Aug 21 2006 12:53PM | Permalink | Email this | Comments (1) |
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Fixed mortgage rates dropped 30 basis points in the last six weeks and variable rates fell 20 points. Neither has yet fully adjusted to the 40 basis point drop in the 10-year bond rate, the reference rate for fixed mortgages so further mortgage rate declines are likely in the last week of August. This would provide a measurable boost to new home demand. But that would appear in the housing starts report for September released two months from now. Until then the monthly housing market reports on starts and sales will continue to be sour.

The financial futures markets are now showing that that the current 5.25% federal funds rate will be the peak for this cycle. There is still a risk of another 0.25% rate increase by the fed later this year but the market consensus is that will not happen. Already, some financial market forecasts foresee federal funds rate cuts by the fed before next summer.

How did this happen? All of the drivers of long-term interest rates reversed direction this summer. There is probably some temporary overshooting so mortgage rates will drift up slightly ahead. First, loan demand across the economy declined due to slower spending growth, especially for housing and cars, as well a slowdown in inventory accumulation after a spring surge. Second, the supply of lendable funds has continued to increase. 45 states had larger surpluses than budgeted at the end of the fiscal year on June 30th. These funds are available for lending until the states spend them. Much of the surplus was added to reserve funds and will not be spent in the next year. Also, foreign investors have resumed sending enough money to the US to cover our monthly trade deficit after falling short for three months. Third, inflation eased in both the latest CPI and PPI reports as commodity prices generally stabilized. As a result, inflation expectations implicit in money market yields have stabilized at about 2.6% after rising earlier in the year.