Mortgage Market Perspectives -- LendingTree -- July 31, 2009

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Mortgage Market Perspectives 

st

July 31 , 2009

 by

Cameron Findlay Chief Economist 11115 Rushmore Drive Charlotte, NC 28277

 

INTRODUCTION

This is the first installment of “Mortgage Market Perspectives” to be published on a quarterly frequency, usually one month post the closing of each quarter. The goal of this document is to  provide a brief perspective on the key economic and mortgage related market influences described in a manner that make reading this material interesting. We always welcome suggestions, please send us yours [email protected]  [email protected]  HIGHLIGHTS  

 

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The mortgage origination process is overheating under weight of new guidelines. The risk is extended extende d origination times thereby constraining the flow of mortgages the Fed can  purchase and restricting its influence.

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Economic Stabilization Act is having the desired impact on Mortgage rates keeping them low. Paying interest on the excess reserves held at the Central bank will allow the Fed to control its balance sheet operations and rate policy objectives separate.

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Measuring inflation has always created a healthy discussion of what exactly are the measures we should monitor? Below we make the argument that CPI and PPI alone do not suffice and a third measure GDP Price Deflator in these times may be a good  benchmark.

 

MORTGAGE EXPOSURE

ORIGINATION CONSTRAINTS

The mortgage application universe is presently comprised of 53% Refinance applications at a time when 30yr Fixed Rates Mortgages are ~ 5.44% assuming 1pt. To provide perspective that’s way down from the 85% high back in January of this year when rates hit their national average low of 5.08%, suggesting as rates declined refi volume would pick up. th Fast forward from January to April 28  rates hit their low point of 4.85%. The Refi volume which you would have expected to  jump, staggered at just 75% which was well below the 85% despite lower rates. More recently between June and July rates came down but Refi volume which you would expect to pick up has also declined bottoming out at 46% by the end of June.

[Fig 1] Note : Rates Inverted on Left Axis

 Refi Volume decline despite rates directionally heading lower

 

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[Fig 1.] identifies how mortgage rates & refinance volume disconnected in June/July. This was a clear sign that refi activity traditionally rate dependant was no longer a function of rate only. Other influences are affecting the Refi market and

 Refinance Volumes depend on more than just low rates

capacity in terms processing and underwriting has a lot to do with it along withof seasonality. Lower rates, like levels we saw back in April will only be seen with healthy competition so when your evaluating your refinance opportunity consider that once you lock make sure your evaluating offers competitively in consideration of the  potential for extended processing times exposing you to a rate lock that may expire. If rates rise and your lock expires being locked to current market may be expensive.

ECONOMIC STABLIZATION th

 A measured exit strategy from Quantitative  Easing is likely given the tools available to control the Money Supply

 

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From March 18  (When the Fed announced their intention to th  purchase Govt Debt) to May 26  (when Treasury announced no further expansion of the program) we went through a period of “quantitative easing”, this is simply where the Fed expanded its  balance sheet but they didn’t just stop there. The Fed expanded  beyond what the banks needed supplying excess funds (which in turn are recycled back to the Central bank), all part of the Economic Stabilization Act from back in October’08 allowing the Fed to begin making payments not only required reserves  but excess reserves as well. By encouraging banks to keep their excess reserves at the Fed it saves flooding the market with cash and as a result the Fed can work down the balance sheet slowly while retaining control over the Fed Funds rate.

 

MORTGAGE RATES (VS) TREASURY MARKET

Traditionally looking to the Bond Market specifically 10yr Treasuries was guidance enough for brokers eager to communicate future direction of mortgage rates, that was yesterday. Below in [Fig 2] you see the spread between note rates and 10yr Treasuries on the right hand scale presently at ~170bps or 1.70%.

10yr Treasuries against consumer mortgage rates  for a 30yr Fixed

Buoyed by indecision regarding inflation and exposure to foreign central bank buying of the huge supply of Government debt 10yr Treasuries have been noticeably poorly correlated to mortgage note rates. [Fig 2]. 30yr Fixed Mortgage Rates (assuming 1pt) vs 10yr Trsy

Spreads have  finally started to align to their historical median

Looking back 10yrs for example this historical median spread has been 150bps, not too different from where we are today at 170bps. This doesn’t suggest much other than a comfort  

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knowing where things have been, spreads can easily gap out again. The basic difference in these two items is the “risk  premium” assumed by investing in a Mortgage instrument vs a risk free treasury investment. There are more technical measures we use to calculate this but bottom line as a consumer recognize when the expectation of o f default is high mortgages rates will be higher, over and above what’s happening in the treasury market. Use caution if you are only monitoring the Treasury market. INFLATION RISK

KEY ECONOMIC INDICATORS

Consumers ability to substitute for lower priced goods exposes the deficiency of CPI as a sole measure of Inflation

Most inflation indicators build their data from two key indicators; [1] Consumer Price Index [CPI] a measure of price changes in consumer goods and services (items like gas, food clothing and auto’s) it’s published by the Bureau of Labor Statistics. CPI Data takes the perspective of the purchaser. [2] Producer Price Index [PPI] is measuring the average change over time in selling prices by domestic producers of goods and services and is comprised of a family of indexes. It’s also  published by the BLS but takes the perspective of the seller. For your consideration, when measuring inflation I’d suggest a third item might provide more insight relative to current economic times, it’s the GDP Price Deflator. Some quick but painless math that will help calculate and understand why the GDP Price Deflator is a great index to monitor, especially in this market. Nominal  GDP 

 

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Real  GDP 

GDP  Price  Deflator 

Yr  / Yr  % Chg 

2006 

13,370 

11,356 

117.74 

2007 

14,031 

11,621 

120.74 

2.6% 

2008 

14,200 

11,522 

123.24 

2.1% 

 

The “Yr / Yr % Change” which can be considered inflation guidance is being derived by calculating Nominal GDP divided  by Chain Weighted GDP and is measuring PRICE changes while excluding the increase in GDP due to increases in Quantity. [Fig 3].CPI (vs) GDP Price Deflator -Measured YOY % Change

[Fig 3] Shows current CPI change year over year measured at the rate of (1.40%) versus the GDP Price Deflator published by the Bureau of Economic Analysis as Analysis as +2.14%. The “GDP Price Deflator” provides a method of over coming some of the deficiencies of CPI data which is basically constructed from a “Fixed Weight” applied to a basket of goods. Using a fixed weight system in CPI does d oes not consider consumers basic choice of substitution, where prices have fallen. If you have ever shopped at health food stores (think  premium pricing, premium goods) and have converted back to your local grocery store (generic brands) you have caused a ripple in CPI  

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 Noticeably [Fig 3] the CPI numbers (Blue) are painting a  picture of very low arguably too low a drop as compared to GDP Deflator (Red) which shows a decline but not as drastic as CPI might indicate.

DOCUMENT INFORMATION This material has been prepared by Cameron Findlay, the opinions contained within this report (which are subject to change without notice) are his own and may not represent LendingTree’s (or its affiliates) views on the market. market. LendingTree (and its affiliates) issue publications ffrom rom time to time for informational, educational and promotional purposes only. The data and analysis presented are based upon information obtained from sources that we consider reliable and any mention of levels or prices are indications only and do not represent firm market levels. Changes in market conditions since the issuance of this document may affect some or all of the levels and prices listed. We make no warranties, express or implied, regarding the accuracy or completeness of any information, analysis, or opinions presented. No part of any LendingTree publication may be reproduced in any manner without the written permission of LendingTree, LLC. LendingTree (and its i ts affiliates), its employees, agents, and contractors are not registered investment advisors, financial advisors, advi sors, or broker dealers, and they are not acting in a fiduciary capacity. The information contained in this newsletter does not constitute a recommendation, offer to sell, or solicitation of an offer to purchase any particular investments or products, including without limitation securities of any companies discussed, and it should not be construed or relied on as such. It is the reader’s responsibility to evaluate the suitability, risks, and merits of any investment, funding strategy, or business proposal presented in this publication. The products mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the iincome ncome they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.

 

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