Great Rates, but Summer Bummer
New Two-Month Forecast at new HSH.com

July 23, 2010 -- Low interest rates can only do so much for the economy, and while their benefit isn't exhausted by any means, there's not much spark being generated by them at the moment sans mortgage refinancing.

Even opening that window of refinancing opportunity to include borrowers in the 5.5% class - literally millions of mortgages - is producing only muted effect. There simply are too many borrowers who have already refinanced at rates just above these, or who cannot refinance at all, to produce a huge, durable surge in demand.

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HSH's overall mortgage-rate gauge, our Fixed-Rate Mortgage Indicator (FRMI) includes rates for conforming, jumbo, and the GSE's "high-limit" conforming products and so includes a broad swath of the mortgage-borrowing public. The FRMI closed the week by falling eight basis points (.08%), landing at 4.90%. If a long-term fixed-rate mortgage isn't the best option for you, perhaps you might consider a hybrid 5/1 ARM, which finished the week at 3.92%.

At its heart, refinancing is simply a paper-shuffling exercise and so produces little economic benefit at the time it occurs. The skip in monthly payment which accompanies a refinance -- due to the gap between the closure of the old loan and initiation of the new -- can produce some temporary spending, and a rebalanced homeowner balance sheet might even allow for an accumulated increase in spending over time, but only after any expenses have been cleared.

Homebuying, on the other hand, creates more widespread economic benefits. There is of course paper shuffling galore, but many more retail and service firms are engaged in the process, from do-it-yourself truck rental agencies to contractors and tradesman, depending upon the nature of the purchase. However, interest rates are but one component when considering the purchase of a home, and even record-low interest rates can only do so much.

We have also begun to wonder about what will happen to housing markets when mortgage rates ultimately return to more typical levels (see the nearby graph). The combination of interest rate and home price serve to produce the property's "carry cost" - a.k.a. affordability. The two factors are intertwined to a great degree: As one rises, it pressures the other to fall and so (within limits) restores some semblance of balance. We are better than a full percentage point below both five- and ten-year averages for interest rates, and a rise back to "normal" from these levels might crush demand and re-collapse home prices. At the moment, though, that's a problem off in the future.

While information about brand-new home sales won't be revealed until Monday, few expect that the report will bring encouraging news. The National Association of Home Builders sentiment index presaged what will probably be another weak report, possibly even worse than last month's all-time (since 1963) low. After flaring as high as a still-awful reading of 22 in May, the NAHB index for July slipped back to 14, the lowest reading of 2010 and the worst since a year ago April. Sales, traffic levels, and future expectations all declined, and optimism is in short supply.

With housing starts slipping by 5.1% in June, there certainly has been less for builders to do. Although most of the drop was due to a 21.5% drop in starts of multifamily housing, the more important single-family portion of the market held up fairly well, slipping just 0.7% for the month. Permits for future building activity told a mirror-image story: overall, permits rose, driven upward by multifamily project but dragged backward by single-family plans.

Existing home sales for June did come out this week, and reported a continuation of a downward trend which began at the expiry of the $8,000 homebuyer tax credit. The decline to a 5.37 million (annualized) rate of sale -- a 5.1% slide -- was an acceleration of the 2.2% decline in May. Sales in the northeast and midwest moved higher, but backslid in the south and western regions. With the decline in sales came a new ballooning in inventory levels, which popped back up to 8.9 months available at the present rate of absorption, the highest such since last August, renewing concerns that home prices might again begin to soften after a few spotty months of firming.

After a strong run, the information collectively presented in the index of Leading Economic Indicators has turned decidedly mixed. While there have only been two declines in the index over the past 15 months, both of them have occurred in the last three months. The 0.2% decline in the LEI for June does represent a deceleration in the economic recovery, one which has only produced a 2.7% rate of GDP growth in the first quarter of 2010. The first look at GDP for the second quarter is due out next Friday and is expected to show that growth has slowed further from already-meager levels. Of course, the LEI is an imprecise forecasting tool for the period just ahead and may better reflect the present environment, but two declines out the last three reports make a case for a sluggish period just ahead.

Little wonder, then that optimism about the state of things has darkened. After pushing to match 2010 highs of minus-41 just a few weeks ago, the weekly ABC News/Washington Post poll of Consumer Comfort had downshifted over the past three weeks and has retreated to a middle-of-a-poor-range reading of minus-45 during the week ending July 18. The final July reading of UMich Consumer Sentiment comes next week, and will hopefully show some recovery from a mid-month plummet, but we're not counting on it.

That decline may have been related to the expiry of jobless benefits for up to 2.5 million unemployed persons, benefits restored this week with the stroke of a presidential pen. That's both good and bad news: good in that it means that some folks will have at least some income coming in for the next six months, bad in that it means the recovery is still not only not producing jobs, but that more people are joining the ranks of the unemployed (to say nothing of adding still more government debt). Another 464,000 new applications for benefits hit state offices during the week ending July 18, dumping us back in the middle of what seems to be an intractable range.

Low mortgage rates are providing just a slight bit of cheer in what is an otherwise dull and sometimes downright gloomy pattern of recovery. We have expressed concerns at times about the durability of the production-led recovery, and we'll get some fresh information in that regard next week with the release of the Fed's survey of regional economic conditions (known as the Beige Book for the color of its cover). In addition to the GDP report, we'll get a more current look at broad economic trends and a couple of localized manufacturing reviews. We're trying to find reasons to be optimistic about the collective tenor of the reports but expect few surprises on the upside.

The summer bummer of weak economic recovery should continue next week. Mortgage rates again stand at new lows, and what's to stop the downward march? Will appetites for low-yielding mortgage paper continue to develop, even as new risks to home valuations may be forming and economic growth faltering? It's hard to come up with any sound reasoning why it should, but with stock markets finding a little footing, we might just hold pretty steady next week.

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

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