CINCO de MAYO, 2009

Economic activity will turn a positive corner later in the year as long as the financial sector continues to mend. The improvement will come even as unemployment remains high. This was part of the fairly positive assessment of economic conditions Fed Chairman Bernanke provided to the Joint Economic Committee of Congress earlier this morning. Bernanke said central bankers see reason to believe the housing market may be approaching the bottom of its three-year slide, driven in part by tentative signs of a rebound in consumer spending, the primary driving force behind economic growth. He went on to say that even after the recovery begins, "the rate of growth of real economic activity is likely to remain below its longer-run potential for a while."

The story behind all this mumbo-jumbo from a mortgage market perspective is that improved economic activity levels tend to lead to an increased demand for capital from consumers and businesses -- which in-turn ultimately leads to higher interest rates. I realize there are those that argue higher mortgage interest rates are unlikely if for no other reason than the Fed has been an aggressive buyer all year.

Granted, at one time this year the Fed had roughly $1.25 trillion dollars in their back pocket to support steady to lower mortgage interest rates through the direct purchase of mortgage-backed securities. As of last Thursday, the Fed has spent a $404 billion of their available capital. The good news is that experts agree these purchases by the Fed have been instrumental in driving agency- eligible mortgage interest rates to historical lows. The bad news is that the Fed is running a "burn-rate" of roughly $100 billion per month in direct purchases of mortgage-backed securities.

The "so what" factor here is definitely worth noting. Once the Fed passes the half-way point (roughly $612 billion in direct mortgage-backed securities purchases) their ability to hold mortgage interest rates near historical lows will begin to fade at an accelerating rate. The probability the Fed will choose to ramp up the amount of capital currently authorized is small. As we move into the second half of the year it is reasonable to expect conforming mortgage interest rates to begin a slow, but progressive march to 6.0% levels and above.