Sunday, May 16, 2010

Real Estate Update, May 16th 2010

Greek Troubles Overshadow Strong Data

Last week, the global financial markets remained focused on the economic troubles of Greece. Greek workers responded to proposed austerity measures with strikes and riots, and investors grew increasingly concerned that other smaller European countries will face similar problems cutting their budget deficits. As a result, US mortgage markets were helped in two primary ways:

1. Investors sought a flight to quality and shifted funds to safer investments, including US Treasuries and mortgage-backed securities (MBS).

2. Continued economic turmoil in Europe will reduce US exports to the region, which will slow US economic growth and reduce inflationary pressures.

Increased demand for MBS and lower future inflation are both positive for mortgage markets and contributed to keeping mortgage rates low over the last week.

Strong April Employment Report

Last week's April Employment report exceeded expectations in nearly every area. Against a consensus forecast of 190K, the economy added 290K jobs in April, the most since March 2006! In addition, the data from prior months was revised higher by an additional 121K. The manufacturing sector also added the most jobs since 1998! The Unemployment Rate rose to 9.9% from 9.7%, but that was due to unexpectedly large growth in the labor force as more people began to seek jobs.

The Fed Stays the Course

The recent Federal Open Market Committee ended without any major changes. The Fed kept the Fed Funds Rate the same and made no change to their Policy Statement, stating that rates will remain low for an "extended period" of time. Although the Fed does not directly control residential mortgage rates, there are presently three major threats to low rates lurking out there that do relate to the Fed:

1. The Fed made no mention in their latest Policy Statement about selling any of their Mortgage Backed Security (MBS) holdings. However, minutes from the meeting will be released at a future date and if the Fed discussed this topic at the meeting, it could cause rates to rise.

2. There is growing concern that if the Fed doesn't begin selling some of their MBS holdings by 2011, additional asset bubbles may arise. It's likely that the Fed will look to sell a meaningful chunk before year-end and, when this does happen, there stands to be some upward pressure on rates at that time.

3. Despite a stronger Stock market, higher consumer confidence, and an improved housing market, St. Louis Fed President Thomas Hoenig remains the lone dissenter to the verbiage in the Policy Statement regarding keeping rates low for an "extended period." He feels that there is a strong risk of inflation ahead and that the Fed needs to prepare the markets for the eventual hikes that will be coming to the Fed Funds Rate. When other Fed members agree with Hoenig (and the day will come), this verbiage will change and this will be a signal that the Fed now considers inflation to be a real threat. Since inflation is the archenemy of mortgage rates, the change in verbiage will cause rates to move higher.