MARKET RECAP
Homebuilders are showing signs of waking from their slumber. Construction of new homes jumped 17% in May to an annual rate of 532,000 units, according to the Commerce Department, while applications for new home permits rose 4% to an annual rate of 518,000 units. Much of the increase was attributed to the 61.7% spike in multi-family housing starts, but not all. It’s worth noting that single-family starts posted a gain as well. Despite the increased activity, homebuilders remain cautious. The outlook for home sales has improved somewhat in recent months, to be sure, due largely to the implementation of the first-time home buyer tax credit and gains in housing affordability. Looking forward, though, homebuilders are facing a few headwinds, including expiration of the $8,000 first-time buyer tax credit at the end of November, a continuing lack of credit for housing production loans, and a recent upturn in mortgage rates. Fortunately for homebuilders and the rest of the housing market, mortgage borrowers found some relief last week, with rates dropping across the board for most types and durations. According to Bankrate.com’s national survey, the benchmark 30-year fixed-rate mortgage dropped 19 basis points to average 5.76%, while the benchmark 15-year fixed-rate mortgage dropped 18 basis points to average 5.24%. Mortgage rates could drop further this week, given last week’s very favorable data on inflation. On the producer front, prices rose 0.2%, in May, with higher energy prices offsetting a drop in food prices, while the core producer price index, which excludes food and energy prices, actually fell 0.1%. Consumers are finding more stable prices as well. The consumer price index rose 0.1% in May, with the core CPI, which, like the core PPI, strips out volatile food and energy prices, also rising 0.1%. Even more encouraging, the CPI has posted a decline of 1.3% over the past year, the biggest year-over-year decline since 1950, which is somewhat remarkable, considering the recent spike in oil and gas prices and the trillions of dollars in government spending.
Lower Rates Aren’t In The Bag
Last week’s drop in mortgage rates was a welcome relief, and you would think that more relief should be forthcoming. After all, inflation appears to be a dead issue, given recent data on producer and consumer prices. Inflation and interest rates are highly correlated: When one falls, the other usually falls in tandem. But there is more to the story than inflation. All interest rates are determined relative to risk-free market interest rates, with short-term Treasury bills serving as a proxy. But most interest rates are not risk-free. Mortgages rates are certainly not risk-free, which is why they are higher than Treasury bill rates. What’s more, mortgage rates are heavily influenced by rates on mortgage-backed securities (MBS). MBS rates, in turn, are heavily influenced by yields on Treasury bills, notes, and bonds. And there is the rub. Treasury securities prices tumbled last week after the government announced $104 billion in debt auctions. As rates on Treasury securities increase to attract buyers, there is a crowding out effect, because Treasuries compete with other debt instruments for buyers. If Treasury securities must raise their yields to attract buyers (which happened last week), then so do most other debt securities; hence, a possible increase in mortgage rates. We can’t be sure what impact this crowding effect will have. Rates could go higher, but they could go lower too, particularly if the Federal Reserve continues to implement its $300-billion program to create demand and keep a lid on rising rates. But why chance it? Thirty-year fixed-rate loans averaging between 5.5% to 5.75% are still a very good deal, as are the deals found on most existing and new homes on the market.
