- The Washington Times - Friday, June 12, 2009


Over the last few weeks I have received a fair amount of reader e-mails, but a recurring theme has developed more recently.

Boiling some of these themes down led to two central questions that more or less dealt with mortgage rates - does it make sense to consider locking in now, and what are the near-term prospects for inflation compared with the concern of disinflation only a few months ago?

Both of these are not only good questions given the current environment, but the answers to both are also more complex than it would initially appear. Moreover, certain aspects of the answers are interrelated.

As I touched on previously, interest rates have been rising over the last several weeks and a number of factors contributed to that increase: inflation, economic growth and monetary policy. Thirty-year fixed mortgages reached 5.74 percent earlier in the week, up from 5 percent two weeks ago and a low of 4.85 percent in April, according to Bankrate.com. To put this into perspective, 30-year mortgage rates are now back at levels last seen in December 2008.

Why did those rates fall to such lows? Earlier in the year the Federal Reserve was purchasing debt in order to help bolster a fragile economy by driving down interest rates. In March, the Federal Reserve announced a plan to buy $300 billion in Treasury securities, which had some success in moving interest rates down. Those lower rates helped do two things: Get consumers off the sidelines and back into the housing market, and encourage existing homeowners who could take advantage of lower rates to refinance their mortgage payments, giving them more disposable income to throw at the economy.

While that happened, unemployment claims have mounted, oil prices have risen as prices for other commodities have bounced off their respective lows, and the 10-year Treasury yield has climbed in recent weeks amid concern about the federal deficit.

In recent weeks, we have gotten signs that the worst of the economic turmoil may be behind us. To be fair, that does not necessarily mean that things will be dramatically better, but in this case the markets are welcoming what can be termed “fewer losses.” Not exactly comforting, but better than “more losses.”

Make no mistake: While up from their lows, mortgage rates are still historically low by comparison and far lower than levels reached in the second half of 2008 when mortgage rates were north of 7 percent.

At the heart of this is what I would call “expectations,” which at times may not be rational. In this case it surrounds the expectations that rates will head lower, which may or may not be grounded in reality.

As interest rates and mortgage rates have risen over the last several weeks from near 50-year lows, there has been a blow to housing activity. The number of Americans signing contracts to buy previously owned homes climbed 6.7 percent in April due to favorable interest rates. However, as borrowing rates climbed, refinancing activity fell. The weekly data confirm a similar change. On Wednesday, the Mortgage Bankers Association’s Weekly Mortgage Applications Survey for the week ending June 5 showed a 7.2 percent decrease in mortgage loan application volume and a 12 percent drop in refinance activity, both compared with the previous week. Driving this was a climb in the average contract interest rate for 30-year fixed-rate mortgages to 5.57 percent from 5.25 percent.

What is as disconcerting to me is the upward move in oil and gasoline prices of late, as well as a pickup in other commodity prices. Yes, for the most part these are down from year-ago levels, but as with interest rates, they appear to have bounced off their lows and are again on an upward trajectory.

On a combined basis, this has me pondering a rise in inflation along with interest rate and mortgage issues, not to mention prospects for a continued, albeit slower, upward move in the unemployment rate. Despite the recent reprieve in jobless claims last week, consensus forecasts call for the unemployment rate to climb further from recent levels.

Wednesday saw the release of the Federal Reserve’s most recent Beige Book, which describes the current economic conditions of each Federal Reserve Bank in its respective district. Wednesday’s report showed that economic conditions remain weak. The report found that labor market conditions continue to be weak and that both commercial real estate and labor markets continue to face challenges.

Adding this all together, if inflation does rear its head, the Fed will raise rates and have to balance that activity with stalling what is at best a fragile recovery. If we return to economic growth, odds are the Federal Reserve will raise rates from today’s near-zero short-term rates in order to manage inflation and help manage growth as they have done historically. If concern over the size of the federal deficit continues, then odds are that rates will move higher. Seems to me that no matter how you slice it, rates will be heading higher before moving lower on a sustained basis. Don’t be surprised to see refinancing activity heat up once this becomes more evident. No one wants to catch a falling knife, but sometimes when you can time it right, it’s not all that bad. So the answer to the question is: Yes, I would be looking to take advantage of rates before they move even higher near term or long term.

Chris Versace is the director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston. He can be reached at [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.

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