Better News: Rates Rise (a little)

September 10, 2010 -- If the economic news gets less worse, interest rates will rise. If panic and "flight to safety" become a less-favored investment strategy, interest rates will rise. If yields become too puny to keep investor interest, but that debt must be sold into the market, interest rates will rise. It is the nature of the market.

Mortgage rates are of course one of those market interest rates, influenced by the yields on risk-free investments such as Treasury securities. Spreads between Treasuries and mortgages had widened appreciably in recent weeks, owing more to a desire for safety than a disdain for mortgage investments. The yield on the 10-year Treasury has risen by about 15 basis points (0.15%) over the last two weeks, but only a little of that increase has passed through to mortgage rates, which hold near record lows.

HSH's overall mortgage monitor -- our weekly Fixed-Rate Mortgage Indicator (FRMI) -- saw its average interest rate lifted by two basis points to close our survey at an average 4.78%, back to where it was two weeks ago. The FRMI includes rates for conforming, jumbo, and most recently the GSE's "high-limit" conforming products and so covers much of the mortgage-borrowing public. Following its fixed-rate cousin, the average rate for Hybrid 5/1 ARM also moved two basis points higher, ending the week at 3.75%

The Federal Reserve released its latest observations about regional economic conditions, a report called the "Beige Book" for the color of its cover. Given the slowdown over the summer, it's not surprising that there was little to cheer about found in the text. Information gathered in the six-week period covering mid-July through the end of August "suggested continued growth... but with widespread signs of a deceleration compared with preceding periods." For regular followers of real estate trends, it's hardly news that "Home sales slowed further following an initial drop after the expiration of the homebuyer tax credit at the end of June, prompting a slowdown in construction activity as well." The rest of the report told of an economy which seems to be more than lackluster, with expressions of caution and concern outweighing optimism pretty handily.

"Consumer spending appeared to increase on balance despite continued consumer caution that limited nonessential purchases," noted the Fed. That's pretty easy to see just by looking at the figures for Consumer Credit during July. During the month, net borrowing by consumers retracted again, slipping by $3.3 billion for the month, with use of credit cards also falling again, this time by $4.4B for the period. Only installment lending -- usually for cars and high-ticket items like furniture -- managed any gain, and just a small $0.8B one at that. With ongoing economic uncertainty the order of the day, consumers remain reluctant to borrow.

However, they do seem to want to continue to spend... cash, anyway. A survey conducted by Javelin Strategy & Research found that in 2009, credit card use was at an all-time low; at the same time, and for the first time ever, the total payment volume for debit cards surpassed that of credit cards, a trend that the financial industry research group expects to continue throughout 2010. Where "putting it on plastic" used to mean taking on debt, today's meaning is more akin to pulling cash out of a wallet. Higher interest rates and more limited access to credit do seem to changing American spending patterns and is an interesting sidebar to the recession.

It's a safe bet that some additional spending would come if the estimated eleven million borrowers who are current on their mortgages but underwater (owe more than their homes are worth) could refinance at today's fantastic interest rates. They cannot. However, the administration this week revealed a plan to try to create a solution for borrowers by asking lenders to voluntarily write down substantial amounts of principal an refinance homeowners into FHA-backed mortgages. Like many of the programs in place, it is complicated, and merely allows the investor to accept a large loss today in order to avoid a potential loss tomorrow.

At the same time, revealed its own plan, called the Value Gap Refinance. Mortgage investors -- who did nothing wrong except lend hard-earned dollars to worthy and responsible borrowers -- and many homeowners, who did nothing wrong except buy a home at the wrong time, shouldn't be penalized or excluded from participating in the refi market. With government involvement in mortgages and real estate at an all-time high, and with the risk of additional walk-aways and short-sales rising every day, we think our plan provides a workable solution to what is becoming an intractable problem. Read it for yourself, and let us know what you think.

Consumer spending and borrowing will also improve if hiring picks up. Failing that, fewer layoffs will certainly help, and in that regard, we had the best news in a while. While no doubt distorted by the Labor Day holiday, the 451,000 applications for first-time unemployment benefits was the best figure since July and possibly a hopeful start of a new trend as we close the summer and move into the fall.

Just as suddenly as it expanded in June, the nation's imbalance of trade contracted back again in July. The $42.8-billion gap for the month was a narrowing of $7.1B, as exports rose and imports declined. It would seem that the interruption in demand from wobbly euro-zone economies in late spring represented a temporary blip rather than a shift in demand of longer duration.

This could be an optimistic signal, as might the 1.3% increase in inventory levels at the nation's wholesaling firms in July. These intermediaries between manufacturer and retailer had been increasing stockpiles for months, but only muted increases had been seen as the spring wound to a close. That there is a resumption in the build of goods is an expression of confidence that final demand will continue to improve as we wend out way through the rest of the year and beyond.

A little additional optimism was seen in the two-tick increase in the weekly ABC News/Washington Post survey of Consumer Comfort, which nudged up to minus-43 during the week ending September 4th. While still bound in a year-long range, it nonetheless was the highest reading for this indicator since July.

While it remains difficult to generate much enthusiasm for the economic climate, the economy's natural tendency is to grow. We talked about confidence and certainty last week to a great degree, and it's worth noting that absent repeated or ongoing shock, a kind of hopeful stability can begin to form as the noise subsides. Perhaps that is where we find ourselves at the moment, past the overseas mess of the Spring, neither growing very fast but not failing, either. A little bit of solace, and maybe even some careful consideration and thoughtful direction from fiscal and monetary authorities, and we might be able to pick up some speed as we go.

Mortgage rates have perhaps a little space to increase next week. The rise in underlying rates is largely serving to narrow spreads, but there may be a little spillover into mortgage rates. A mixed bunch of data next week includes retail sales, consumer and producer prices, and some consumer sentiment and production data. Is optimism firming? We'll find out.