Dennis' Mortgage Blog

Question of the week:  Why does the Federal Reserve doing nothing impact rates?

Answer:  Just as not making a decision is making a decision, doing nothing is doing something, especially when it comes to the Federal Reserve and its Open Market Committee which determines the fed funds and discount rates.  Doing nothing for the Fed puts them closer to doing something, saying nothing puts them closer to saying something.  Getting closer to the Fed doing something or saying something, about interest rates gets investors betting as to when and how much that something will be.  When investors bet on future events, markets move.

When looking at financial markets, and mortgages are a financial market, we need to remember that investments are made, or sold, based on what others feel will happen in the future so they can make money.  Accurately predicting when the Fed will increase rates can pay off handsomely for investors.  So when the Fed ends its meetings and announces not only are rates the same but also their outlook for rates retains the same language, investors begin to bet, invest, when that language will change, when the Fed will increase rates.

“Extremely low rates” will remain for “an extended period of time” is the critical language everyone is waiting for the Fed to change.  Some cannot wait and start betting, investing, ahead of the language change, to say “near future” or “low rates for now” anything that indicates the Fed will raise rates from near zero and when.

Investors have access to the same economic information and data as the Fed governors.  They know that Consumer Confidence is up, that the Gross Domestic Product rose in the 1^st quarter, they know that employment costs have risen, they know that unemployment filings may have leveled off.  They know that the data is showing an economy slowly turning around and beginning to level off before, hopefully, begin to grow again. 

Investors know that the number one concern for the Fed is, or should be, controlling inflation in the economy once it does begin to grow to prevent an economic cycle worse than a recession, stagflation where the economy remains stuck on no growth with prices rising, or worse hyper-inflation.  To control inflation the Fed must increase rates.

The Fed’s next meetings are June 22^nd and 23^rd.  By then they will have more economic data, data that may cause a change in language of when rates may be increased, or an actual increase in the rates.  As we reach that date you can bet that investors will bet on whether rates will be increased.  Having done nothing this week in regards to any change in policy or position, the Fed is closer to doing something. 

My bet?  By June 23^rd at a minimum the Fed will change its language discarding the “extended period” phrase and replacing it with “when circumstances dictate” or other sufficiently vague phrase announcing coming rate increases; more likely a 0.25% bump may be coming in June to the discount rate, which will reverberate through mortgage rates.

Have a question for me?  Ask me!

As mentioned above there has been some positive, or less negative, economic news this week.  Foremost was the large Consumer Confidence number, reaching its highest level since October 2008.  You remember October 2008 don’t you?  When the Troubled Asset Relief Program, or TARP, was presented to the U.S. taxpayer and world markets?  That October 2008?  Our stock market prices are at or above where they were before TARP and the full fledged credit melt-down.  Our interest rates are lower than they were in October 2008.  Our home prices are lower than October 2008.  Our unemployment is higher than October 2008.  Mix it all up and our national Consumer Confidence is lower than October 2008, but the highest it has been since then.  A very key sentiment for the economy.

Former Fed Chairman Alan Greenspan felt that Consumer Confidence is one of the most important economic indicators.  Our economy consists of many factors, but 70% of it is driven by the consumer.  Consumer spending and consumption drives our economy, drives employment creation, drives prices, drives interest rates.  When you decide your financial future is bright enough to go out to dinner once a week, to buy the new washer and dryer, to repaint the house or to update the wardrobe, the economy begins to grow.  When the American consumer begins to spend a little more and save a little less dollars start to flow through the economy.  All of this is known by the Fed, as they see Consumer Confidence grow the move closer to the “Raise Rates” button.

Mortgage applications nationwide showed burst in purchase applications according to the Mortgage Bankers Association Weekly Applications Survey for the week ending April 23, 2010.  The number of purchase applications increased 8.5% from the prior week, the highest number since October 2009.  Driving the purchase applications was an almost 12% increase in government mortgage applications—almost all FHA mortgage applications.  The primary reason for the jump in purchase applications is the expiration, today, of the federal homebuyer tax credit.

Given the relationship between the economy and consumers, with consumer spending increasing and consumer confidence rising the Gross Domestic Product, GDP, rose 3.2% for the 1^st Quarter.  While much of the increase lies in larger inventories which need to be sold, growth is growth and better than continued shrinking.  Balanced out by the continuing growth in unemployment and weekly unemployment insurance filings well in excess of 400,000 filings per week, the GDP growth number is supporting that our economic recovery will be a jobless recovery.  While our economy will turn from recession to growing at some point, in doing so the number of unemployed Americans will stay high for sometime beyond the beginning of the growth cycle.

Greece, Portugal and Spain all had their bonds downgraded by Standard & Poors and other rating companies/groups.  When your national debt exceeds your national GDP it makes your debt offerings very risky.  To give you an idea of the risk, this week you could get an 18% return if you purchased a 2 year note offered by Greece.  The same 2 year note from the U.S. Treasury would pay you a few points over 1%.  The strain on the European Economic Community from the Greek financial cliff-diving, to be followed soon probably by Spain and Portugal at a minimum, will be long-lasting.  Currently most of the clean up work is being financed by German tax payers with the French close behind.  As those countries national debts approach 100% GDP and beyond there is no more strength in the European Union. 

As we watch and feel the effects, currently benefits from lower rates as investors buy our bonds instead of theirs, of European economic failures due to excessive government spending and high taxes, I hope those in charge of spending in Washington (and Sacramento) are learning something.  As a reminder our current national debt is almost 90% of our GDP and climbing.

Rates for Friday April 30, 2010: Daily volatility continues in the mortgage market.  Helping rates this week were the downgrades of Euro-debt and the Goldman-Sachs charges moving investment money from equities to quality, i.e. bonds and mortgages.  With the Fed holding steady on rates and language and no confirmation of when it will begin to sell the $1.26 Trillion in mortgages on its balance sheet investors are waiting for those shoes to drop and briefly bid up rates for the week.  Quickly countered by Greece and Wall Street.

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional 4.807%                            Down 0.068

30 year conforming-jumbo 5.00%                     Down 0.125%

30 year FHA    4.75%                                      FLAT

30 year FHA jumbo 4.875%                            Down 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, 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 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.

We’ve had the April showers, and wind, tomorrow I expect to see May’s flowers!  I am available throughout the weekend if you have any questions for me or help putting together a mortgage package.

Have a great week,

Dennis