Last week's Treasury auctions' effects heavily amplified; High volatility still common in fixed-income markets; Traders coming back this week; Strong beliefs that economic growth in 2011 will be significant; What about housing?
The final week of 2011 was quite the roller coaster for mortgage originators and home buyers waiting to lock in their mortgage rate. After a very weak 5-year Treasury note auction on Tuesday, mortgage pricing worsened by almost 1 point, roughly the equivalent of a 0.25% increase in interest rates. Then, on Wednesday, 7-year notes were on the block. Surprisingly, that auction saw the healthiest bidding in many auctions. Mortgage pricing reversed, more than offsetting Tuesday's losses. Activity was minimal on Thursday, in spite of the best weekly unemployment claims report since 2008, while Friday, mortgage pricing improved on minimal activity, as traders closed out positions to close the year.
The key characteristic seen recently in fixed-income markets, such as those for Treasury debt and mortgage-backed securities is volatility. Movement in markets since the November 3rd announcement of "Quantitative Easing II" has been exaggerated, with daily pricing changes often more than twice the previously common change. That is to say, if mortgage originators had become accustomed to mortgage prices changing by 1/4 to 1/2 point on a busy day, since November 3rd, the new reality is that it isn't uncommon for mortgage prices to change by 1/2 to 1 point. That type of change results in very rapid shifts in mortgage rates, and volatility like that makes home buyers nervous.
A significant factor that has contributed to this volatility is low trading volume. Traders are tending to purchase fewer Treasury secruities, which is contributing to the exaggerated swings we have seen in markets. This is not at all uncommon in the holiday season. From the Monday before Thanksgiving through New Year's Day, many bond traders schedule time off from work, as do professionals in many other industries. The result of this is that the remaining traders are more likely to be swayed when markets make a sudden move in one direction or another. Short sellers, betting that mortgage prices will continue to worsen, also contributed to this effect.
On Wall Street, the consensus is that 2011 will be a strong year for the economy. Recent economic data (other than employment and housing data) has borne this out, with most of the regional Federal Reserve Bank business indexes showing positive signs for growth, inflation starting to pull away from zero, and retail sales figures suggesting the just-ended holiday season was the best in 4 or 5 years. The Federal Reserve, on the other hand, isn't so sure, and is continuing its $600 billion asset-purchase program, intended to provide some stimulus to the economy, but, more importantly, to keep inflation positive.
A too-low inflation rate can lead to economic stagnation much like what Japan experienced in the latter part of the 20th century. The bigger concern is that the economy might actually slip into deflation, in which prices of goods and services decline over time. This causes consumers to defer purchases, expecting lower prices, which leads to lower economic growth and still-lower prices. It can be a very difficult economic cycle to break.
If recent data is correct (and we'll have a very good idea on January 28th when the advance reading on 4th quarter GDP is released), we should expect mortgage rates to continue rising gradually, with the 30-year fixed rate mortgage staying between 5%-6%for most of 2011, barring other significant economic shifts. If, however, the Fed is correct, and economic growth has been overestimated, mortgage rates could correct significantly later this month, likely bringing the average 30-year fixed rate back below 4.5%. At present, according to Freddie Mac, the average 30-year fixed rate is 4.86% with an average of 0.8 points.
This week will provide a significant test for mortgage rates, as the most significant data of any month is published: employment market data. November was a conundrum, as only 39,000 jobs were added, in spite of continual declines in weekly unemployment claims. When we get a reading on December, it is hoped the picture becomes much clearer. Here's what to expect later this week:
Monday:
ISM Manufacturing index
Construction spending
Tuesday:
Factory orders
Same-store sales
Fed minutes
Wednesday:
ADP employment - private payrolls
ISM Non-manufacturing
Thursday:
Weekly unemployment claims
Monster employment index
Friday:
EMPLOYMENT SITUATION REPORT
Ben Bernanke speaks
All the key data points this week hit Americans in their pay checks. Are those checks growing? We'll know by Friday. If they are, then predictions of a better-than-expected 2011 may come true.
But what about housing? Housing led the US economy into the Great Recession, as home prices tumbled when many owners were unable to make their payments, whether initially due to predatory lending, poor underwriting, or poor consumer choices, or later as the initial effects of the crisis sparked wave after wave of layoffs. Housing data has been dismal since the expiration of the home buyer tax credit last June. Because so many middle-class Americans held such a large proportion of their wealth in their homes, this has precipitated the largest broadening in the wealth gap in decades.
Consumer confidence will not rebound strongly until consumers are confident of when home prices will stop falling. At present, there are between 9-11 months of housing inventory on the market, and housing experts suggest there are many more months worth of inventory that have yet to be placed on the market. Will 2011 be the year that housing markets hit bottom? Check back here regularly to find out.
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