by Kevin Whatley (NMLS #113781)

Last week in the mortgage markets was thick with hype and thin with action.

Whenever the Fed meets, there is potential for wild swings in mortgage rates. And, although the Fed doesn’t control mortgage rates, it’s views on inflation and the economy carry tremendous weight with traders, with economists, with banks, and with governments across the world.

It’s the opinions of the Fed that cause mortgage rates to move in one direction or the other.

In its press release, the Fed stated that inflation remains “somewhat elevated” and that its predominant concern is that inflation “will fail to moderate as expected”. The remarks were slightly more defensive on inflation than expected, but markets took it in stride.

For now, markets are focusing on the American Consumer’s ability to push the economy along in the face of rising gas prices, weakening sales at retail stores, and other cost of living increases. This plays directly into Tuesday’s Consumer Price Index (CPI) data.

CPI measures the expenses of everyday living for Americans and — even excluding gas and food prices — it is expected to increase. Because personal income is usually a fixed number, rising costs force people to eventually make difficult choices and the usual casualty is “free spending”.

Less spending slows down the economy so if CPI is higher than expected, there will be downward pressure on mortgage rates in response.

In addition, keep Wednesday’s Housing Starts number in the back of your mind.

Housing’s well-publicized weakness on a national level is no longer moving the mortgage markets but if this figure is unexpectedly hot, mortgage rates will bounce higher on speculation that the worst of the housing market is over. That runs contrary to the current opinion in trading pits that have watched a precipitous decline over the last 24 calendar months.

Mortgage rates will be extremely volatile at the beginning of the week and should taper to relative calmness by Friday barring any jarring, non-economic forces.

When consumer spending slips, it can send shockwaves through the economy. Consumer spending, after all, makes up 70% of the economy.

The best measure of consumer spending data is Retail Sales, a monthly figure describing how much money Americans are spending, and where they’re spending it.

Retail Sales unexpectedly fell in April and that would usually push mortgage rates lower on the prospect of a slowing economy.

Not so much this month, though, and the answer lies in the sector-by-sector breakdown.

Against expectations of a 0.4% increase, sales were down 0.2% in April. That downturn was clearly led by the performance (or lack thereof) in the Building and Garden Stores sector.

Its sales decreased by 2.3% month-over-month and the industry served as a parachute slowing down spending that is, otherwise, consistent and strong.

As we keep hearing in the press, housing is the most likely candidate to slow down the economy. It’s not a surprise or a secret and markets are acutely tuned in to the sector.

So, as Building and Garden lays an egg and drags down the overall Retail Sales figures, markets shrug. Overall this week, mortgage rates are slightly higher, still recovering from the Fed’s press release Wednesday.

The Fed left the Fed Funds Rate unchanged again today for the seventh time in a row after 17 consecutive hikes. But, we knew that was going to happen.

The Fed’s press release highlights a growing concern in mortgage markets: growth is slowing overall even as inflation threats remain.

This combination is sometimes called stagflation, but has also be referred to as “slowflation” by economists that don’t want to invoke memories of the early-1980s interest rate cycle.

Mortgage markets did not take favorably to the Fed’s press release and mortgage rates are slightly higher this morning.

Source
Parsing the Fed Statement
The Wall Street Journal Online
May 9, 2007
http://online.wsj.com/public/resources/documents/info-fedparse0705.html

The Federal Open Market Committee meets today and markets will be hanging on their every word.

There is virtually no chance that the Fed will change the Fed Funds Rate from its current 5.250% level, so its the Fed’s press release that will get all of the attention.

We’ll disect the message in tomorrow’s blog post.

Important to know: The Fed does not control mortgage rates. At least not directly — their words can cause mortgage markets to make bets on the future and that can change mortgage rates.

The Fed only directly controls the Fed Funds Rate.

FFR matters to you and me because it is used to calculate Prime Rate, a popular consumer interest rate used for credit cards and home equity lines of credit.

When the Fed holds the FFR at 5.250%, it means that the interest rate on our collective credit card and home equity line debt will remain unchanged, too.

In his weekly syndicated column, Kenneth Harney pulled back the curtain on a nasty piece of IRS tax code that can penalize homeowners with foreclosures and short sales.

Because the IRS treats canceled debt as ordinary income, homeowners that “work something out” with their lender may inadvertently add tens of thousands of dollars to their annual tax liability.

According to the tax code, when a creditor agrees to cancel a personal debt of $600 or more, it is required to submit a 1099-C, Cancellation of Debt form to the IRS. And, when the IRS receives this form, it treats the canceled debt as income.

So, if your mortgage lender agrees to “forgive” $40,000 on your mortgage in a short sale, you are required to report that $40,000 as income to the IRS — even though you never physically held the $40,000.

This is how a person’s tax liability can dramatically increase. Imagine if you were taxed on $40,000 that you never “earned”.

Capitol Hill is taking steps to offer relief to homeowners by modifying the tax code related to cancellation of debt.

The Mortgage Cancellation Tax Relief Act of 2007 would amend the tax code to forgive debt cancellations on primary residences and is currently before the House Ways and Means Committee, the primary tax legislation body of Congress.

Data painted a dismal picture for the economy last week including tempering inflation readings, slowing job growth, depressed home sale data, and ever-higher gasoline prices. This gave markets hope that the Fed may start to ease up on the Fed Funds Rate.

But, while the stock market rallied on the news, the bond market continued its same blah performance that stretches back three weeks. Once again, mortgage rates were left relatively unchanged.

That all might end this Wednesday when the Federal Open Market Committee adjourns and releases its statement to the markets. Expect the Fed to hold the Fed Funds Rate at 5.250%, but as always, it’s not what the Fed does that matters as much as what the Fed says.

If the press release indicates that the Fed sees weakness in the economy, mortgage rates will fall. If the Fed indicates persistent strength in the economy, mortgage rates will rise.

In the Fed’s statement, expect to see verbiage about rising oil prices, stabilizing housing markets, and questions of the American consumer’s ability to sustain its spending habits.

Then, Friday morning, we’ll get our first look at how that question may be answered. The April Retail Sales report will be released at 8:30 A.M. ET and if it shows up weaker than expected, mortgage rates will fall.

Relocate-America.com selected Asheville, NC as their #1 city in the annual report “America’s Top 100 Places To Live”. This is the second time that the mid-size city of 70,000 ranked in the list’s Top 10, compiled since 1998.

Rounding out the rest of the Top 10:

1. Asheville, NC
2. Traverse City, MI
3. Ithaca, NY
4. Chicago, IL
5. Cary, NC
6. Portland, ME
7. San Francisco,CA
8. Stevens Point, WI
9. O’Fallon, MO
10. Spencer, IA

You can view this year’s complete list at http://top100.relocate-america.com/.

If yesterday’s ADP Employment Report is any indication, tomorrow’s jobs report may fall short of the 100,000 new job expectation from the Bureau of Labor Statistics.

ADP reported 64,000 new jobs were created in April.

The ADP report has never been in lock-step with the “official” report from BLS, including this well-publicized event in June 2006 when ADP reported 368,000 new jobs created versus the BLS’s figure of 121,000.

In that week, mortgage rates swooned on the ADP news and then tanked on the BLS report. To say traders were surprised at the discrepancy is an understatement. Mortgage rates jumped 0.25% and fell 0.25% within 48 hours.

In the past 11 months, though, the ADP report is growing increasingly more “accurate” with respect to the Non-Farm Payroll report from BLS and that is why yesterday’s 64,000 is getting some respect in trading pits.

If ADP is on track and job growth is lower than expected, mortgage rate shoppers should benefit from lower mortgage rates overall because fewer workers means fewer dollars spent in the economy.

There’s a palpable uneasiness in mortgage markets right now and Friday’s payroll report looms large.

Remember: it’s not the actual data that matters — it’s how close the data is to its expected levels.

All week, traders have been jockeying for position based on a projected 100,000 new jobs created and if the number is not 100,000, there will be a lot of scrambling.

If the actual figure is lower, than it signals additional weakness moving forward in 2007.

Fewer workers means fewer paychecks spent on food, clothing and housing so rates should retreat on economic weakness. Consumer spending, after all, makes up 70 percent of our economy.

The reverse is true if the actual jobs figure is higher. Rates should increase in that instance.

Expect a lull in market activity until tomorrow afternoon and then be prepared for shock waves Friday morning.

This is the last set of major data before next Wednesday’s FOMC meeting and it will be closely monitored by traders the world over.

Pop Quiz: Which interest rate is lower? 8.25% or Prime Rate?

If you answered anything other than “they are the same”, then you can understand first-hand why banks refer to Prime Rate by name instead of by number.

It’s a neat little piece of sales psychology that keeps people from recognizing their true cost of credit.

Prime Rate is based on the Fed Funds Rate and is pegged to be 3.000% higher. FFR is currently 5.250% (see chart at right) so Prime Rate is three percentage points higher, or 8.250%.

Since June 2004, Prime Rate has increased by 4.250% from 4.000% to today’s levels (again, see chart at right). During that time span, the interest rate paid on home equity lines of credit have increased by 4.250%, too. For many homeowners, this is surprising (and costly) news.

And it’s also one of the main reasons why Prime Rate is called by its name, and not by its value. Homeowners are less likely to pay attention.

For example, home equity lines of credit are based on Prime Rate and many homeowners know that their rate is “Prime + 0.500%”, or something similar. Many, however, are unaware of the actual number that is their interest rate.

As Prime Rate has increased, homeowners that aren’t paying attention to their mortgage(s) are carrying a household “blended” interest rate that may be much higher than anticipated.

What good is the 5.000% interest rate on the first mortgage if the second mortgage is clocking in at 9.000%? It may make sense to “rebalance” your loans to lower your overall payments because HELOCs are so much more expensive, relative to past years.

If you don’t know your household’s blended mortgage rate, or how changes to Prime Rate have impacted your monthly interest payment, ask your mortgage professional for help.