Monday, August 3, 2009

Amazing - the economy appears to be picking up steam even without its strongest engine - consumer spending.

While the shape of the recovery is still in doubt, signs of economic growth are appearing more frequently. One big factor working in the economy's favor is that businesses cut inventories to the bone as the worst recession since the Great Depression dragged on -- and now those inventories need to be replenished.

The Institute of Supply Management said this morning that its index of national factory activity increased a larger than expected 4.1 points to 48.9 in July from 44.8 in June. The index is 16 points above it cycle low and it highest since August 2008. The component details of the report were very encouraging - most notably the employment component - which increased roughly 5 points in a month to 45.6 - its highest mark since last August. The sharp improvement in the employment picture in the manufacturing sector was a bit of a surprise for many mortgage investors - who instantly reacted to the data by nudging interest rates higher. Most investors are keenly aware that an economic recovery based solely on a bounce in inventories won't have much staying power - but a recovery driven by steady employment growth will almost certainly prevail for an extended period of time. The jury is still out on which of these two underlying dynamics is truly at work now.

Following the "hot" ISM numbers earlier this morning mortgage investors used their erasers to make adjustments to their earlier projections for Friday's July nonfarm payroll figures. Most market participants have now penciled in expectations for a loss of 320,000 jobs last month (revised from earlier forecasts calling for a loss of 340,000) and a national jobless rate in the neighborhood of 9.6%. If the actual numbers match or very closely approximate these projections -- Friday's report will likely have little, if any noticeable impact on mortgage interest rates. A headline number that exceeds 320,000 (say 345,000 or more) and or a national jobless rate of 9.7% or higher will tend to be supportive of fractionally lower interest rates. The big risk is that the government's actual numbers fall below the current consensus estimates -- say a headline job loss lower than 320,000 and/or a national jobless rate of 9.5% or less. If those conditions were to prevail - mortgage rates will almost certainly spiral higher.

Given the upside "surprise" with respect to the labor picture embedded in this morning's Institute of Supply Management report - look for mortgage investors to adopt a "better-safe-than-sorry" pricing strategy up and through the release of Friday's much anticipated, and far more important July nonfarm payroll figures.

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