Weekly Market Update

Keeping you updated on the market!
For the week of

September 27, 2010

MARKET RECAP

Patience is a virtue on so many levels: It preserves sanity; it prevents rash behavior; it maintains perspective.

Patience has been in short supply since the expiration of the federal homebuyer tax credits at the end of April. Each drop in home sales over the subsequent months has tilted the consensus expectation toward a double-dip recession, while each bit of bad news has been extrapolated into 2011 and beyond.

We don't want to jump to conclusions – a double-dip recession isn't beyond the pale – but sometimes it helps to think in longer periods instead of shorter ones. For instance, we expected to see a housing sales dip following the tax-credit expiration and we weren't surprised to see the dip extend several months out. (We'd seen the same scenario unfold in the auto industry.) However, we have been surprised at the number of pundits who were surprised that there was a sales drop. As Mark Twain said, “History doesn't repeat itself, but it does rhyme.”

Four months hence, it appears the dip (and the rhyme) is playing itself out. Housing starts posted a larger-than-expected rise in August, boosting hopes that the housing market could be poised for a turnaround. On that front, residential starts increased 10.5 percent, the largest gain this year, to reach a seasonally adjusted annualized rate of 598,000 units. The increase suggests that September's housing market index – a gauge of homebuilder sentiment – will post meaningfully higher than August's lowly 13.

Existing home sales have been expressing a similar willingness to regain lost ground. Sales of previously owned homes rose 7.6 percent in August, increasing to an annual rate of 4.13 million units. The increase has helped ease inventory concerns, with the supply of existing homes dropping 0.6 percent to 3.98 million units available for sale, which represents an 11.6-month supply at the current sales pace.

Meanwhile, the price of existing homes has held firm, posting a median price of $178,600 in August. To be sure, pricing remains a concern. The FHFA home price index posted a slight decline in July and price expectations from most economists are for more slippage. Overall, prices are expected to remain relatively firm compared to the recent past.

Mortgage rates also continue to experience some slippage, but to most borrowers it has been hardly noticeable. This is surprising considering the Federal Reserve publicly stated that inflation is too low and that inflation is inconsistent with the central bank's mandate "to promote maximum employment and price stability." In other words, the prospect of the Fed injecting even more money into the banking system had little impact on mortgage rates this past week.

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Economic
Indicator

Release
Date and Time

Consensus
Estimate

Analysis

S&P/Case-Shiller
Home Price Index
(July)

Tues, Sept. 28,
9:00 am, et

3.2%
(Increase)

Important. The consensus estimate is for a price increase, but a decrease is more likely.

Consumer Confidence
(September)

Tues, Sept. 28,
10:00, et

54 Index

Moderately Important. Confidence has stabilized in recent months.

Mortgage Applications

Wed, Sept. 29,
7:00 am, et

None

Important. The impact of low mortgage rates on activity continues to diminish.

Gross Domestic Product
(2nd Quarter 2010 Revised)

Thurs, Sept. 30,
8:30 am, et

1.6% (Annualized Growth)

Important. GDP growth has been revised down in recent months, but it is expected to pick up heading into 2011.

Personal Income
& Outlays
(August)

Fri, Oct. 1,
8:30 am, et

Income: 0.2% (Increase)
Outlays: 0.3% (Increase)

Moderately Important. Moderate growth in income and outlays will keep price-inflation subdued.

Construction Spending
(August)

Fri, Oct. 1,
10:00 am, et

0.4%
(Decrease)

Important. Residential spending should show some improvement.

Inflation or Deflation?

Whether a Federal Reserve action is inflationary or deflationary is difficult to gauge, for the simple fact that there isn't a definitive definition of inflation and deflation. Some economists argue that rising prices are a measure of inflation while falling prices are a measure of deflation. That's too simple, though, because there are many variables that influence prices – supply and demand, technology and money supply to name the obvious. It's impossible to gauge which variable has the greatest impact.

A change in money supply is the less vague interpretation, especially when measured by base money – money the Federal Reserve injects into the banking system. On that basis, we are definitely in an inflationary cycle. (Yes, consumer prices have remained relatively stable, but assets prices have not.) The amount of money commercial banks have on reserve with the Federal Reserve has increased many-fold over the past two years. This money is a potential source of price inflation: when it's lent, it will have a multiplying effect on the overall money supply that will likely be reflected in consumer prices and mortgage rates.

The question is when. We don't know, but when banks hold record-levels of reserves, the pressure increases to lend those reserves. This is why we think price inflation will be the overriding concern down the road. Price inflation, in turn, will be reflected in higher mortgage rates, and possibly much higher mortgage rates. This is one of many reasons we keep importuning homebuyers and refinancers to act now.