Dennis' Mortgage Blog

Question of the week:  What happened?

Answer:  My original question of the week was regarding the release of the outline of the report from the Debt Reduction Committee put together by President Obama to make suggestions as to how to cut the federal debt and deficit in the next decade.  (I don’t need a commission—quit spending more money every quarter!) 

However given the big spike in mortgage rates this week I am switching to a question I had just a few hours ago speaking with a client about mortgage rates from last Friday:  What happened?

Last week I discussed the Federal Reserve announcement that it would push $600 billion into the economy to purchase U.S. Treasury debt (here is the post).

This week the short term impact of the Federal Reserve has hit American markets, most particularly the residential mortgage market.   The impact has come not so much from within as from without our borders.

As you are most likely aware President Obama departed last Wednesday, the same day as the Federal Reserve announcement, for a ten trip to Asia.  The trip started in India, touched down in Indonesia and then off to South Korea for the G20 summit (which not too long ago was the G8 summit), a meeting of the heads of state of twenty nations to discuss economic policy and trade.

Unlike prior meetings of the G groups, the President was not given the full welcome-mat-red-carpet treatment of prior summits.  G2-20 were waiting for the American President with rancor as a result of the Fed announcement last week.

Why?

The Fed’s policy to pour more money into the American economy to keep, or push further, down interest rates to try to stimulate our economy weakens the dollar.  The dollar is not real strong anyway, but in comparison to many countries it could be considered strong.  After all when Europe went into fiscal free fall last spring where did the world turn for safety for their investments and deposits?  The U.S. 

A weaker dollar puts emerging economies more at risk of staying emerging and not being moved into the realm of stable or strong economies—moves by the United States that purposefully invite inflation and a weaker dollar are seen by these nations as hostile to their interests.  Creating a weak currency is not a whole lot different than putting up trade tariffs, instead of paying the tariff when imports hit a country the “tariff” is paid because the goods cost more due to the weaker currency.  Got it?

Let’s say last month the cost after conversions of currency for a toy truck manufactured in Vietnam costs $1.00 in the U.S.   Now let’s say that Congress passes a tariff on imports from Vietnam of 10%.  That truck now costs $1.10 and theoretically sales of Vietnamese toy trucks should decline by 10%, or if the supplier keeps the price at $1.00, because of the tariff he is making 10% less.

What is happening with the dollar through the Fed’s monetary policy that has already moved $1.7 trillion into the economy and now looking for another $600 billion is that it is weakening and in doing so makes imports more expensive.  If the dollar weakens 10% against the Vietnamese dong the cost of that toy truck moves in “real” dollar terms from $1.00 to $1.10.  While the Vietnamese exporter/manufacturer does not have to pay the extra 10% tariff to the customs agents, due to the weaker dollar the American consumer is paying an extra 10% for the toy truck—and hence demand will drop for the product. 

So go beyond the toy truck and think oil tankers, automobiles, tractors, whole cargo ships of textiles, and any other product that comes through the ports of Long Beach and Los Angeles.  With the move by the Fed last week every product being imported into the U.S. from Asia and other markets was worth less to the manufacturers by the time it was unloaded on our docks from the time it was put on the ship a week or more ago.

That is why the other G’s are upset with President Obama and the United States.  They see the move by the Federal Reserve as only in the best interests of the United States and harmful to their economies.  Since we consume more products than any other country in the global economy and have a very large trade deficit (i.e. we import more than we export) a devaluation of the dollar costs real money to every country that counts on U.S. consumption as part of their economy. 

The reaction has been quite heated.  South Korea and the U.S. were poised to come to an historic trade agreement, not now.  China, which owns almost $1 trillion of U.S. debt, sees the Fed move as weaken their investments in our country.  Never mind their own currency has been undervalued for years to encourage our purchasing of their goods, what matters now is that currency imbalance has become more balanced.

In retaliation China raised its interest rates this week.  The move is to lift of the strength of its currency and encourage investment in China at higher rates of return.  If investors other than the Fed look for other alternatives to the offering from the U.S. Treasury that are offering higher rates of return our markets will naturally see higher rates to attract those investors back to the U.S.  Higher rates in the U.S. are what China, South Korea, Japan, Vietnam, Germany, etc. desire as it strengthens the dollar and helps their economies.

So what happened to interest rates?  Everyone but the Fed and many in the U.S. want our rates to increase and reacted accordingly.  As result this week investors stayed away from American bond investments, including Mortgage Backed Securities, which pushed prices lower and yields (i.e. interest rates) higher.

The obvious question now is “what next?”  The Fed started its $600 billion buying spree today and it did not go too well.  But it is day one.  President Obama is on his way home and the mob mentality he faced in Seoul has dispersed.  When they get home the leaders who smacked Obama around will get pats on the back for standing up to the Americans and then get on the phone to negotiate deals with American companies because in the end they need the American market and consumer.

At some point in the near future the situation in Europe will go from worse to even worse, particularly in Ireland where its national deficit is over 30% of its GDP.  Seeing that Europe is not a safe place to invest with several countries facing defaults already and everyone holding the other’s debt, perhaps not fully trusting the Chinese to not manipulate their currency and rates further, investors will see the safest haven for investment is the United States and no one pays like the U.S. Treasury from the day it issued its first piece of debt. 

While we may have seen the bottom of the mortgage rate market in the past month, and while we have seen a big jump in rates this week as a result of international reaction to our domestic monetary moves, underlying everything are the same weak fundamentals that caused the Federal Reserve to move to stimulate the economy and a Congress that appears incapable of any measured fiscal policy to stimulate long term economic growth and job recovery.

Patience may, I’ll say should, be rewarded with lower rates in coming Fridays than we see today.  Keywords: “may” and “should.”

Have a question for me?  Ask me!

After such a lengthy dissertation on the international situation with our currency and rates I will skip the economic update for the week.  It was a short week with the Veteran’s Day holiday and little economic news domestically was released other than initial unemployment claims which fell last week more than expected.  Either layoffs are slowing because companies are starting to turn the corner or they are running out of people to lay off; until we start seeing new hires in the private sector breech the 250-300,000 a month number we are still in a very, very slow jobless recovery.

Rates for November 12, 2010:  For only the fourth time in the past year the benchmark 30 year conforming fixed rate rose 0.25% from Friday to Friday.  The last two times this happened (in May and April) the following week the rate dropped 0.25%--the only times all year for such a large week to week decline.  Rates retreat to mid-to late Septembe after several weeks of being flat Friday-to-Friday

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional                             4.125%             Up 0.25%

30 year conforming-jumbo                    4.375%             Up 0.25%

30 year FHA                                         4.00%               Up 0.25%  

30 year FHA jumbo                              4.25%               Up 0.25%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. 

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment with an impound account for taxes and insurance and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

Fall weather seems to finally hit Southern California, maybe we’ll get back to normal after the unusually cool summer and warm October.

Lots of economic news next week that could move rates either direction as markets look for some stability and a trend instead of reaction.

Have a great week,

Dennis