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Your Interest Rate Update

June 12, 2009

Who's afraid of a little inflation?

Granted, if you missed the latest window of opportunity with super-low interest rates, where they ranged between 4.625% and 5% for about 6 months - you might be a little bummed about the market's fears, and the recent rate hikes they've spurred.

But, from a home buyer's perspective, I always think it's best to find the home that meets your needs and goals, whether as a primary residence or investment property, rather than trying to time anything. Rushing to buy - simply because rates are low - is a little like buying that suit you don't really need - just because it's on sale. Sure, you saved a few bucks, but...you may have spent money, or bought a suit, you otherwise wouldn't have. And, to keep things in perspective, even if rates head back to the 6%s - and they will at some point - those are still great!

From the refinancing standpoint - absolutely, the last six months represented an unprecedented window of opportunity to lower your interest rate and net some real savings. A lot of people flew right through that window, saving them some real money. Others wanted to wait. Some were hoping for even lower rates. Others were riding the low points of their adjustable rate mortgages. And others may have just figured the savings they'd net weren't that important.

Either way, I do think there's a better than even chance we'll see 30 year fixed mortgage rates dip back down below 5% again. So, if you're at all bummed you missed the last window of opportunity, line up your ducks and be ready to move as soon as the next one opens. If it does, I don't think it'll be as long lived as this round. But, the recent run higher is a little out of place, too.

What's driven mortgage rates and Treasury yields up recently, are fears of inflation stemming from all the stimulus/recovery/bailout efforts, the burgeoning supply of Treasuries issued to fund those efforts, and hopes that those efforts are returning our economy to growth - so money is flowing out of "safe haven" investments back into riskier equity markets, that "could" yield greater returns.

However, here's why I think inflation will likely be kept at bay. Why the supply of Treasury issuance and Federal Reserve's balance sheet growth is manageable (at least in the short and medium term). And why our economy will not return to trend growth (3%+ GDP growth) for some time, which will likely subdue corporate and equity returns, allowing investors to keep money in Treasuries and bonds, without suffering significant lost opportunity costs.

I believe inflation will remain in check because of the massively deflationary impact of the housing and credit bubbles bursting. Our economy, more than two thirds of which is driven by consumer spending, is healing and will heal. However, the base line is likely to be somewhat lower than what we've seen over the last 20+ years.

In order for inflation to really take hold, we need to see upward wage pressures, in addition to an increase in the cost of goods. Currently, both of those metrics are heading backwards. Yes, we're seeing a slow-down of job losses. That's a good thing. But, by looking deeper, we see that average wages, and hours worked are being cut. The average work-week dropped to 33.1 hours for May, and average weekly earnings have dipped by .7%, on an annualized basis, over the last three months. That means that companies are saving money on labor, without hacking quite as many jobs.

So, what happens if you're working fewer hours, and making less per hour? You might stop spending as much. And, since you don't have the ol' housing ATM, and your 401k/retirement account value has probably been hacked, you might be trying to SAVE money, while also spending less.

It follows from there, that if income and hours worked are down, spending is down, and savings are up, companies vying for your business - and believe me, they're vying - "might" lower prices to entice you to buy. Basically, businesses have absolutely no pricing power right now. Anyone shopped for a car lately? There are some amazing deals. But, car sales are still in the tank. So, looking solely at a decrease in headline job losses can be misleading.

Beyond that, during the Consumption Era that peaked in the early 2000s, way too many malls, office buildings and homes were built. Companies ramped up their capacity to feed what they didn't realize could be short-term demand. How often do you ask yourself "Geez, there's a Starbucks (or name your chain store) here? Didn't I just pass one down the street?" In Sacramento, I do it all the time - or used to. There is a pretty large oversupply and overcapacity for almost everything, it seems. As a business, that's now a cost-center, not a profit center. So, they'll continue cutting that overhead, one way or another.

To whom will companies sell their wares to make profits? Without a return to strong consumer demand - and spending driven growth - where will inflationary pressures stem from?

Some say they'll stem from all the new money rolling around that the Fed is flushing into the system, and that because we're financing that influx through debt, our debt servicing costs will rise, driving inflation from that side too. I'm not convinced that will necessarily lead to uncomfortably high inflation, either.

So far, despite unprecedented Treasury issuance and a few scathing remarks from China's Ministers, foreign demand for our Treasuries has actually grown, with foreign participation at yesterday's bond auction coming in at 49%.

Additionally, Japan's Finance Minister, made a strong statement affirming his comfort with US Treasuries, and his belief that current yields are "attractive." Since Japan owns nearly as much of our debt as China, within a 100 billion or so at $687 billion, those words carry some weight. Granted, some of that may be reciprocal stroking, but... it still bears consideration.

The growth of the money supply and the Fed's balance sheet can also be unwound relatively quickly, as most of it was short-term in nature. And, so far, much of that extra money is still sitting on the sidelines in case they need to cover future losses. Moreover, according to the Fed, that money can "simply be allowed to run off as the programs and facilities are scaled back, or shut down" which will soak up much of the liquidity they've injected into the system.

And lastly, I believe - although I might be wrong and maybe missed a golden buying opportunity at March 2009's stock market low's - that the "green shoots" people are seeing are merely fuzz that will be mowed once or twice before our economy really heads back towards trend growth. A review of the Fed's latest Beige Book economic summary highlights: "Reports from the Federal Reserve Banks indicate that overall economic activity contracted further or remained weak. However, five of the twelve Districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level." So, in less than half of their reporting districts, things were "less bad."

Additionally: "Manufacturing activity weakened across a broad range of industries in most Districts, with only a few exceptions." And: "Downward pressure on prices was reported across Districts." Then: "Districts that report on nonfinancial business services said demand continued to fall across most industries."

Plus: "Consumer spending remained generally weak." And: "Housing markets remained depressed overall, but there were some signs that conditions may be stabilizing. New home construction activity fell further, however, as inventories remained elevated. Home prices continued to decline in most Districts, although a few reports noted that prices were unchanged or that the pace of decline had eased." And on the commercial property front: "Nonresidential real estate conditions continued to deteriorate over the past six weeks. Demand for office, industrial and retail space continued to fall, and there were reports of increases in sublease space."

If I'm correct, then we're looking at a period of slowly slogging along a lower plateau of economic performance. In that environment, I think it's likely equities will slide again as the reality sets in that we're going to get a period of "less bad" but not "good" news on corporate earnings, layoffs, and our long climb out of our Consumption Era, as we work to find a new "normal" foundation to foster economic growth.

For all those reasons, plus the fact that the Fed is still buying Mortgage Backed Securities and Treasuries - they're about half-way through what they said they'd buy, which can be extended if needed - I think we could see another dip in mortgage rates. If it's important to you, be ready.

If there's one thing that's certain, these low rates cannot and will not last forever. In fact, the Fed Futures market is betting a 58% chance of a Fed rate hike by November. I think that's ludicrous, based on the economic backdrop, but.... that's just my opinion. I could be wrong. It has happened before...

And, keep in mind - this is a short-to-medium term forecast (or educated guess, really). Our deficits and entitlement programs will need to be dealt with, in the medium-to-long term, which adds another layer of complexity to managing steady economic growth, interest rates, and inflation. Fortunately, I don't have to navigate those decisions. I'll just report my thoughts.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me. Here are today's rates. Cheers! E

Conforming	Rates	Points	APR	Loan Amt	Payment
30 yr fixed mortgage	5.125%	1	5.365%	$300,000.00	$ 1,633
15 yr fixed mortgage	4.750%	1	4.950%	$300,000.00	$ 2,333
3/1 ARM	4.250%	1	4.440%	$300,000.00	$ 1,476
5/1 ARM	4.750%	1	4.960%	$300,000.00	$ 1,565
5/1 ARM Int Only	5.000%	1	5.260%	$300,000.00	$ 1,250
Jumbo (ask me about the new limit, per your zip code)
30 yr fixed mortgage	6.750%	1	8.010%	$550,000.00	$ 3,567
15 yr fixed mortgage	6.000%	1	6.255%	$550,000.00	$ 4,641
3/1 ARM	4.875%	1	5.055%	$550,000.00	$ 2,911
5/1 ARM	5.750%	1	5.970%	$550,000.00	$ 3,210
5/1 ARM Int Only	6.000%	1	6.250%	$550,000.00	$ 2,750
Rates subject to change without notice.
These rates and statistics are for informational purposes only to give you a sense of market movement and my opinion as to why. Although these rates exist today, based on certain qualifying characteristics, your scenario may allow for lower or higher interest rates. Licensed by the CA Dept of Real Estate, #01760965. Equal Opportunity Housing Lender. If you'd like to be removed from this list, please reply with REMOVE in the subject line. You can also use this link, mailto:egrathwol@priority1stmortgage.com and add REMOVE to the subject line. To add someone who would appreciate this information, send me their email with SUBSCRIBE as subject.