GDP 1.6%, Vigilant Fed

August 27, 2010 -- Economic growth has weakened to the point where we now have 1.6% GDP readings as bookends to the year-old recovery. After the deep recession, any positive growth readings are of course welcome, but the very muted pace of growth in the second quarter of 2010 isn't warm enough to feel much different than the recession did.

Addressing the audience at the annual Economic Symposium in Jackson Hole, Wyoming, Federal Reserve Chair Ben Bernanke detailed the Fed's disappointment with the present rate of growth, and stock markets were cheered that he took pains to express both optimism for the coming year and that the Fed still has tools it can employ to ward off deflation or even a double-dip recession. Frankly, what else could he say?

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Just as 1.6% growth is insufficient to produce much economic heat, cheap mortgage rates alone are insufficient to produce recovery in the housing market.

Each week, HSH produces an overall mortgage monitor -- our Fixed-Rate Mortgage Indicator (FRMI). The index continues to hang at or near all-time lows. The FRMI includes rates for conforming, jumbo, and most recently the GSE's "high-limit" conforming products and so covers much of the mortgage-borrowing public. HSH's FRMI declined by a two basis points (.02%) to 4.78% to close HSH's national survey. If you prefer a shorter-term fixed-rate period, it's hard to find the average interest rate for a Hybrid 5/1 ARM to be compelling. At 3.73%, it's more than a full percentage point lower than it's FRMI counterpart.

The second quarter GDP rate represents a considerable deceleration from the 5% rate seen during Q409, when optimism was growing and job losses fading. That boost lasted though the winter, but turned into a 3.7% rate in the 1st quarter, and now has again settled back again. The decline in the economy has been tracked by the Chicago Federal Reserve's National Activity Index, which sported a -0.7 figure in June, the end of the second quarter. However, the most recent report, covering July, found an improvement to a flat 0.0 figure, indicating that the economy likely returned closer to its natural annual growth rate of perhaps 2.7% or so. Of course, July's meager improvement was just the first month of the third quarter, and unfortunately, more recent data hasn't been very good.

Along with the broad economic slowdown, the hangover from the homebuyer tax credit "party" has become increasingly apparent. Arguments about its benefits or drawbacks aside, there can be no doubt that the credit has produced distortion in the housing market. The advancement of already weak demand into the spring of this year created a minor peak of sorts, and we are now deep into the valley on the other side, with (hopefully) no place to go but up in the coming months. Given the summer economic swoon and a lack of job growth needed to foment demand, a rebound will probably come later rather than sooner.

Existing Home Sales dropped by a shocking 27.2% in July, landing at a pace far weaker than expected. The 3.83 million annualized pace was the worst reading of either the recession or the recovery. Meanwhile, the slump in demand means that available supply ballooned up to 12.5 months, a level certain to put renewed downward pressure on home prices. Given the size of the drop from June's 5.26m rate, there is some hope that next month will bring an upward revision, but even if it does, homebuying has come to a virtual standstill.

New Home Sales told much the same tale. In July, an annualized sales rate of 276,000 units was revealed, the lowest in the 46-year history of the series. Worse, downward revisions to the last couple of months make the picture even bleaker, with May's already-pathetic showing ratcheted down to only 281K. There are still some 210,000 units built and ready to be sold on the market, probably the most difficult to sell units far from city centers and amenities, but it is quite clear that there is not enough demand to warrant any optimism among builders (or any economic boost from homebuilding) at this point.

There is perhaps a little irony in that among the worst housing markets in memory comes what might be the best refinancing opportunity ever... provided you can make it over the hurdles needed to access today's fantastic mortgage rates. Unfortunately, too few borrowers can, and while refinancing activity has picked up to a fair degree, the aggregate amount of activity so far is small relative to other refi booms and boomlets. With about 11 million borrowers underwater to some degree, there are a lot of people who might wish to refinance but cannot, and probably many millions more who lack the steady income needed to qualify.

While the economic recovery to date has been largely a production-led one of inventory rebuilding, there are continuing signs that the momentum from that burst of activity is fading. Orders for durable goods did manage an overall 0.3% increase in July, but all of the upward strength came in the form of transportation-related orders. Excluding them left a drop of 3.8%, and so-called "core" spending by businesses on items intended to last three months or more dipped by 1.5% during the month.

That ordering slump was reflected in two localized August readings of manufacturing activity by two Federal Reserve Banks. In the Richmond district, their measuring stick moved from a mark of 16 in July to 11 in August, still a fair level but a fourth consecutive decline from an April spike to 30. Over in the Kansas City region, a more pronounced fall to flatline was seen, as their indicator fell from 14 in July to 0 in August. It was the lowest reading in a full year.

Enthusiasm among consumers has improved a touch of late. The University of Michigan survey of Consumer Sentiment firmed by 1.1 points in the final August report, recovering just a little of an 8.2-point slump in July. Confidence readings remain near the at the lowest levels of 2010 and are comparable to the same July-August period last year, when the economy had just begun to emerge from recession.

The weekly ABC News/Washington Post poll of Consumer Comfort nudged up another notch to -44 during the week ending August 22, continuing a climb off a recent bottom which seems to have been fostered by the interruption in unemployment benefits. After a recent crest of 504,000 during the week ending August 14, initial claims for unemployment benefits backed off a little to 473,000 for August 21, producing a bit of a sigh of relief that the labor market wasn't worsening anew to any real degree.

We seem to be in a vicious little trap at the moment in a number of ways. There's not enough job growth to produce the kind of consumer spending which can produce more and more self-sustaining growth. There aren't more jobs available because there isn't enough final demand to produce them. Due to that lack of growth and a lack of inflation, we have fantastic rates for borrowers who either lack the confidence or income to take advantage of them to buy homes, and we have millions of folks who would love access to those rates but cannot qualify to borrow... because they have no jobs, or because others have no jobs to produce the kind of growth which would serve to create demand to firm home prices... and around we go.

We certainly hope that the swoon to a 1.6% GDP rate in the second quarter was a temporary one. The ugly news from July and August doesn't give us a great feeling about the potential for a huge increase in that rate for the third quarter. On the bright side, there is still more than a month to go, and there have been a few indications here and there that we could finish the period more strongly than we began it.

Rates moved down a little bit again this week, but at least one of our friends called in to observe that spreads relative to the benchmark 10-year Treasury have widened appreciably over the past few weeks. For the most part, that's due to very solid flight-to-quality demand for the 100% safety and security of the Federal debt, and also perhaps a reflection that mortgage rates are certainly low enough to keep lenders fairly busy with refinancing at the moment. With about 55-year low interest rates in place, they don't need to compete quite as hard to get borrowers in the door, and there's no reason to run a sale if the store's already full of people.

For more on spreads in influence on mortgage rate pricing, you might check out What Moves Mortgage Rates?.

Next week is chock full of both last-of-the-month and first-of-the-month economic reports. The minutes from the last FOMC meeting should be interesting, and the ISM manufacturing and employment report revealing. Based on Mr. Bernanke's remarks, stocks put in a good day on Friday, and mortgage rates steadied, which is what we expect for next week.

Looking down the road toward September? Take a look at our latest Two-Month Forecast.

Also, if you haven't seen the new HSH.com, why not drop by, have a look and give us your impressions?

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