Friday, November 13, 2009

Trading volume in the mortgage market so far today has been light and sporadic - with the few transactions that are being completed drawing higher prices for the underlying security.


There is really not much to talk about in terms of economic news - even though some media sources are trying to make a mountain out of a mole hill with their breathless announcement that the University of Michigan's consumer sentiment index fell four (4) percentage points in October. Hmmm - let's see - I wonder if the fact the national jobless rate jumped to a 26-year high during the month might have bummed consumers out just a bit. I have yet to see one mainstream media report that drills down into the data deep enough to discover that while the index fell back to about the level seen in July and August -- it remains comfortably above its cyclical lows.


Take today's consumer sentiment report with a grain-of-salt. Mortgage investors are generally far more interested in what the consumer is actually doing - as opposed to how they say they are feeling during a telephone interview. Consumers' true underlying sentiment will be abundantly clear when the Commerce Department releases the October Retail Sales figures Monday at 8:30 a.m. ET. Interestingly enough, the headline number is expected to have posted a 0.9% gain - a handsome recovery from September's 1.5% slump. The ex. auto component of the report is expected to have matched September's 0.5% improvement. Not bad for the supposedly crestfallen consumer most media sources would have you believe currently dominates the retail marketplace.


****Definitely worth a mention - the Federal Reserve reached a milestone with its direct mortgage-backed purchase program this week, topping the $1 trillion mark. The Fed's purchases of agency mortgage-backed securities totals roughly $1.007 trillion so far in 2009. The central bank has started to slow the pace of its purchases, with buying decreasing from about $25 billion per week in mid-September to only $13.5 billion for the most current week ending Wednesday, November 11th. The Fed is committed to buying the entire $1.25 trillion allotted for its direct mortgage-backed security program by the end of March 2010.


These security purchases by the Fed have been hugely supportive of lower mortgage interest rates. (The following maybe a bit technical for some - but bear with me - and please don't stop reading.) The yield premium on Fannie Mae mortgage-backed securities paying 4.5% compared with the 10-year Treasury note (the assumed "riskless" rate of return) tightened to 0.668 percentage points on Thursday from 0.720 percentage points on Tuesday, according to Reuter's data. When yield premiums tighten - mortgage rates move lower. For comparison, the yield premium was around 1.863 percentage points last year prior to the initiation of the Fed's direct mortgage-backed security purchase program.


The "so what" factor here is probably obvious to most - mortgage interest rates are almost certain to begin a move to higher levels as the Fed's direct purchase program draws to close. Look for the pace of the upward move to be in direct, but opposite correlation to the number of dollars remaining in the central banks checkbook. The fewer dollars rolling around in the bottom of the Fed's bucket - the more intense the upward pressure on mortgage interest rates will become.


Ultimately mortgage interest rates will once again reach their natural equilibrium point -- but until then -- the process of transition may be uncomfortable for those insistent upon trying to hope and wish rates to dramatically lower levels. I'll keep you posted on the Fed's "burn rate" as this mortgage market friendly program fades into history.


Looking ahead to next week -- Monday's October Retail Sales figures and Wednesday's inflation data contained in the October Consumer Price Index will draw considerable investor attention. As I mentioned earlier in this commentary, the retail sales report has the potential to be a bit stronger than many market participants are anticipating. If such an event were to occur -- it will likely put some slight upward pressure on mortgage interest rates. The Consumer Price Index is expected to show the prices consumers are paying for goods and services remain devoid of meaningful inflation adjustments.