Market update for the week of June 23, 2104. "These “Twos” Really Aren't So Terrible"

MARKET RECAP These “Twos” Really Aren't So Terrible Bond markets were given a slight jolt this week on unexpectedly high consumer-price inflation. Specifically, the Consumer Price Index (CPI) jumped 0.4% month over month in May. This was the largest monthly increase since February 2013. The latest increase in consumer prices lifted annual CPI to 2.1%. This is within the Federal Reserve's tolerable inflation range, but it still raised a few eyebrows. Eyebrows were raised because inflation influences interest rates. When inflation rises, bond yields rise as well. At the same time, bond prices fall. Investors want to be compensated for lost purchasing power over time (which is the result of inflation). If investors anticipate higher inflation, they will demand a higher interest rate. The CPI was released Tuesday, and mortgage rates rationally rose. But they've actually eased back since. When we look at the national averages we don't see much change week over week: Bankrate.com's survey has the 30-year fixed-rate loan at 4.33%, a basis point lower than the previous week. Freddie Mac's survey pegs the 30-year loan at 4.17%, a three-basis point decrease. To be sure, the national surveys unlikely captured the full impact on rates when the CPI was released. (The 10-year U.S. Treasury note serves as a good proxy for the 30-year fixed-rate mortgage. You can see that the 10-year note's yield spiked higher .) But there is a mitigating factor for rates to remain subdued – low Gross Domestic Product (GDP) growth. We've been cautiously optimistic that growth would accelerate this year. Indeed, we've been encouraged by the trend in job growth, with the economy adding 200,000-plus new jobs each month for the past three months. This seemed like a good omen. Today, we are a little more cautious and a little less optimistic. This past week, the Fed cut its growth prediction to 2.2% from 3% for 2014. That's a sharp reduction and reflects the 1% economic contraction that occurred in the first quarter. The reduction also suggests the Fed is still wary that widespread predictions for an economic growth breakout will not occur. Low growth, in turn, will hold inflation at bay, because loan demand will remain muted. For anyone unfamiliar with how our banking system – which is based on fractional reserves – works, more lending increases the money supply. More money chasing the same amount of goods and services eventually leads to consumer-price inflation. Today, the 30-year fixed rate mortgage is as close to 3.5% as it is to 5% – the year-end prediction we proffered in January. So do we still think we'll hit 5% by the end of December? We have to confess that it's appearing less likely. That said, keep an eye on the monthly employment numbers, which are released the first Friday of every month. Should the economy continue to create jobs at a 200,000-plus rate each month, 5% on the 30-year remains a possibility.

 

Economic Indicator	Release Date and Time	Consensus Estimate	Analysis
Existing Home Sales (May)	Mon., June 23, 10:00 am, ET	4.7 Million (Annualized)	Important. Sales have yet to gain traction, but recent job numbers could lead to sales growth.
New Home Sales (May)	Tues., June 24, 10:00 am, ET	440,000 (Annualized)	Important. Sales have sputtered in recent months, but could trend higher on better weather.
Mortgage Applications	Wed., June 25, 7:00 am, ET	None	Important. Purchase activity points to sluggish sales activity.
Gross Domestic Product (1st Quarter 2014 Revision)	Wed., June 25, 8:30 am, ET	2.0% (Contraction)	Important. Downward revisions point to low economic growth through 2014.

 

Mixed News on Housing Existing home sales account for the majority of sales and mortgage-finance activity, but new home sales and construction contribute more to overall economic growth. Therefore, we were someone disappointed that housing starts eased in May, with starts falling 6.5% month over month to a 1.001 million annualized rate. Single-family starts dropped 5.9% after a 4.6% rise in April. Permits followed a similar pattern, falling 6.4% month over month. This suggests starts could tread water over the next month or two. That said, we could still see a pick up in starts based on home builder sentiment. The National Association of Home Builders' confidence index rose four points to a seasonally adjusted 49 in June. The future sales component also moved higher, up 3 points, to 59. This is the best reading since January. This is particularly encouraging, because the future matters more than the past. Topping our wish list, though, is rising purchase mortgage activity. Unfortunately, purchase applications – after posting a couple weeks of gains – decreased 5% in the Mortgage Bankers Associations' latest survey. With institutional buyers (cash buyers) pulling back, we want to see the individual owner-occupied buyer – the buyer likely to take on mortgage – move into the lead. We still haven't seen that. Until we do, we don't expect to see continual improvements in the housing numbers.