MARKET RECAP

Everything isn’t turning up roses quite yet, but last week’s slate of economic news suggests that at least blooms are forming. Existing-home sales hit a five-month high, according to new data from the National Association of Realtors, jumping 3.1% in July to 5 million units from 4.85 million in June.

Meanwhile, on the new-home front, sales rose 2.4% in July to a seasonally adjusted annual rate of 515,000 units after falling to a revised 17-year low in June, the Commerce Department reported. More encouraging, the inventory of unsold homes declined for the second month in a row, to a 10.1 months’ supply at the current sales pace. It appears that new home sales have begun to stabilize, as sharply reduced prices have lured buyers back into the market.

Prices on both existing and new homes should continue to stabilize along with the economy. On the latter, gross domestic product grew at a seasonally adjusted 3.3% annual rate during the second quarter, exceeding most economists’ estimates by over a percentage point. The new GDP numbers reflect new data showing that exports were even stronger than first estimated and that business inventories weren’t depleted as much as earlier thought.

Further proof of a recovering economy could be found in durable goods orders – products that have a life expectancy of at least three years, including cars, computers and aircraft. They increased 1.3% in July, matching June’s revised number. Economists had predicted orders would drop 0.5%. (Overall, it was a bad week for the professional prognosticators.)

Even long-suffering shareholders in Fannie Mae and Freddie Mac had something to cheer about. It seems that the prior week’s talk of nationalization may have been premature (but that doesn’t mean it won’t happen yet). An emerging sentiment among investors is that both institutions might still have a life as independents, which lifted both Fannie’s and Freddie’s stock 50% higher. (Keep in mind, though, it doesn’t take much price movement to produce big percentage swings in a low-priced stock.)

Economic
Indicator

Release
Date and Time

Consensus
Estimate

Analysis

Construction Spending
(July)

Tues. Sept 2,
10:00 am, et

0.5%
(Decrease)

Moderately Important. Residential construction spending continues to weigh on overall spending.

Mortgage Applications

Wed. Sept 3,
7:00 am, et

None

Important. Purchase activity turned upward, suggesting increasing home buyer interest.

Factory Orders
(July)

Wed. Sept 3,
10:00 am, et

0.1%
(Increase)

Important. The rise in factory orders is another sign the economy continues to avoid a recession.

Beige Book

Wed. Sept 3,
2:00 pm, et

None

Important. Data in the book is expected to favor future interest rate increases.

Productivity and Costs
(2 nd Quarter, Revised)

Thurs. Sept 4,
8:30 am, et

Productivity: 2.4% (increase)
Costs: 1.4% (Increase)

Important. Both numbers are expected to hold near an earlier release.

Employment Situation
(August)

Fri. Sept 5,
8:30 am, et

Unemployment Rate: 5.8%
Hourly Wage: 0.3%
(Increase)

Very Important. A decrease in the unemployment rate would mean the economy is doing better than most economists think.

But the relationship isn’t exactly as you might think. Many pros will tell you that mortgage rates are tied to yields on mortgage-backed securities, like those issued and guaranteed by Fannie Mae and Freddie Mac. But if you dig deeper, you’ll find that rates are really tied to 10-year Treasury notes – a fact that has been mentioned many times in these missives.

A new study by the Columbia Business School and reported in Housing Wire explicates the relationship. The study’s authors argue that a recent rise in mortgage rates has significantly hurt home prices, reducing them by 10%. But the issue isn’t actual mortgage rates; it’s mortgage rates relative to the 10-year Treasury rate. For the past 20 years, mortgage rates have averaged 1.6% above the 10-year Treasury rate, but in today’s distressed market, mortgage rates have exceeded the 10-year Treasury rate by more than 2.4%.

The relationship is really about risk – the higher the spread, the less willing lenders are to accept risk. Higher mortgage rates relative to 10-year Treasuries make it more difficult for homeowners with subprime loans to refinance into lower rates, resulting in a greater number of foreclosures, and they discourage potential new home buyers from entering the housing market, lowering demand. Both of these effects put downward pressure on housing prices.

The study suggests that lower mortgage rates are an important factor in getting the housing market back on its feet, but lower spreads between mortgage rates and 10-year Treasury notes might be even more important.

MARKET RECAP

What began as a week with credit and equity markets anticipating an economic rebound and a forthcoming rate increase ended in heightened concerns over a full-blown recession and the prospect of an interest-rate cut.

Early in the week, the general mood was that the economy was stabilizing and that the Federal Reserve could be positioning itself to support an over-depreciated dollar. In a speech last Monday, Fed Chairman Ben Bernanke said that the Fed is “attentive” to the currency and will guard against a jump in inflation expectations. Markets interpreted his remarks to mean that the Fed was finished lowering rates. In fact, many market participants began betting that the next rate change would be an increase.

But market sentiment did a 180 by week’s end. First came the news that people are losing their homes at the highest rate on record in the first quarter of 2008. About 2.5% of home mortgages are in foreclosure, while another 6.4% of home mortgages are delinquent, but not yet in foreclosure, according to the Mortgage Bankers Association. Aggregated, that means that almost 9% of mortgages nationally are in trouble.

The good news, slight as it might be, is that the trouble does not appear to be caused by the widely anticipated "rate shocks” caused by resets. According to the American Securitization Forum, an industry trade group, a borrower with a typical-size subprime ARM could expect payments to increase about $70 a month if it reset now, compared with about $450 a month if it had reset in December.

The second blow was delivered by the Labor Department, which reported that a greater-than-expected 49,000 jobs were lost in May, pushing the unemployment rate up to 5.5%, the highest it’s been since October 2004. A loss of jobs is one of the criteria used by the National Bureau of Economic Research to determine when recessions begin and end.

Economic
Indicator

Release
Date and Time

Consensus
Estimate

Analysis

Pending Home Sales Index
(April)

Mon. June 9,
10:00 am, et

83
Index

Important. This leading indicator is expected to hold steady despite recent signs of a deteriorating economy.

International Trade
(April)

Tues. June 10,
8:30 am, et

$59.3 Billion
(Deficit)

Moderately Important. The deficit will show a slight increase because of higher energy prices.

Mortgage Applications

Wed. June 11,
7:00 am, et

None

Important. Purchase applications fell to a six-year low as more buyers wait for home prices to stabilize.

Beige Book

Wed. June 11,
2:00 pm, et

None

Important. Markets expect to see heightened inflation concerns from the Federal Reserve.

Retail Sales
(May)

Thurs. June 12,
8:30 am, et

0.4%
(Increase)

Important. Though sales are expected to increase, most of the gain is likely due to higher food and energy prices.

Import Prices
(May)

Thurs. June 12,
8:30 am, et

0.2%
(Increase)

Important. Lower demand is keeping import prices in check.

Business Inventories
(April)

Thurs. June 12,
10:00 am, et

0.4%
(Increase)

Moderately Important. Slowing growth in inventories suggests slowing consumer demand.

Consumer Price Index
(May)

Fri. June 13,
8:30 am, et

All Goods: 0.4% (Increase)
Core: 0.2% (Increase)

Very Important. An unexpected increase in consumer prices could send interest rates higher.

MARKET RECAP

The Federal National Mortgage Association, better known as Fannie Mae, sent a brief chill through the markets last week when it reported an unexpected loss of $2.2 billion in the first quarter of 2008. It also announced that it planned to raise $6 billion in capital through an equity offering, and said that it would cut its dividend starting in the third quarter.

But the market soon warmed. Two days later, Fannie Mae raised $4.5 billion by selling preferred and common stock. While the sales will dilute the stake of existing shareholders, Fannie Mae managed to get a good price for its offering, nonetheless.

Fannie Mae is simply the only game in town. As commercial banks shy away from lending, Washington officials have increasingly relied on Fannie Mae and its sister government-sponsored entity, Federal National Mortgage Corporation (Freddie Mac), to keep the housing market afloat. Both have recently received broad new powers and billions of dollars of investing authority from the federal government.

U.S. workers provided a burst of warmth as well. Productivity, a measure of worker efficiency, rose at a 2.2% annual rate in the first quarter of 2008 after a 1.8% gain in the prior quarter, the Labor Department reported. That’s good news for the credit markets; productivity is solid and labor costs are slowing, which lessens the inflation pressure for the Federal Reserve.

The prospect of lower inflation, in turn, helped ease mortgage rates last week. The 30-year fixed-rate mortgage averaged 6.13%, the 15-year fixed-rated mortgage averaged 5.71% and the five-year Treasury-indexed ARM averaged 5.87%, according to Bankrate’s weekly survey.

Economic
Indicator

Release
Date and Time

Consensus
Estimate

Analysis

Retail Sales
(April)

Tues. May 13,
8:30 am, et

0.1%
(Increase)

Important. Continued increases in monthly retail sales suggest some confidence in the economic outlook.

Import Prices
(April)

Tues. May 13,
8:30 am, et

1.4%
(Increase)

Important. Higher energy prices are driving the prices of all goods higher.

Business Inventories
(March)

Tues. May 13,
10:00 am, et

0.6%
(Increase)

Moderately Important. The expected increase reflects neither optimism nor pessimism on economic growth.

Mortgage Applications

Wed. May 14,
7:00 am, et

None

Important. Range-bound rates and increased application activity might be a sign of market stabilization.

Consumer Price Index

Wed. May 14,
8:30 am, et

All Goods: 0.3% (Increase)
Core: 0.2%
(Increase)

Very Important. Consumer prices are showing remarkable restraint given the pressure from higher oil prices.

Industrial Production
(April)

Thurs. May 15,
9:15 am, et

0.1%
(Decrease)

Moderately Important. Manufacturers are reducing production on slowing demand.

Housing Market Index
(May)

Thurs. May 15,
1:00 pm, et

20 Index

Important. The index appears to have stabilized and could begin to move higher.

Housing Starts
(April)

Fri. May 16,
8:30am, et

910,000
(Annualized)

Important. The new multi-year low is reflective of the need to reduce inventories.

Consumer Sentiment
(May)

Fri. May 16,
10:00 am, et

62.6
Index

Moderately Important. High energy prices continue to cloud the consumer outlook.