Monday, November 16, 2009

Earlier this morning the government reported the pace of October Retail Sales rose a brisk 1.4% -- but were much less impressive once auto sales were stripped out. The "ex. auto" component of this report posted a lower than expected gain of 0.2%. Even so, given the backdrop of a very anemic labor market, the October retail sales numbers were about as good as could be hoped.


Consumers remain financially constrained with wage income running 5.0% below its year-ago mark - a condition strongly suggesting recovery at the retail level will continue to be lethargic for many months to come. In the convoluted world of mortgage interest rates investors see slow retail sales activity as a indication that demand for capital will remain low - a scenario that tends to support steady to perhaps fractionally lower mortgage interest rates.



Definitely worth mentioning again - the Federal Reserve reached a milestone with its direct mortgage-backed purchase program last 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 last Thursday from 0.720 percentage points last 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.