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   ARTICLE   |   From Scotsman Guide Residential Edition   |   September 2018

Stay Informed and Ignore the Buzz on Rates

Originators should follow these sources to see where the market is going

Stay Informed and Ignore the Buzz on Rates

Your phone rings. It is a client saying that he heard on TV or from a co-worker that interest rates are going up and wants to know your opinion as to whether he should lock in his rate today. It would serve you and the client well if you could provide an informed answer.

How do you stay well-informed? Although many people derive their opinions on the economy from cable news, it is best if your views are gleaned from actual data. The intent here is to help mortgage originators track the data having the most effect on interest rates and be able to explain or discuss this with clients.

Each week, macroeconomic fundamentals are released. Some of these come from the government, some from professional organizations such as the National Association of Realtors or Mortgage Bankers Association, and some from other business or academic sources.

There is “hard” data and “soft” data. Hard data is derived from actual numbers. This includes jobs data and gross domestic product (GDP), or the total value of goods and services produced by the country. Soft data is derived from opinion surveys. These include reports like Consumer Sentiment, Housing Market Index and Small Business Optimism. Hard data is, in general, more important than soft data.

The movement of markets in reaction to economic fundamentals is not immediately based on the data itself but more on how the released data varies from what consensus expected it to be. There is a saying, “Markets are made on the margins.”

On a given day the large holders of U.S. Treasury debt neither buy nor sell a significant portion of their portfolio. It is people who hold this debt for short-term profits who trade. Their positions are based on short-term expectations.

Their trades are driven by deviation of the released data from expectations. If data surprises, it is this set of people with one foot in the pool who move the market that day. Short-term reaction to data results from the intent of those with short-term goals.

Inflation picture

Mortgage interest rates move in harmony with the yield on the 10-year U.S. Treasury note. Treasury yields move in response to inflation or, more accurately, the anticipation of inflation. To understand why inflation and perception of inflation are so important, you must think like someone with $100 million in liquid assets.

If you’re wealthy, own your own home and have little debt, the goal of your investing strategy typically is to ensure you can buy as much stuff with that $100 million in the future as you can buy today.

You have one enemy: inflation. Consequently, you invest in fixed-income securities such as corporate bonds, Treasury debt and mortgage-backed securities. If annual inflation is running at 2 percent, and your average annual return equals or exceeds that mark, your $100 million is not losing any future purchasing power.

Hard data is derived from actual numbers. This includes jobs data and gross domestic product (GDP), or the total value of goods and services produced by the country.

If inflation rises you will want better returns to protect the future purchasing power of your money. You will demand higher yields on fixed-income securities. It is wealthy people who buy fixed-income securities. Similarly, as a mortgage originator, inflation is your enemy. It is necessary to stay informed about signs of inflation.

There are two metrics of actual inflation — the Consumer Price Index (CPI) and Producer Price Index (PPI). CPI measures inflation at the retail level. PPI measures inflation at the wholesale level. Increases in PPI do not always get passed into CPI. As long as corporate profits are high and there is competition for market share, companies can absorb PPI increases in order to maintain market share.

Fixed-income markets, including mortgage-backed securities, do not appear, at present, to tolerate CPI exceeding about 2.5 percent annually. Consistent increases above that will send interest rates up.

Employment outlook

The Employment Situation Report, or the labor report, from the Bureau of Labor Statistics (BLS) is important because it gets an enormous amount of media attention. People understand jobs and unemployment better than they understand CPI.

Politicians love to take credit for any increase in jobs. This attention gives the labor report the power to significantly move Treasury yields and mortgage rates. The underlying concern is that low unemployment will cause wage inflation. Inflation in wages is different from inflation in the price of goods because wage inflation is thought to be “sticky,” meaning wages do not fall when unemployment increases.

There are a few items of note which do not get discussed enough regarding the BLS report. The headline reported data is seasonally adjusted. There are very large seasonal adjustments before and after Christmas. These adjustments can be 10 to 20 times the size of the headline number, making data for those months less significant.

The BLS report for January 2018, for example, showed a seasonally adjusted gain of 200,000 jobs but a loss of 3,085,000 when not seasonally adjusted. The seasonally adjusted number is what is important but, in months when the adjustment is very large, are we measuring the change in jobs or are we measuring the accuracy of the seasonal adjustments?

The jobs report actually consists of two reports. One is termed the Establishment Survey, with information coming from 149,000 businesses and government agencies. This produces the count of jobs and the headline change in jobs seen each month. The Household Survey covers 60,000 households and it determines the size of the labor force. The unemployment rate is based on the Household Survey. It is the number of people in the Household Survey who say they are unemployed, divided by the number of people who say that they are in the labor force. People are in the labor force if they are either working or looking for a job.

Politicians love to take credit for any increase in jobs. This attention gives the labor report the power to significantly move Treasury yields and mortgage rates.

For those in the mortgage industry, the most important number in the BLS report is the average hourly wage. Pay attention to that. Higher wages can translate to higher consumer prices and higher prices tend to increase mortgage rates.

Human resources and payroll management firm Automatic Data Processing, Inc. (ADP) releases its own report two days before the BLS report. The ADP report consists only of private-sector jobs and is viewed as an indicator of what the BLS report will show. It does not often cause large market movement because it is an inconsistent predictor of the BLS number.

The Initial Jobless Claims report is published every Thursday and states the number of people who filed unemployment claims the previous week. A low count implies a healthy jobs market. If the economy is faltering, people get laid off and this is where that softening may first show up. Consider Initial Jobless Claims below 300,000 a sign of a healthy economy and jobs market.

Measuring the rest

GDP measures the size of the economy. The data is seasonally adjusted, annualized and expressed in real (inflation-adjusted) dollars. The goal should be 4 percent annual growth but it has been less than that for years. Sustained 4 percent growth does not necessitate inflation. Because government debt is constantly increasing, we need GDP to increase at a similar pace.

A recession is defined as two consecutive quarters of declining GDP. If there is any sign of recession, the Federal Reserve will lower the overnight rate immediately. In fact, one of the reasons the Fed is, at present, increasing the federal funds rate is so that there is sufficient room to lower it when a recession occurs.

Inside the GDP report is the GDP Price Index. This is a metric of inflation where each component is weighted according to its percentage of GDP. In effect, it combines CPI and PPI. There also is an on-the-fly GDP estimate calculated each week by the Federal Reserve Bank of Atlanta. This can be found by looking for GDPNow on the Atlanta Fed’s website.

Retail Sales, a report released monthly by the U.S. Census Bureau, is a measure of consumer purchases of goods. This includes money spent at restaurants. This is the largest component of GDP. If consumer purchases slow, the economy slows and interest rates should fall.

Personal Income and Outlays, released by the Bureau of Economic Analysis, is a broader measure of spending than retail sales. It includes spending on goods and services, including mortgage payments and other interest payments.

The personal-income report includes wages and salaries; fringe benefits; income from rent; dividends and interest; and transfer payments such as Social Security, welfare and unemployment compensation. People also can spend their savings or buy things with borrowed money, both of which reduce future spending.

Debt is the residue of borrowed money spent in the past that cannot be spent at present or in the near future. If personal spending falls then the demand for goods will fall, which should translate into low inflation and lower rates.

•  •  •

One common misconception is that the Fed has a significant effect on mortgage rates. It really does not. The Fed affects the prime rate, which is used for most home equity lines of credit, but fixed mortgage rates are only loosely correlated with the federal funds rate.

Data moves markets and originators who study the data to get a feeling for how the data influences interest rates can share this information with their clients — both helping them and making you a trusted source.


 


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