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Fannie economist: Outlook looks rocky


Fannie Mae Chief Economist Doug Duncan was making the rounds this week at the Mortgage Bankers Association annual convention in Washington, D.C. Duncan spoke with Scotsman Guide News at the conference about what has been on his mind and the outlook for the mortgage industry.

The mortgage industry has been facing some tough times, but is there any reason to be optimistic?

fmduncanWell, there are short-run and long-run considerations. In the short-run, it is going to be difficult because rates are going up.There are multiple pressures for rates to rise. One is that the economy is growing stronger than some market participants had thought, and that is putting upward pressure on rates. When investors see the potential for growth in earnings, then rates rise to reflect that. Second, the Fed is tightening, and we expect them to continue to tighten. Third, the size of the deficit adding to the size of the debt is going to have to be funded in the Treasury market. That will put upward pressure on rates. In the mortgage space, the competition you are seeing now because of the decline in refinances is leading lenders to narrow spreads to compete to try to stay in business.

Eventually, a bunch [of players] will leave the industry, and those spreads will widen back out to normal profit levels, and that will put upward pressure on rates. And then, the Fed is running its portfolio off. When it built its portfolio of mortgage-backed securities, it was intended to bring rates down. When they release all of that, it will probably put upward pressure on rates. So, if you are looking for an environment where rates are not going up, in the next couple of years that is probably not realistic.

In the long run, if you are in the business to finance the purchase of homes that people want to live in, it is a good business to be in, because our population is still growing. And there has been no change in attitude about owning a home. The millennials are just like their parents, who were just like their parents, and there are more millennials than there were boomers. So, 90 percent of millennials say they eventually want to own a home.  In the longer-term, that's a reason to be optimistic, but in the near-term, it is going to be a tough market.

The economy appears incredibly strong, but is there anything that worries you?

In credit and capital markets, there is no question that in the corporate sector there has been an increase in debt, and we are hearing stories of easier credit terms in that space. This is not so much in the single-family space. This incredible pressure [on mortgage companies] to compete is leading people to dabble in riskier loans, but it is only at the margins. We are not seeing evidence of them broadly easing credit conditions. Over the last two or three years, credit conditions did ease, and consumers did pick up on that. Part of it was lenders going out to the edges of the credit box. But there is not a lot of growth in the subprime, private label market. There has been a little bit of growth there, but not a lot.

Is there any evidence that the economy is overheating?

We are not seeing that. We do think that one of the impacts of the very long period — seven years — of very low interest rates with the federal funds rate at basically zero means that that Fed policy has boosted asset values. It is not a surprise to us that there has been this recent volatility in the stock market. Rates are moving up, which means that the discount rate is moving up, which means that some of those assets are going to get revalued. In the employment market, most macro-economists hold the view that, given our workforce growth, you need to see the addition of between 80,000 to 120,000 jobs monthly just to hold the unemployment rate constant.

We have been getting significantly more than that, between 190,000 to 200,000, for a long time. People keep saying that is going to show up in wage pressures, and the Fed is going to get tense about it and raise rates based on what is going on in the employment market. What that suggests is that there are 70,000 or 80,000 workers per month [that have been] sitting on the sidelines that are being brought back into the market with the growth in the economy. So, there is still some slack left in the labor market. How much? When we get down to where we are only adding 100,000 jobs a month, that is where you will see some appreciation on the wage side. And the Fed will also be watching to see if there are also productivity gains, so that wage growth is real wage growth and not nominal and inflationary.

Have you revised your projection on rates?

We are revising rates up somewhat, and that is based on growth having accelerated faster than what we had thought. We are probably going to get a quarter-percent to 40 basis points more growth when 2018 is all in and done than what we thought at the beginning of the year. That will push rates up higher than what we had anticipated.

Is there anything significant about the 30-year fixed rate crossing the 5 percent threshold?

If you look at the 30-year fixed rate from World War II to the year 2000, it averaged 6 percent — if you take out the high-inflation late '70s. So, 5 percent is still a full 100 basis points under the long-term average of what that rate would be. However, we are moving to that 5 percent from an environment where we were at 3.5 to 3.75 percent for five or six years. So, the adjustment is not how you compare that rate to the very long-term rate. It is what have you done for me lately, and what you have done for lately is give me access to long-term debt at 3.5 to 3.75 percent.

This rise has clearly been paired with the strong house-price appreciation to slow the market down. You will see total sales in 2018 will be below total sales in 2017. In 2019, it will be roughly flat to 2018. Household incomes have to adjust to that higher level of interest rates, and you are going to see some slowing in the pace of price growth. In our view, 2017 will be seen as the peak pace of price appreciation. It doesn't mean that prices are falling in '18, they are just not rising as fast. They will also rise less fast in '19.

What do you think the big story of the next 12 months is going to be?

It is how far the Fed goes, and whether this expansion has more legs than people think. One of the things about the tax bill was that a lot of its provisions expire. The Republicans in the House passed an extender to make some of the components permanent, but it didn't get addressed in the Senate. There is an awareness in the market that [some of the tax cuts] would come to an end at some point unless the Congress acts to make them permanent. That is all going to be affected by the election. I am including the election in my list of the risks that people should think about when they are doing planning for their company.  


 

Questions? Contact at (425) 984-6017 or victorw@scotsmanguide.com.

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