Monday, January 26, 2015

ECB Embraces QE: Why We Should Care

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January 26, 2015

ECB Embraces QE: Why We Should Care
It's probably best to begin by defining acronyms. The ECB is the European Central Bank, the European Union's (EU) equivalent to our Federal Reserve. QE refers to quantitative easing. QE is something our Fed commenced in 2008 and ended late last year. QE, of course, refers to a central bank buying bonds and other assets, which it pays for with new money, thus injecting new money into the economy.
The end result of QE, as we know from experience, is lower interest rates, including lower mortgage rates. From 2008 to 2013, the rate on the 30-year loan dropped three percentage points to 3.5%. The 30-year loan isn't quite that low today, but it's close: has the 30-year loan averaging 3.81%; Freddie Mac has it averaging 3.63%.
Will mortgage rates hold current levels?
Many economists believe the Fed will begin to raise the federal funds rate in the second half of 2015. Raising the fed funds rate raises lending costs to banks. Interest rates, therefore, are prone to rise. In the past, this is how it all played out.
But today isn't like the past. QE is a relatively new phenomenon. It was new when the Fed undertook it in 2008. It is new when the ECB undertakes it this March. European QE is expected to run through September 2016. By then, the ECB is expected to have injected another 1.1 trillion euros into Eurozone economies.
How far European interest rates will fall is anyone's guess. As it is now, interest rates in Germany, Europe's economic powerhouse, are already very low. A 10-year German bond yields roughly 45 basis points. The U.S. Treasury equivalent yields roughly 1.8% – more than four times the German bond.
So what does this mean to us?
We think that we'll see continued strong demand for U.S. Treasury and mortgage agency debt. Relative to European government debt, U.S. Treasury debt looks attractive. We're already seeing strong demand for U.S. dollars. A year ago, it took $1.36 to buy one euro. Today, it takes $1.14. We expect that many of these dollars will flow into U.S. financial assets, including long-term U.S. debt. The ECB's QE should help hold U.S. interest rates down, all things constant.
But we have to offer a caveat: all things aren't constant. Mortgage demand is again on the rise. The MBA reports that applications increased 14.2% last week. The MBA's refinance index was up was up 22%, the purchase index was up 3%.
Over the past year, we've seen underwriting standards on conventional loans ease. As for government loans, HUD's 50-basis-point reduction of PMI premiums on FHA loans have helped lift demand. If demand continues to rise, it's possible mortgage rates could rise to take advantage of rising demand.
That said, we expect today's low interest rates to hold through the first quarter of 2015. But as it is with interest rates, there are no guarantees. So we see little upside to procrastinating.


Date and Time
New Home Sales
Tues., Jan. 27,
10:00 am, ET
448,000 (Annualized)
Important. Sales should trend higher on rising construction and strong job growth.
Mortgage Applications
Wed., Jan. 28,
7:00 am, ET
Important. Sustained low rates should raise demand for mortgage financing.
Pending Home Sales Index
Thurs., Jan. 29,
10:00 am, ET
0.5% (Increase)
Important. Sales look poised to move higher on rising home-purchase affordability.
Gross Domestic Product
(4th Quarter 2014)
Fri., Jan. 30,
8:30 am, ET
3% (Annualized Increase)
Important. The U.S. will continue to have the strongest economic growth among Western developed countries.


Still Up for New Housing
Home builders were slightly less optimistic in January compared to the previous month. The NAHB/Wells Fargo Housing Index dipped to 57 from 58 in December. Fifty is key, though. A reading above 50 means builders view the outlook favorably. The good news is sentiment has consistently held above 50 for the past 12 months.
We're not surprised confidence remains elevated. Housing starts increased 4.4% to 1.089 million units on an annualized basis in December. Single-family housing starts were particularly strong, rising 7.2% to 728,000 units on an annualized basis. History leads us to believe that starts should continue to trend higher.
Housing starts and completions had an outlier surge after the bursting of the tech bubble in 2000. The surge continued to 2007. As we know, single-family starts and completions then fell off a cliff and bottomed in 2011. Activity remains below the historical annual average of around one million single-family starts. In other words, we have plenty of room to run.
Factor in basic economics, and there is even more reason to be optimistic. A dearth of new supply coupled with increased demand and inexpensive financing options points to a very good year for new home sales.
Article Courtesy of Patti Wilson, American Momentum Bank.

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