June Spike, but Mortgage Rates Likely to Ease

June 27, 2008 -- The economy is managing to hold to the positive side of the ledger even as much of the data covering June has been pretty sour. Stock markets slumped hard this week, as the latest June indicators revealed a more difficult business climate. Money generated by the selloff in stocks seemed to flow right into already-sky-high oil, putting crude at new per-barrel highs, as well as into Treasuries, which drove yields down despite persistent inflation concerns.

Rates remained elevated for much of the week, but the late-week downdraft in underlying yields should begin to pull rates back somewhat as we move into next week.

After a five-week climb, the overall average for 30-year fixed rate mortgages in HSH's Fixed Rate Mortgage Indicator (FRMI) rose by an additional six basis points (0.06%), and has now reached a flat 7% interest rate, driven higher by a still-troubled private jumbo mortgage market. HSH's FRMI includes rates from conforming, jumbo, and the new "jumbo conforming" loans.

The divergent paths of mortgage pricing became more evident again this week, as the average for 30-year conforming loans remained unchanged at 6.55%, while the average for a private-market jumbo 30-year FRM rose by eleven basis points. The gap between those two price streams had narrowed to its smallest point in months as of last week, but has now widened again, much to the chagrin of jumbo mortgage borrowers.

Borrowers won't find much relief from rising rates with products with a shorter fixed-rate period. Five-one Hybrid ARMs largely stopped rising, adding just a single basis point this week to finish at 6.66% for the period after stepping up by 20 basis points two weeks in a row.

Looking for news that would help to push mortgage rates downward is a pretty fruitless search. The economy stubbornly (thankfully!) continues to grow, and with inflation worries high, the combined effect is to keep upward pressure on rates.

The final reading for the Gross Domestic Product (GDP) for the first quarter of 2008 came in at 1%. Although it hardly shows a strong economy, the reading bested previous estimates by a tenth of a percent; it also represented a decent improvement over the 0.6% clip in Q407. So far, despite a considerable downturn, the economy has skirted the official definition of a recession which looks for two consecutive quarters of negative GDP growth. The 1% growth rate is quite weak, though, and the present quarter will need to work at holding that level. The first reading for the second quarter comes out at the end of July.

For their part, in looking at the numbers which are being released of late, it does strike us that May was a stronger month, on balance, than June seems to have been. Most June numbers won't come out until next month, but the ones which have been released aren't encouraging.

The Chicago Federal Reserve's National Activity Index -- a tool which measures whether economic growth is running above or below its natural tendencies -- pointed to an economy which improved in May when compared to April, but only to a better grade of lousy. The -0.96 did represent an increase from April's -1.23 reading, and was the first uptick since January, but still indicates an economy which has no forward momentum to speak of.

Find fresh mortgage rates you can believe every day at HSH.

Orders for Durable Goods managed to get back to flatline, with orders placed in May unchanged from April's level. Orders for "core capital goods," a proxy for business investment, eased by 0.8% after a stout 3.1% increase in April. The deceleration in business spending corresponds with the downturn in employment and an unsteady operating climate.

Real estate and finance markets remain stressed, but there are some encouraging signs. Sales of New Homes slipped back again in May, sliding by 2.5% for the month. On an annualized basis, some 512,000 homes were sold, but at the present rate of sale there are still almost 11 months of inventory available on the marketplace. Although sales are off by 40% compared to last May, the good news is that inventory is slowly being depleted, albeit at an anemic pace. There are some 453,000 actual units available for sale, a number which has been steadily declining since we stood at 549,000 units in April 2007. At some point, builders will need to begin to build new units again, but it could still be a while before that happens.

That's less the case with sales of Existing Homes, which comprises the largest portion of the shelter market. Sales rose by 2% in May, as used homes were moved at an annualized rate of 4.99 million. Prices were 6.8% lower in May 2008 than in May 2007, serving to attract at least some bargain hunters into the market. Sales are off by almost 16% when compared to last year at this time, but sales of existing homes have wandered on either side of five million units (annualized) for eight months now, a fair suggestion that they are bouncing along the bottom. By the time we get to September, declines compared to year-ago won't look so extreme, and that may help to change the tenor of housing reports somewhat.

Stimulus payments and tax rebate checks goosed Personal Incomes in May, which rose by an outsized 1.9% during the month. That was way better than forecasts of just a 0.4% lift, and served to power spending ahead by 0.8% and boost the nation's rate of savings to a full 5% rate for the month. While such a sizable increase is likely short-lived, stimulus payments will continue along until August which should provide some income and spending support. Even absent tax rebates, incomes rose a pretty fair 0.4% for the month.

Our latest Two-Month Forecast is up -- check it out!

None of the June numbers this week had even the remotest sense of optimism to them. A local measure of manufacturing health in the Richmond Federal Reserve district went from -3 in May to -12 in June, indicating an accelerating decline in activity, and much the same tale was told in the Kansas City district, where their comparable indicator went from 0 to -13 during the month.

Weekly unemployment claims ticked 4,000 higher to 384,000 during the week ending June 21, and continuing claims for benefits are running at about four-year highs. The weekly patterns here suggest that the national employment report due out next Thursday is likely to show another decline in payrolls of about the same size as May.

Measures of consumer moods are about as dark as they can be. The University of Michigan survey sported a final June reading of 56.4, a level last seen in May 1980. Consumer Confidence, reflected in the poll by the Conference Board, registered a 50.4 mark, the fourth worst reading since the survey began way back in 1969, while the weekly ABC News/Washington Post survey of Consumer Comfort moved one tick higher to -43, an improvement but still within shouting distance of the record low of -51 set just a month ago. Rising gas and food prices, plummeting stock markets, and sliding home values are more than enough to keep enthusiasm at bay, not to mention the sparring of ongoing political campaigns.

In the midst of all this came a Federal Reserve Open Market Committee meeting, where short-term interest rates were left unchanged for the moment. In recent weeks the markets had been agitating for an increase in the Fed Funds rate to start quashing price pressures, but the Fed resisted, citing softer labor markets, the housing contraction, and troubled financial markets. The Fed did note that "upside risks to inflation and inflation expectations have increased," and such rhetoric might be construed as preparing the market for some increases in rates before long. The next Fed meeting is in August, with another in October, but that's probably too close to the election to see a change to policy. At present, there are no expectations for a move in August, but we think that if GDP growth for the second quarter comes in fairly positive the Fed might strongly consider a small increase at that time. Right now, it's too early to tell, let alone make any predictions.

After bravely putting its toes in the swirling waters of stock markets, money turned and ran for shelter this week. The yield on the 10-year Treasury declined by 20 basis points from Monday to Friday, and that should have some tempering effect on mortgage rates as we turn into July. Still, there is little reason to expect any significant downward trend for mortgage rates, absent a huge fall in inflation, a pronounced downturn in the economy, or a sudden appetite for mortgage paper by investors. Outside of Fannie or Freddie, those are quite scarce at the moment.

For today's top stories, see our daily news column. For a longer-term analysis, check out our Two-Month Forecast!