Monday, July 20, 2009

This morning's release of June's leading economic indicators put mortgage investors a little on the defensive as the day began. The index, designed to project economic trends six to nine months ahead, rose 0.7% last month. Most economists had anticipated a positive reading in the neighborhood of 0.5%. The index value for May was revised to reflect a 1.3% gain versus the 1.2% improvement initially reported. The leading economic indicators have now posted three consecutive monthly gains. If this trend continues, although large job losses will continue to be part of the landscape, we will almost certainly see a slow improvement in overall economic growth this fall. Today's surge in the leading economic indicators was broadly anticipated - and therefore its impact on the current level of mortgage interest rates was barely discernible.

Mortgage investors will be keenly interested in what Fed Chairman Ben Bernanke has to say about the state of the economy when he goes to Capitol Hill tomorrow and Wednesday to present his semiannual monetary policy testimony. Mr. Bernanke is going to face stiff questioning from members of the House Financial Services Committee and the members of Senate Banking Committee.

For mortgage investors, the primary focus will be on what Bernanke has to say about future "quantitative easing" efforts directed specifically at the mortgage market. Mr. Bernanke will likely tell Congress the Fed has no plans at this time to expand their $1.25 trillion direct mortgage-backed security purchase program. Not only will he indicate there are no plans to "up-the-ante" - he will likely inform congressional leaders that Fed staffers are busy modeling various methods the central bank might use to "unwind" its large mortgage portfolio in an effort to shrink their overall balance sheet and return to normal operations.

The Chairman will have to tread lightly here. If mortgage investors were to get the impression the Fed intends to morph from a major buyer of mortgage-backed securities (buying more than 80% of all issues so far this year) to a steady seller of those same securities -- the upward pressure on mortgage interest rates will be significant. The probabilities are high that Mr. Bernanke will simply say a number of options are under consideration - and significant additional study will be necessary before action is taken. He will likely stress that the economy in general, and the housing sector specifically, are still too weak to withstand higher borrowing costs at this time. If this assessment proves accurate, mortgage interest rates will likely trade within a very narrow range of their current levels.

Look for the majority of the "question-and-answer" period that will follow Mr. Bernanke's prepared text testimony to be taken up by committee members howling about the Fed's latest updated economic projections. Even though the figures show the current recession won't likely be as deep as feared earlier in 2009, and the recovery next year may actually be stronger than expected, Fed research shows unemployment has the potential to top the psychologically significant 10% mark before the year is over, with little additional improvement anticipated in 2010. It will be the labor story that congressional delegates will focus on - and not particularly for the altruistic reason you might initially expect. Just so you can put all the chatter in perspective - know that the entire House of Representatives and one-third of the Senate faces reelection next year. You can bet lawmakers are well aware that unemployment breeds angry voters -- so the congressional squawking and blame-laying surrounding the employment issue, especially when the media focus is highest, will likely be deafening.