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Mortgage Market
Perspectives
July 31st, 2009
by
Cameron Findlay
Chief Economist
11115 Rushmore Drive
Charlotte, NC 28277
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INTRODUCTION
This is the first installment of “Mortgage Market Perspectives” to be published on a quarterly
frequency, usually one month post the closing of each quarter. The goal of this document is to
provide a brief perspective on the key economic and mortgage related market influencesdescribed in a manner that make reading this material interesting.
We always welcome suggestions, please send us yours Cameron.Findlay@LendingTree.com
HIGHLIGHTS
The mortgage origination process is overheating under weight
of new guidelines. The risk is extended origination times
thereby constraining the flow of mortgages the Fed can
purchase and restricting its influence.
Economic Stabilization Act is having the desired impact on
Mortgage rates keeping them low. Paying interest on the excess
reserves held at the Central bank will allow the Fed to control
its balance sheet operations and rate policy objectives separate.
Measuring inflation has always created a healthy discussion of
what exactly are the measures we should monitor? Below we
make the argument that CPI and PPI alone do not suffice and a
third measure GDP Price Deflator in these times may be a goodbenchmark.
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MORTGAGE EXPOSURE
ORIGINATION CONSTRAINTS
The mortgage application universe is presently comprised of
53% Refinance applications at a time when 30yr Fixed Rates
Mortgages are ~ 5.44% assuming 1pt. To provide perspective
that’s way down from the 85% high back in January of this year
when rates hit their national average low of 5.08%, suggesting
as rates declined refi volume would pick up.
Fast forward from January to April 28th
rates hit their low point
of 4.85%. The Refi volume which you would have expected to
jump, staggered at just 75% which was well below the 85%
despite lower rates. More recently between June and July rates
came down but Refi volume which you would expect to pick uphas also declined bottoming out at 46% by the end of June.
[Fig 1] Note : Rates Inverted on Left Axis
Refi Volume decline
despite rates
directionally heading
lower
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MORTGAGE RATES (VS) TREASURY MARKET
Traditionally looking to the Bond Market specifically 10yr
Treasuries was guidance enough for brokers eager to
communicate future direction of mortgage rates, that was
yesterday. Below in [Fig 2] you see the spread between noterates and 10yr Treasuries on the right hand scale presently at
~170bps or 1.70%.
Buoyed by indecision regarding inflation and exposure to
foreign central bank buying of the huge supply of Government
debt 10yr Treasuries have been noticeably poorly correlated to
mortgage note rates.
[Fig 2]. 30yr Fixed Mortgage Rates (assuming 1pt) vs 10yr Trsy
Looking back 10yrs for example this historical median spread
has been 150bps, not too different from where we are today at
170bps. This doesn’t suggest much other than a comfort
10yr Treasuries
against consumer
mortgage rates
for a 30yr Fixed
Spreads have
finally started to
align to their
historical median
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knowing where things have been, spreads can easily gap out
again. The basic difference in these two items is the “risk
premium” assumed by investing in a Mortgage instrument vs a
risk free treasury investment. There are more technical measures
we use to calculate this but bottom line as a consumer recognize
when the expectation of default is high mortgages rates will be
higher, over and above what’s happening in the treasury market.
Use caution if you are only monitoring the Treasury market.
INFLATION RISK
KEY ECONOMIC INDICATORS
Most inflation indicators build their data from two key
indicators;
[1] Consumer Price Index [CPI] a measure of price changes in
consumer goods and services (items like gas, food clothing and
auto’s) it’s published by the Bureau of Labor Statistics.
CPI Data takes the perspective of the purchaser.
[2] Producer Price Index [PPI] is measuring the average change
over time in selling prices by domestic producers of goods and
services and is comprised of a family of indexes. It’s also
published by the BLS but takes the perspective of the seller.
For your consideration, when measuring inflation I’d suggest athird item might provide more insight relative to current
economic times, it’s the GDP Price Deflator.
Some quick but painless math that will help calculate and
understand why the GDP Price Deflator is a great index to
monitor, especially in this market.
Nominal Real GDP Price Yr / Yr
GDP GDP Deflator % Chg 2006 13,370 11,356 117.74 2007 14,031 11,621 120.74 2.6% 2008 14,200 11,522 123.24 2.1%
Consumers ability
to substitute for
lower priced
goods exposes the
deficiency of CPI
as a sole measure
of Inflation
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The “Yr / Yr % Change” which can be considered inflation
guidance is being derived by calculating Nominal GDP divided
by Chain Weighted GDP and is measuring PRICE changes
while excluding the increase in GDP due to increases in
Quantity.
[Fig 3].CPI (vs) GDP Price Deflator -Measured YOY %
Change
[Fig 3] Shows current CPI change year over year measured at
the rate of (1.40%) versus the GDP Price Deflator published by
the Bureau of Economic Analysis as +2.14%.
The “GDP Price Deflator” provides a method of over coming
some of the deficiencies of CPI data which is basically
constructed from a “Fixed Weight” applied to a basket of goods.
Using a fixed weight system in CPI does not considerconsumers basic choice of substitution, where prices have
fallen. If you have ever shopped at health food stores (think
premium pricing, premium goods) and have converted back to
your local grocery store (generic brands) you have caused a
ripple in CPI
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Noticeably [Fig 3] the CPI numbers (Blue) are painting a
picture of very low arguably too low a drop as compared to
GDP Deflator (Red) which shows a decline but not as drastic as
CPI might indicate.
DOCUMENT INFORMATION
This material has been prepared by Cameron Findlay, the opinions contained within this report (which
are subject to change without notice) are his own and may not represent LendingTree’s (or its
affiliates) views on the market. LendingTree (and its affiliates) issue publications from time to time for
informational, educational and promotional purposes only. The data and analysis presented are based
upon information obtained from sources that we consider reliable and any mention of levels or prices
are indications only and do not represent firm market levels. Changes in market conditions since the
issuance of this document may affect some or all of the levels and prices listed. We make no
warranties, express or implied, regarding the accuracy or completeness of any information, analysis,or opinions presented. No part of any LendingTree publication may be reproduced in any manner
without the written permission of LendingTree, LLC. LendingTree (and its affiliates), its employees,
agents, and contractors are not registered investment advisors, financial advisors, or broker dealers,
and they are not acting in a fiduciary capacity. The information contained in this newsletter does not
constitute a recommendation, offer to sell, or solicitation of an offer to purchase any particular
investments or products, including without limitation securities of any companies discussed, and it
should not be construed or relied on as such. It is the reader’s responsibility to evaluate the suitability,
risks, and merits of any investment, funding strategy, or business proposal presented in this
publication. The products mentioned in this document may not be eligible for sale in some states or
countries, nor suitable for all types of investors; their value and the income they produce may fluctuate
and/or be adversely affected by exchange rates, interest rates or other factors.