddie Mac next Thursday morning, if the tenuous calm in markets can hold.

For an outlook for mortgage rates that carries past Labor Day and into the start of the scholastic and football years, 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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