Investors Shift Back to Stocks

Investors became more comfortable during the week that the worst of the credit crisis has passed, and that turned out to be bad news for mortgage markets. While it may seem counterintuitive, the credit crisis originally drove conforming mortgage rates lower. During the early stages of the credit crisis, investors responded to the uncertainty by shifting funds to relatively less risky assets such as bonds, including agency mortgage backed securities. Now they are reversing their portfolios back to a more typical allocation. In general, that means buying more stocks and selling bonds. The stock market surged during the week, while mortgage rates jumped.

The monthly inflation data was expected to be the week's major story, and all through the week Fed officials talked up the threat of higher future inflation. The Fed's Fisher, in particular, warned "against inflating our way" out of the credit crisis and suggested that further rate cuts may just "compound the problem". The actual results contained few surprises, however. As expected, the March Core Consumer Price Index increased at a 2.4% annual rate, which is higher than the Fed would like to see. With energy prices at record highs, the inflation threat must be taken seriously. As a result, investor expectations for the number and size of future Fed rate cuts diminished.

In the housing sector, March Housing Starts fell to 947K, far below the consensus forecast, and the lowest level since March 1991. Building Permits, a leading indicator for future housing market activity, showed similar declines. Analysts consider a drop in the construction of new homes to be a vital step for the housing market to turn higher. Rising inventories of unsold homes are a drag on prices, and a smaller supply of new homes will help reduce the surplus.