August 23, 2004

Fixed mortgage rates drifted sideways this week, ending with a slight downward dip to an average 5.96%, a slide of just two basis points.

There were few significant revelations about the state of the economy this week, but at there was at least some fair-to-good news.

It appears as though the inflationary worries of the spring are fading, now that the last two reports on consumer inflation have failed to find evidence of a growing problem. For July, the Consumer Price Index declined by 0.1%, a considerable change from the pace seen as recently as May's 0.6% increase and June's 0.3% uptick. Even the "core" CPI -- which factors out the effects of highly-variable food and energy prices -- budged only the barest amount of 0.1%.

While still high, energy prices actually declined during the month, dragging the "headline" number down. That happy circumstance seems unlikely to recur once the effects of near-$50 per barrel oil begin to be felt in the coming months. Of course, prices are higher than they were a year ago -- some prices considerably higher -- but the general level of inflation remains at or near what the Fed believes are acceptable levels, with core inflation running at 1.8% over the past twelve months.

Markets might be more worried about inflation if hiring was occurring at the same pace as earlier in the year. While the last two monthly employment reports have been poor, weekly state unemployment claims downshifted several weeks ago to the mid-330,000 level, and remained there last week, as just 331,000 new applications for benefits were filed. To us, that suggests that the August employment report will likely be considerably better than the last two -- and that could be a triggering event for higher mortgage rates, as was the case in the spring. The August employment report is still several weeks away, so stable rates should be with us through the end of the month, at least.

While June has been acknowledged to have been a very slow month for economic activity, July has seemed to fare somewhat better. During the month, Industrial Production ticked up by 0.4%, nearly reversing the June decline, and factory Capacity Utilization crept back up to 77.1% from June's 76.7% mark.

With the decline in mortgage rates from May's mid 6% levels, housing activity has picked up in the last several months. In July, for example, Housing Starts rose by over 8% from June, landing at a 1.98 million annualized level. Building Permits, a precursor to future starts, also jumped up to a 2.055M annualized rate. While mortgage rates are one of the driving factors, the healthier job market of earlier this year and new builder sales incentives are likely keeping the pace high. The National Association of Home Builders poll of its members found that optimism about sales prospects improved in July, rising to a reading of 71 from June's 67.

As we approach the end of summer, it's not uncommon to see mortgage rates hold fairly steady. The late August pattern of nearly no move in rates for several weeks usually yields to more pronounced market forces once September gets into full swing. Next week features some home sales and consumer sentiment readings, but we're betting that the tranquil pattern for the period seen in previous years will persist this year as well.

Rates wander around next week again, with maybe a few basis point change in either direction.

Mortgage rates dipped as expected this week, with the average overall 30-year fixed rate sliding 14 basis points to 5.99%. It was the first time since the week ending April 16 that the overall average broke the 6% level. 

The Federal Reserve lifted interest rates again this week, a move which was widely anticipated, so there was little market reaction. Mortgage rates have largely been declining in recent weeks, serving to reinforce the fact that the Fed's moves have little direct influence on long-term mortgages. To some, this seems counterintuitive, but it's really not. If higher short-term interest rates act as a brake on growth and especially inflation, then long-term interest rates -- mortgages and such -- can fall to a degree, as there's less of an "inflation premium" required to be added to those yields to make them attractive to investors.

In the release which accompanied the close of the August meeting, the Fed explicity mentioned that they believed that high energy prices were the likely cause of recent weakness in the economy. If that's the case, the return of oil prices to record levels in the past weeks will dampen economic growth in the months ahead. Of course, high energy prices are a contributor to inflation as well, so the Fed will probably continue to lift rates as the year progresses even if growth remains sluggish.

There's little doubt that the spike in gasoline prices drained wallets. Retail sales for July increased by just 0.7%, and once expensive autos were subtracted, that increase was just 0.2%. Still, July positive reading was a nice rebound from June's half-percent drop, so things may be getting better for the retail sector.

Consumers, too are feeling pressured. The weekly ABC News/Money Magazine poll, last week at a three-year high, slumped by two points to a reading of -9. As well, the University of Michigan survey of Consumer Sentiment drifted down to 94.0 in the initial August reading; July finished with a 96.7 mark.

Weekly state unemployment claims spent a second encouraging week in the 330,000 range, with 333,000 new applications filed. The last two weeks at these levels seem to suggest that July's pathetic employment report won't be repeated, but we'll need a few more weeks of data for a clearer picture.

The decline in interest rates in recent weeks has been due to a moderation in economic activity, inflationary pressure and job growth. To that, we've added the income drain of higher energy prices and the tempering of slightly higher short-term borrowing costs. The Fed has made it fairly clear that it thinks that transitory inflationary pressures will pass and that the economy "appears poised to resume a stronger pace of expansion going forward."

At the moment, it's not clear when that resumption will occur, and nothing in the recent data strongly suggest that there is a imminent leap about to happen. Interest rates are still in a sensitive position, and a outsized report could cause a bounce in rates fairly quickly, but even the next employment report is weeks away. Meanwhile, new drags on the economy have formed, and we wonder if they won't create a more pronounced economic slowdown in the months ahead.

Mortgage rates seem mostly likely to drift next week, as it seems unlikely that the economic data due out will feature any major market-moving surprises.

For the week, fixed rate mortgage averages declined by seven basis points (.07%) to 6.13%, but Friday's employment report for July promises lower rates to come.

the Market eagerly awaited the July employment report; expectations were for the creation of perhaps 220,000 jobs, which would have represented a significant reversal of June's poor showing. A strong pickup in hiring would also have signaled that the "soft patch" referred to by Fed Chairman Greenspan in recent weeks would be falling behind us.

However, Friday's employment report covering July showed just 32,000 new hires, and June's already-weak number was revised downward considerably. May's figure was also notched downward. Taken together, they point to a much broader soft patch than was assumed, one which began with the sharp run-up in gasoline prices and which has not yet abated to any degree.

Caught leaning the wrong way for the fourth time this year, bond traders took the weak number to mean that the Fed's process of lifting rates may now be prolonged, along with prospects for wage-reinforced inflation. Treasuries rallied furiously, and yields on the benchmark ten-year bond had fallen by about 20 basis points (.20%) by day's end.

Since fixed mortgage rates are strongly influenced by the 10-year bond, mortgage rates declined all day as well with the promise of more declines to come Monday.

One bright spot was the the nation's Unemployment rate slipped to 5.5%, down one tick from June.

While there were other economic data out this week, some of it pointing to a resumption in growth during July, the open question is whether or not the Fed will lift rates again next week when the FOMC committee meets to discuss policy. Futures markets indicate that there is a 90% probability that the Fed will raise short-term rates by one-quarter percent. Given that the Fed has spent considerable time preparing the market for such a move, delaying the hike might be more disruptive than doing going ahead with it. A quarter-point move is still likely to happen.

While the change to interest rates is expected, the commentary released at the close of each FOMC meeting, where clues to the Fed's thoughts are revealed, has featured very interesting language at times. It will be very instructive and potentially market-moving if the Fed should indicate even subtle shifts in the size or frequency of future policy changes. We'll find out about that Tuesday, sometime after 2:15 pm.

Weekly State Unemployment Claims dipped to 336,000 during the week of July 31; hopefully, August will see new applications for benefits at that level or lower, as fewer layoffs would be welcome if new hiring isn't happening.

While many of July's numbers have suggested that economic growth has resumed after a pause, the reluctance of businesses to hire workers during an unsettled period has become a significant stumbling block to a broader expansion. Inflationary pressures have abated somewhat, but remain well above last year's levels, and high energy prices are mopping up disposable dollars at every corner, serving to depress economic growth.

Higher short-term rates are all but a certainty. While we've expected to see a flattening of the yield curve this year, I assumed that it would be caused by fairly stable long-term rates but considerably higher short-term rates. The current yield curve environment has been produced by falling long-term rates of late, and higher costs of short-term money might serve to depress economic activity further, possibly pressing long-term rates down a bit more.

At the moment, fixed mortgage rates are falling, and there's little indication that we'll be revisiting the near 6.5% rates seen in May anytime soon. In a broad sense, this summer is turning out to be an economic bummer -- but a good one for homebuyers and now for would-be refinancers, too.

A small lift in fixed mortgage rates this week erased the small declines of the past three weeks, raising the average 30-year FRM by eight basis points (.08%).

While economic activity has seemed punky of late, it appears that the entire first quarter was rather subdued. The period experienced only a 3% growth in GDP, a significant slowdown from the 4.5% level of Q1-04. Analysts forecast that growth might have been as strong as 3.8% for the quarter, and certainly that 3% could be revised upward in subsequent reports. For now, however, it's apparent that we entered the third quarter on a bit of a stumbling note.

Economic data still being released for June continue to point to a poor showing, with the notable exclusion of home-buying. Purportedly in a rush to beat rising mortgage rates, would-be homeowners snapped up existing homes at a record annualized pace of 6.95 million units, while sales of new homes were essentially flat at a 1.326m annualized sales level.

The surge may serve to put a damper on sales in the months ahead, since the upswing in activity may have somewhat thinned the ranks of potential buyers. The continued escalation in home prices, which will continue to crimp affordability, also bears watching.

Affordability will, of course, suffer further if and as interest rates rise -- especially in the case of the short-term rates which govern the initial pricing for adjustable-rate mortgages (ARMs). A growing number of buyers are turning to ARMs as a way to offset a higher loan amount, but the benefits of doing so have diminished lately as the Fed has begun its tightening campaign. The second move is expected in just a few weeks.

New week bring perhaps the biggest market-moving number for the month, the monthly Employment report. This year, that release has moved fixed mortgage interest rates by nearly a quarter percentage point on several occasions: up by nearly a quarter in April, May and June, then down by a quarter in early July. The direction of the move is influenced by how much stronger (or weaker) the actual number of jobs created has been in relation to the forecasted number. Last month, it was expected that perhaps 225,000 jobs might have been created.... but only 112,000 actually were. For July, that consensus calls for perhaps 215,000 new hires.

While we don't know what that number will be, we follow weekly state unemployment claims for clues. Aside from a one-holiday-week blip downward, claims have been only slightly lower on average for July when compared to June. This week's 345,000 new applications were pretty typical for the last two months. It's our opinion that we'll fall shy of the 215,000 hires, but should be well above the 112k from June. We'll find out next Friday.

If it's any indication, the Conference Board's Index of help-wanted advertising declined by one tick to a reading of 38 in June. While it's now only one of the ways in which openings are exposed to potential workers, it isn't suggestive of any ramp-up in activity.

Also, next week is a "setting up for the next FOMC meeting week" (August 10) as well. A slew of fresh data; a Fed likely to lift rates unless those data point a dire economic picture; and thinly-populated trading pits in the midst of summer doldrums make higher mortgage interest rates the more likely course for the week, though probably by just a few basis points.

As expected, mortgage rates slipped this week, with the average for the 30-year fixed rate falling by three basis points.

This week, in Federal Reserve Chairman Greenspan's semiannual report to the Congress on monetary policy, the chairman discussed the Fed's belief that the economy had grown more solidly in the period since his February appearance. While he noted that the Fed will likely hike interest rates in the coming months, he added that those increases could be scaled back if inflationary pressures warrant such a move.

While this repeat statement by the Chairman isn't usually market-moving news, it became so in light of recent economic conditions, which have been less than stellar.  Some market players had recently come to believe that the Fed was becoming less inclined to raise interest rates in August (and beyond) because the economy seemed to be softening. Those positions served to press interest rates downward in recent weeks.

Despite the acknowledgement of a softer economy, the Fed appears to still be committed to lifting interest rates another quarter percent at its August meeting. This news caused Treasuries to be sold off on Tuesday; the ten-year Treasury rose by about a tenth percent. Such a move in Treasuries is usually followed by a move in mortgage pricing, but the effect was muted this time around.

The chairman's prepared remarks had little new to say. However, his remarks to a question posed by Senator Dole were more candid. He professed that the economy had endured a "soft patch" in June which seems to have lasted into early July, but most likely was only a pause in activity.

The economic news out this week certainly reinforced the chairman's position. Despite still-low mortgage rates and plenty of liquidity, Housing Starts in June caved by 8.5% in June to a 1.80 million annualized level, the softest pace in some time. Permits for future building activity fared marginally better, sliding by 6.2% to 1.92m annualized. While the craze of buying new homes isn't over, it may have just downshifted notably. Despite that, the National Association of Home Builders poll of their members still found considerable optimism, as their index reading of 67 for July was down just a tick from June.

New Claims for State Unemployment benefits came in at 339,000 for the week ended July 17, a welcome decline from the recent run of near-350K numbers which have come to indicate a sluggish pace of hiring.

More evidence appears every day that we transitioned to the third quarter of 2004 or a fairly soft note. However, the threat of higher short-term interest rates isn't diminished by the "soft patch," so there are limits to how far fixed rate mortgages might drop. In fact, we're probably at or very near the potential lows for the current environment, and up still remains a more likely direction than down for rates.

For the moment, though, most markets are trading sideways, changing little. A lot of new economic data is due next week, most of it covering the June swoon which the market has now discounted. The available July data will be somewhat more instructive... has the soft patch continued through late July?

Mortgage rates? That sell-off in Treasuries might press rates up a couple of basis points... more sideways trading is the likely course, though.

The average 30-year fixed rate mortgage (FRM) rose by a single basis point this week to 6.16%, but that probably won't be the case next week.

As news about the economy in June dribbles out, the overall impression we're left with is that economic growth has, on balance, slowed. Price pressures, which have been in the forefront of market players' minds since early this spring, also seem to be cooling.

This week's release of price gauges for June pointed out an interesting situation. While the flare in costs over the last three months has lifted prices measurably -- the Producer Price Index is up 5%, the Consumer Price Index nearly as much -- more recent reports suggest that those pressures, while not eliminated, have leveled off in June. 

If inflation has indeed plateaued, the Fed's wish of a measured cycle of interest rate increases looks more likely. It also suggests that those rate hikes might be phased in over a longer period of time.

Softening of economic activity was also evident in measures of Industrial Production, which declined by 0.3% in June. Factory Capacity Utilization slipped back as well, falling to 77.2% of capacity in active use.

Although Retail Sales in June were expected to slide, the 1.1% decline was a bit of a surprise, even though much of the decline was due to lower auto sales and reduced gasoline costs. Even with slightly lower gas costs, though, the higher prices we've lived with for several months have left most of us with a few less dollars for discretionary spending -- a situation that isn't likely to change soon.

Claims for new unemployment benefits jumped by 40,000 to 349,000 for the week ending July 10. The error-prone seasonal adjustment process seems to be the reason for the sharp dip in the prior week. At the moment, it would seem that June's 112,000 new hires, a weak number, will be replicated in July.

The flattening of inflationary pressures means a flattening of interest rates. A sizable rally in Treasuries on Friday saw the yield on the 10-year note slide by about 13 basis points (.13%). Although FRM rates don't move in lockstep with long-term T-notes, at least some of that decline (and with luck, most of it) will be reflected in mortgage rates early next week.

This means that this week's average 30-year fixed rate conforming loan -- 6.08% plus 0.33 points -- should slip just below 6% next week. With a working discount level (points) of 0.6% like the one Freddie Mac's survey uses, that rate could dip to 5.9% or thereabouts.

Overall, we'll call for a 8-10 basis point decline for next week in our survey averages.

Fixed mortgage interest rates dipped toward the 6% mark this week, the result of a Fed move and a disappointing employment report for June. After declining by 20 basis points, the average 30-year fixed rate mortgage finished the week at 6.15%, the lowest average since April 30. 

The down draft has been a bit of a pleasant surprise to mortgage shoppers, especially after the 20-plus basis point increases in interest rates which followed the outsized employment gains in March, April and May. However, the Fed's renewed vow to take more aggressive measures to trim inflation, coupled with a softer tenor of economic growth, means that such inflationary pressures are less likely to arise. This suggests that low short-term rates may be around a little longer than has recently been expected.

While dips in mortgage rates following Fed moves to lift short- term rates aren't that unusual, such dips more frequently occur at the end, rather than the beginning, of a tightening cycle. At such times, the bond market comes to believe that the Fed has (by then) lifted short-term interest rate enough to keep a lid on economic growth and, therefore, the risk of too-high inflation. Under those circumstances, long-term interest rates can decline, as holders of (and investors in) long-dated paper come to feel that their returns won't be diminished by inflation, and will accept lower yielding notes.

Will the next increase help to produce a similar dip? Unlikely. Disappointing economic growth may, however, especially if the Fed is correct about "transitory" inflationary pressures. We'll need to watch the economy closely between now and the next Fed meeting in August; if soft, those numbers might suggest that additional short-term rate increases can be delayed. At the moment, the odds still favor another 25 basis point lift.

Weekly State Unemployment Claims dropped sharply last week, to 310,000 new applications, but seasonal adjustments and the lure of a four-day Independence Day holiday may have kept some filers from standing in line last Friday. Also, this week's number may be distorted from the July 5 official holiday, so it may be another two weeks until we've got a clean number to work with. However, a report on mass firings by Challenger, Christmas and Gray suggested somewhat fewer layoffs in June than May, so labor markets seem to have stabilized for the moment.

Consumers borrowed a bit more in May, according to the Federal Reserve, when they added $8.2 billion in new debt. For the most part, growth in consumer credit has come on the non-credit-card side this year, as the effects from refinancing and equity draws have removed the need to "put it on plastic".

While the dip in rates this week probably won't last, a typical summertime pattern (if such a thing exists) usually sees little or no change to rates on a weekly basis. Next week will be chock full of fresh economic data, including Retail Sales, and especially Producer and Consumer Price indexes (as well as import and export price reports).

Our guess is that rates probably lift somewhat next week, as even "transitory" inflation has yet to fully work though the economy.

The process of reassessment of market conditions under a new Fed era begins next week. After Friday's rally, we'll start with lower rates on Tuesday, but will probably drift up as the week progresses. This week saw a decline in mortgage rates, but next week will probably be flat as more news about the economy in June is revealed.

Although short-term interest rates will climb, rates for long-term fixed rate mortgages fell this week; the average for the 30-year fixed rate mortgage (FRM) slipped to 6.35%.

After weeks of fear, analysis, repositioning and speculation, the Fed not only did what they were predetermined to do -- raising the Federal Funds target rate by 0.25% -- but took the additional step of expanding their brief discussion of growth, inflation and potential policy moves.

In the release which accompanied the close of the two-day meeting, the Fed noted not only that "output continues to expand at a solid pace," and that "labor market conditions have improved," but that at least some of the recent flare of inflation is likely "due to transitory factors."

While the Fed also reiterated its belief that "policy accommodation can be removed at a pace that is likely to be measured," they also warned that they may take more forceful action, without warning, in order to "fulfill [our] obligation to maintain price stability."

Those two key sets of phrases cheered the bond market greatly. One, the Fed thinks inflation isn't getting much of a toehold, and two, if it does, they will lift interest rates as required to halt it. In market-speak, if the Fed seems to be falling behind the "inflation curve", it will catch up, and perhaps in a hurry, regardless of any stated preference for "measured" increases, politics or considerations outside that goal. Such "hawkish" language soothes bond investors, who at the moment are holding lots of fairly low-yielding paper, where even modestly higher inflation might cause losses.

Although another increase in the Fed Funds rate is expected in August, economic data released this week made that somewhat less likely. This is especially true in the case of the employment report for June, which found only 112,000 new hires, a level less than half of what the market was expecting. Mortgage shoppers will remember that very weak and disappointing employment reports earlier this year depressed fixed mortgage rates -- just as happened with Friday's release as well. The nation's unemployment rate still stands at 5.6%.

In the weeks which led up the Friday's employment report, there were several where claims for state unemployment benefits neared or crested 350,000, which is believed to be the level where employment growth slows appreciably. In fact, last week when we noted that while we thought the employment report "will be positive, but might not feature as many new hires as the past three months", it was due to an upward trend in new benefits applications. For the week which ended June 26, there was no improvement in that regard, with 351,000 new applications.

Taken as a whole, the data this week suggest to us that strong and continually increasing growth is not a certainty, but that the more likely course remains one of moderate growth with somewhat higher (though still moderate, by historic standards) inflationary pressure. The markets have taken to heart the Fed's stance of "measured" increases, and, at the moment, expect that the Federal Funds Rate will be as high as 2% by year's end.

Mortgage rates have dipped, for the moment. That's actually good, since the market's summer doldrums are about to begin. Setting aside last year's panic selloff and the subsequent spike in FRMs, more typical are the patterns of the past five years, which have featured rates with little movement and minor declines overall.

After Friday's rally, we'll start with lower rates on Tuesday, but will probably drift up as the week progresses. This week saw a decline in mortgage rates, but next week will probably be flat as more news about the economy in June is revealed.

A welcome dip in mortgage interest rates came this week, with the average 30-year fixed rate slipping to 6.37%, a decline of nine basis points (.09%). It was the largest change in rates in six weeks. 

The little dip in rates this week was largely due to a growing certainty that the Federal Reserve will lift interest rates just a quarter-percentage point when its two-day meeting closes next week. Market players who had been hedging against a potential half-point rise have rethought their strategies, since that size cut is now highly unlikely.

The markets will be watching more than just the rate rise, though; they'll scrutinize any change in language or tenor of the Fed statement. Meetings in the past year have closed with quotations which left markets uneasy and pondering such terms of art as "considerable periods" (of time? economic conditions?), "patience" (which was rather short-lived) and "measured" increases in interest rates (of size and frequency yet undetermined).

This will be the beginning of a most unusual period for the Federal Reserves. During Chairman Greenspan's remaining tenure (his term will end January 2006), several crucial questions will need to be answered. Can the Fed allow prices to rise enough to promote reasonable price stability without fear of deflation or inflation? If they can, does the Fed have the foresight -- and the means -- to rein in any unwanted excesses? The crystal ball isn't saying, but we are about to begin the process of finding out.

We, and the Fed, begin this journey in fine fashion, economically speaking. While there was a downward revision to final Gross Domestic Product figures for the first quarter of this year, the 3.9% pace of growth is a decent level. Although the price component did lift a bit, the roughly 2% increase in price estimates remains in a fairly comfortable area, though they might seem high compared to the low and falling prices of a year ago.

Although market and mortgage interest rates have recently risen, enthusiasm for buying homes set new records in May, both in sales of existing homes (6.80 million annualized sales) and new homes (1.369 million, annualized). It's likely that we'll see this enthusiasm slide as rates rise later in the year, but a rebounding job market will probably help keep sales strong even if rates rise a little more over that period.

Weekly state unemployment claims crept upward in the week ended June 19, with some 349,000 new applications. While most indicators suggest that hiring has improved, claims for new benefits have remained stubbornly high. June's employment report will be positive, but might not feature as many new hires as the past three months. An index of "Help Wanted" advertising released by the Conference Board increased by one tick to 39, but that's hardly suggestive of employers eager to hire. Perhaps some of the increases over the past few months have been more of the "word of mouth" variety.

Mortgage rates next week will probably not change very much, with a move of perhaps a few basis points upward -- all provided that the Fed's first "measured" move is accompanied by a statement which suggests another such "measured" move come August.

You can practically hear the credit markets counting down the days until the Federal Reserve meets to discuss monetary policy, when what is presumed to be a "measured tightening" will get underway. The suspense has produced fair stability in bond yields and mortgage rates, with the 30-year fixed rate drifting up by four basis points to an average of 6.46% this week.

There has been a lot of discussion lately about the presence of, and trajectory for, inflation. This week's releases of both the Consumer Price Index (CPI) and the Producer Price Index (PPI) caused much concern, but despite sizable increases in the "headline" values of both, investors were cheered by more muted increases found in the "core" readings which exclude the most volatile components.

In May, PPI rose by 0.8%, with a core reading of 0.3%; CPI rose by 0.6%, with a core reading of 0.2%. Because of those more subdued readings, investors again believe that the Fed will hike short-term interest rates by only a quarter-percentage point rather than a half-point.

While we believe that a half-point increase, rather than a quarter, is warranted, we're admittedly in the minority. However, the statement that would be inherent in such a bold move would remove the market's fear that the Fed is falling behind inflation, or has become somehow less committed to ensuring price stability. If nothing else, it might keep the market from playing the timing-and-size guessing game with the next move.

The trajectory for inflation may flatten in coming months, and while prices may not continue to increase, they'll still remain above where they were. This means we'll all be paying more for the goods and services, and we may cause a little wage inflation of our own in turn.

As we mentioned, growth is evident everywhere you look, from our record Trade Deficit, now $48.3 billion as our economy revs up and consumes a greater share of resources from abroad, to Industrial Production, which jumped by 1.1% in May, with factory capacity utilization rising to 77.8%. There is some concern that the official reading of utilization may be understated, and that inflation-forming production bottlenecks closer than currently suggested by the data.

Weekly state unemployment claims dipped back to 336,000 during the week ended June 12, after tripping above 350,000 for just a week.

The index of Leading Economic Indicators climbed a stout 0.5%, pointing to solid economic activity for as much as the next six months.

We look for signs of growth, and strong ones are everywhere; we look for signs of inflation, and more appear prevalent. We look for signs of moderation, and so far, there are few to be found. The days click and the clock ticks, and we wait for the Fed.

Little movement for rates again next week. Movement will come... count on it.

Compared with the overall history of the mortgage market, the 30-year fixed rate mortgage remains a good deal even at the current average of 6.42%. Just a year ago this week, though, that average touched 5.37%, a level not seen in over forty years.

Those extraordinarily low levels were the result of a very unusual set of market conditions and near-panic purchasing of Treasury bonds. Brought on by a set of unrealistic market expectations, exacerbated by sharp waves of mortgage refinancing and egged on by the Fed, that rundown in rates gave way to a painful rout in bonds over the months which followed.

Unrealistic market expectations included a supposed decline of inflation into not only disinflation but into outright deflation (a condition that, while theoretically possible, never really seemed that distinct a possibility). As inflation disappeared, "inflation premiums" were wrung out of bond pricing everywhere. With interest rates now falling, homeowners refinanced millions of loans, leaving lenders with yawning holes in portfolios and handfuls of cash to invest. And invest they did -- largely in Treasury notes, which served to further drive yields and mortgage interest rates downward. Those lower rates fueled more refinances, and a self-perpetuating spiral was born.

Fueling the fire was the Fed, which openly speculated that they might consider "unusual policy actions" which were believed to include outright purchases of Treasuries. If this was supposed to quell concern about the Fed's ability to manage a fall into widespread price declines, it backfired. The possibility of having a ready and willing buyer for unwanted or excess Treasuries meant that stocking up on them was a good idea. Market players snapped up whatever was available and at any price, which drove yields down even further.

And then, it ended. With painstaking clarity, the Fed set a course to tell the markets that in their eyes, deflation was still only a possibility, not a reality; that conditions which might require any unusual policy response didn't seem to be forming; and that although short term interest rates were low, there was still considerable space to lower them if conditions warranted.

The turnaround in rates was swift and painful. In eight weeks time, fixed mortgage interest rates averaged 6.5%, causing a crash in refinances and at least a mortgage lender or two.

A year later, we're in a near 180-degree turnaround. The economy is growing, hiring has resumed, and now the concerns are about inflation rather than deflation. The Fed will be active again, and soon, and their "policy response" may not be as "measured" as some would have you believe. As price pressures continue to form, the likelihood of a more aggressive Fed grows every day.

Consumer borrowing remains soft, with just $3.3 billion in new credit taken during April. Since the big refinance boom has waned, it's likely that somewhat more borrowing will happen in coming months, but some borrowers may opt to put purchases on their Home Equity Lines of Credit rather than plastic, keeping the trend in consumer credit subdued.

Although some 352,000 applications for state unemployment benefits were filed this past week, the Memorial Day holiday probably skewed the figures to the high side; we'll need another week to see.

Fixed mortgage rates have found a level at which they seem happy. We can't see any compelling reason why any significant change might happen between now and the Fed meeting, just over two weeks away, with a notable exception: "hawkish" comments this week may be the start of prepping the market for a half-point increase in short-term rates, a level for which only a portion of the market is hedged. Some repositioning might trip rates slightly higher in the coming days.

We mourn the passing of President Ronald Reagan. Today's mortgage borrowers probably don't remember market conditions way back in the 1980s, but we do: it was during his second term that the original full-blown, industry-crushing refinance (and purchase) boom happened. The low water mark for the 30-year FRM? An average 9.09% for the week ending March 27, 1987.

After a noisy run-up that started in late winter and ended in early spring, fixed mortgage interest rates have level off. For the third week in a row, the average 30-year fixed rate mortgage posted an average of 6.41%.

This apparent stability belies the trove of significant economic data released this week. May's monthly employment report, which in recent months has roiled the markets, reported some 248,000 new hires -- somewhat more than expected -- as well as sizable upward revisions to the last two reports. The nation's unemployment rate remained at 5.6%.

Bond yields and mortgage rates took the good news largely in stride, with ten-year Treasury yields up just a few basis points by Friday's end. Now that job growth has solidified, and given that we're experiencing somewhat more inflation than before, it's a certainty that the Federal Reserve will lift short-term interest rates at its next meeting at the end of the month. The markets are apparently expecting at least a quarter-point increase in the Fed Funds rate, but based on today's lack of reaction, a half-percent move seems considerably more likely.

One of the factors helping to keep the lid on inflation at the moment is a high level of worker productivity, with the most recent estimate for the first quarter of this year now at 3.8%, a little higher than the initial report of a 3.5% gain. The cost of labor per unit produced eased a bit to 0.8% in Q104 from 1.7% in Q402.

Construction Spending climbed in April by 1.3%, considerably higher than the 0.4% forecast. There may have been a little rush to get projects started in April before financing costs rose further, so May's report (out in July) may be a little softer as a result.

Even though new jobs are being created, others are being downsized. The Challenger, Gray and Christmas report on layoff announcements for May showed some 73,368 announced job cuts, up a bit from April. Claims for weekly state unemployment benefits remain stubbornly high, with 339,000 new applications for benefits in the week ending May 29.

It seems a little odd to be discussing solid, even expanding economic conditions, waiting for imminent higher short-term interest rates while experiencing stable mortgage rates, but that's the situation as it now stands. Markets and rates have seemed to become accustomed -- or is that resigned? -- to the new realities in the markets, where growth and inflation have begun to resume their normal dance, while the Fed plays a more familiar tune.

While there is some pressure for rates to rise -- and the month ahead may feature more of that -- we'll enjoy the (probably brief) pause. Mortgage rates may well tick up a little next week, but it isn't likely to amount to much.

Fixed rate mortgages held steady this week, as rates failed to track the drift downward of Treasury yields. By week's end, the 30-year fixed rate mortgage was unchanged from last week's 6.41%.

The economic news released this week can be interpreted both positively and negatively, depending upon how you look at it, but the overall tone served to poke yields downward. For example, bankruptcy filings for the first quarter of 2004 declined by 1.8% over year-ago levels, but actually rose when comparing 3Q03 levels against the latest data.

This yin and yang was evident in complementary data series, as well. Existing Home Sales for April rose to an annualized 6.64 million units sold, the second highest level recorded. However, sales of New Homes slumped by 12%, the biggest one-month decline in ten years, and slipped back to a 1.093 million rate of sale.

The employment situation has improved, especially over the past two months. But it appears as though a little momentum has been lost, if the weekly series on filing for state unemployment benefits can be believed. After starting the month at a recovery-low 318,000 new applications, this week featured some 344,000 new filings, a level more closely correlated with the stagnant hiring levels of earlier this year. In addition, the Conference Board's measure of "help wanted" ads dipped back to 38 in April, a level last seen in January. If such a measure indicates hiring to come, a more moderate hiring level for May seems likely.

The twin reports of Personal Income and Personal Consumption followed the pattern, too: Income rose by 0.6%, more than expected, while expenditures failed to meet forecasts with just a 0.3% lift. Two positive notes could be found in the reports, though -- the national savings rate was 2.4%, the highest since last August, and the inflation reading in the report was the lowest in five months.

While it's a little early to speculate on growth levels for the current quarter, they seem on a par with the latest reading for the first quarter, where the preliminary estimate pointed to growth of 4.4%.

"Push me-Pull you" economic news is good for stability in mortgage rates, so enjoy it while it lasts. More volatility is likely next week, where the holiday-shortened week is crammed with fresh data from May, including the latest employment report. After this week's lull, mortgage rates seem poised for a greater move... probably upwards.

Also, a note for this Memorial Day: If you should happen to see any current or retired members of our armed services, take the time to thank them. If you can't, take the time to remember them.

Fixed mortgage rates declined a bit this week, as the average offered rate for a 30-year fixed-rate mortgage dipped to 6.41%.

At the moment, it's unclear if this week's decline is simply a landing in a staircase of rate increases, or whether rates have now found a level where they are appropriately priced for not one but several increases in the Federal Funds rate.

Market conditions over the past two months should serve to underscore the fact that the Federal Reserve has no direct control over mortgage rates. Rather, despite no action (yet) by the Federal Reserve, concerns about resurgent inflation have caused an appreciable shift in market interest rates, carrying mortgage rates along with them. It is fair to say, though, that the Fed does influence the underlying baseline cost of money by increasing or decreasing the overnight lending rate between banks.

A very simplified explanation of how this works would point out that if it costs lenders more to conduct business among themselves, it's a safe bet that they'll pass at least some of their cost increases along to their borrowers. Of course, it's nowhere near that simple, since there are other, equally potent forces which influence interest rates.

Until January, discussions about Fed policy centered around the definition of what the Fed called a "considerable period" for low interest rates. Recently, they revealed that they didn't intend this phrase to indicate a specific period of time but rather a specific set of economic conditions. Because they felt restricted by the market's interpretation of the "considerable period" definition, the Fed instead proffered that they could be "patient" in raising interest rates. In May, however, they changed that phrase to one where "policy accommodation can be removed in a pace that is likely to be measured."

At the beginning of and during a "tightening trend", the Fed and the markets frequently volley back and forth over a period of time until someone goes too far -- that is, interest rates become high enough to stanch both growth and inflation -- and then market interest rates begin to fall along with prospects for growth and inflation, until the Fed again sufficiently "loosens" the credit spigot, making the cost of money cheaper. Almost always, the markets move first, and the Fed moves in a reactionary capacity. When the Fed moves first (see 1994) markets may react badly, so the Fed is usually content to let the market move first. This time, the market has already moved, and it will soon be the Fed's turn.

The question today, then, is "What constitutes a 'measured' policy move?" Starting from the low, low interest rate levels of today, interest rate increases may be "measured" in one-half percentage point blocks before long, and some analysts believe that the June FOMC meeting will feature one of those. Market interest rates seem positioned for at least two moves of 25 basis points (.25%) each, but may not be prepared for a half-point move, especially if it's accompanied by an indication that more rate increases are forthcoming. In June, the size of the move will matter, at least initially, but the indication of future moves will likely carry much more weight.

By then, and based on growth, hiring and inflation, an initial half-point move may be warranted. However, even if it's not warranted -- especially if it's not -- a Fed move which is more than what the market expects might send a signal that the Fed is serious about not getting too far behind the inflationary curve. Such a statement could actually cause long-term mortgage rates to drift downward somewhat as we trend into mid-summer, and we think that there's a possibility that it might happen. Why? The likelihood of a half-point move derailing the economy is slight right now, largely because rates would be starting from extraordinarily low levels -- short term borrowing costs would remain very, very low despite such a move -- and economic growth is currently at fairly strong levels.

Starts, which slipped slightly in April to 1.97 million (annualized) units begun, a number modestly below forecasts. Building Permits, a signal of future activity, actually increased a bit to a 2.00 million annualized pace. A survey of members of the National Association of Homebuilders showed no change in their market sentiment for May; the reading of 69 in their index matched April's still-high level.

It's likely that happiness would come more easily if there were more jobs available. Despite recent increases in the pace of hiring, job growth is still soft, and layoffs haven't yet fully abated. This week, claims for unemployment benefits at state offices jumped back up to 345,000; at the beginning of the month, that number was considerably lower.

Next week features more significant data. Measures of consumer confidence, home sales, GDP estimates and a few others which are due are likely to move the market to a greater degree, especially since the market needs to position itself for a long Memorial Day weekend. As a result, we'll probably take back at least a few basis points of this week's little dip.

This was another tough week for mortgage hunters; with the average overall 30-year fixed-rate mortgage rising by another 19 basis points (0.19%). Fixed mortgage rates are now at levels not seen since last August -- but at that time, they were on the way down. Aside from that blip, we are now approaching levels for rates seen last in August 2002.

Although the readjustment of buying and selling strategies in the market for bonds and mortgages continues -- changing from one of "low inflation, no Fed moves" to "higher inflation, at least some Fed moves" -- it seems to us that the worst of the increase is over, for the moment.

We're struck with this impression simply because, despite a number of reinforcing data suggesting that inflation is somewhat higher and economic activity continues apace, some slackening (or at least a flatter trajectory) seems likely. For example, there's the report covering Retail Sales for April, which declined by 0.5%; some decline was expected, but this was a little softer than even that forecast. It's very likely that higher gasoline prices will trim available extra spending money in the weeks ahead, suggesting a slower period to come (consumer spending accounts for about 2/3% of all economic growth).

At the moment, inflation is probably the utmost concern. It's quite true that we have moved from sub-1% inflation to a higher level. The question, of course, is will it continue to rise or not, and if so, how far might the Fed's hand be forced?

In April, prices did rise. During the month, values of imported goods rose by 0.2%... but about 0.4% was expected. Those costs have now lifted 4.6% over the past year. Goods priced for export rose by 0.6%, and have risen by 4.1% over the past year.

The Consumer Price Index has also seen a greater acceleration in recent months, but for April, only a rise of 0.2% was found, although the "core" rate was a little higher than that with a 0.3% gain. Year-over-year, those costs are up by 2.3% and 1.8%.

So we do have more inflation. Soon, we will likely have more Fed, as well, but for the moment, mortgage markets seem to be priced somewhat above those levels suggested by a 2.3% inflation rate at the consumer level. Unless we continue to see measurable increases, the Fed probably will be "measured" in lifting short term interest rates, and mortgage rates will likely drift into summer, unofficially just two weeks away.

Markets do remain touchy, just less so. Because of this, mortgage rates are still more likely to increase than decrease at the moment, but we think that there will be little change next week.

Fixed mortgage interest rates marched higher again this week, adding 15 basis points to last week's average with the promise of more to come. The 6.30% of this week is comparable to those seen last summer. 

The Fed met this week to discuss policy, and whether or not it's the appropriate time to lift short-term interest rates. As economic signals point to broader economic expansion, the Fed will be more likely to raise interest rates. 

On Tuesday, the Fed met to contemplate a change in policy, but opted instead for a change to the language in the statement which closes the meeting. Gone are references to deflationary forces, an acknowledgement that inflation is on the rise; additionally, the Fed no longer espouses "patience" before lifting rates but believes that "measured" removal of policy accommodation is possible (translation: interest rates are likely to be increased in small steps). However, in many instances, including this one, any moves the Fed does make may be moot. By the time the Fed actually makes its move, mortgage interest rates have typically already repositioned themselves. Such is the case at the moment.

Although it does influence them, the Fed has no specific control over market interest rates. Those prices and costs are determined not by the decisions of a "group of 15," but through the choices and needs of many millions of investors, at least some of whom are well paid to continually reposition themselves (and the investment money of others) to reflect changes in the investment climate. Right now, those markets and market players are adjusting themselves for a coming higher interest rate environment.

The unanswered question for short-term rates, though, is "how soon, how much?" Before Friday, gamblers in futures markets speculated that there was about a 50% chance of a quarter-point move at the June FOMC meeting; late Friday, that has become nearly 100% (and now includes a 50% chance for a half-point move). Once the first Fed move comes, "How soon, how much?" will be repeated over and over until some sort of balance is achieved.

It's important to stress that the considerable turnaround in interest rates has occurred with no change in policy by the Fed. To some extent, the uptick was exacerbated by the Fed's statement, but the momentum began building weeks ago. Millions of investors, having scanned the economic horizon and observed broadening growth, increased hiring, and gathering signs of inflation, concluded that the days of a 1% inflation and a 1% Fed funds rate are dwindling in number.

As it becomes tougher to borrow cheaply to lend money to others, market interest rates will rise. As renewed (even mild) inflation erodes the return on long-term fixed rate investments (mortgages and bonds), investors will begin to demand a higher return to help offset that erosion. Result: market interest rates will rise. In turn, a stronger economy with more inflation won't need cheap money to fuel it, so the Fed will raise rates again to help keep those forces in check. In conditions like these, the Fed will be following the market, not leading it, for the forseeable future.

With all that said, markets aren't always rational. Just as mortgage rates dipped lower than was warranted in February and March, we're in what might be a "classic" sort of overreaction to a change in the climate. Bond and mortgage markets have a long history of this sort of thing, especially when it comes to rate increases. Last spring and summer we saw a fair run down followed by a sharp run up, only to stabilize and drift lower again over time. This run-up, warranted or not, probably still has some space yet to run and will inflict some damage before its done.

With all the good financial data and the coming return of the Fed, it's little wonder that market players are nervous. It's been a while since we had the beginnings of an accelerating expansion, and the road just ahead is a little uncertain. Nervousness and uncertainty are the hallmarks of higher interest rates, and investors will err on the side of caution (push rates higher yet) until a clearer picture appears.

Next week, higher rates -- another tenth-percent is likely -- and that's without any new 'blowout' news.

Fixed mortgage interest rates stayed on an upward path this week, as the average 30-year fixed rate mortgage rose a tenth of a point to finish the week at 6.15%, up from the recent weekly low of 5.53%.

Although mortgage rates have been rising recently, an unexpected dip in rates during March spurred a lot of homebuyers to action. In that month, sales of new homes posted a record pace of 1.23 million (annualized) units sold; the 8.9% increase was well above forecasts. In addition, Existing Home sales in March climbed to 6.48 million (annualized) as well, the second highest monthly mark on record. Because interest rates began rising more markedly in April, it's likely that at least some slowdown in the torrid sales pace is occurring, even though mortgage rates remain very favorable.

Accompanying March's rate slip was a dip in consumer disposition. Like mortgage rates, this has reversed course. For April, the Conference Board's report on Consumer Confidence posted a larger-than-expected rise, with their gauge landing at a reading of 92.9, versus March's 88.5. A second gauge, the ABC News/Money Magazine survey, rose four points, to hit a nine-week high of -13, suggesting that consumers' confidence strengthened during the second part of the month.

The job market has been doing better; despite March's 308,000 new hires, more recent indicators point to a continuing pickup in hiring. Weekly State Unemployment claims in April have been low as 330,000 at the beginning of the month, but have been considerably above that since. This week, the number of new applications fell to 338,000, a small improvement.

The anemic growth in new jobs has been blamed on a number of factors, high productivity and "off-shoring" among them. Another significant deterrent, however, may be the cost of putting an employee on the books. The Employment Cost Index, a measure of the total cost of adding an employee including salaries and benefits, rose by 1.1% for the first quarter of 2004, faster than the previous quarter. The benefits part of the equation -- up 2.4% -- accounted for more than 2/3 of the increase. Employers will likely continue to be wary about adding fixed overhead costs to their payrolls while they can still wring out increases in productivity from employees already on the books.

On balance, what we have here is an economy that's improving -- not at a torrid pace, at least not at the moment, but doing better month by month. As the job market improves, so too will income, but too-strong wage growth is considered to be one of the warning signs of inflationary pressures -- something the Federal Reserve will be sure to discuss at its Tuesday FOMC meeting.  It's not expected that the Fed will take any action at this time.

Next week, the numbers to watch will be the full employment report for April and the Institute of Supply Managers (ISM) indexes. Last month, all three handily bested expectations. Will they do the same this time? If so, the inflation heat may be kicked up a notch.

We're going to be cautious and forecast only a slight upward drift in mortgage rates for next week.

Fixed mortgage interest rates rose a little more this week, with the average 30-year fixed rate mortgage finishing at 6.05%, an increase of 6 basis points.

Continuing signs of resurgent economic growth have been accompanied by concerns that inflation is poised for a comeback. It's fair to say that there are currently sporadic price pressures evident all around us; gasoline, food and health care costs are higher, for example. But whether those price increases are temporary, or part of a more permanent upward swing, is not yet known... and the basis for the Fed's current stance of talking down inflation, or rather, inflation expectations.

Why is inflation, actual or feared, important to mortgage shoppers? Very simply, the rising costs of goods and services erodes the value of a fixed income investment (in this case, a mortgage bond). For example, an investment in a bond with a 6% yield in a 1% inflation environment means a "real return" of 5%. If the investor requires a 5% return -- that is, it's his for buying that mortgage bond -- and inflation is now 2%, that yield (your mortgage rate) will need to be 7%, or the investor won't buy it, and you won't be able to get a mortgage.

This week, Federal Reserve Chairman Greenspan and other Fed Governors spoke on several occasions and a variety of themes. All of their speeches and testimonies discussed the current price environment and the level of short-term interest rates, and all made allusions to a Fed Funds rate which will inevitably rise. Notably, all espoused beliefs that inflation is not only currently low (if no longer falling), but would likely remain low for the forseeable future.

Are the markets right for worrying, or is the Fed right for downplaying the potential? Both sides have their case. On one hand, it's very hard to ignore the recent pressures now showing in price gauges such as the Producer Price Index. For March, the PPI rose by 0.5%; markets expected a lesser increase, and prices at the wholesale level have risen by 5.1% over the past three months. The Fed, on the other hand, rightly acknowledges that "input costs" of materials make up only a small portion of the total cost of a product, and that still-soft labor markets aren't yet generating any wage inflation.

At the moment, the Fed needs to downplay the risk of inflation, so that markets don't begin to raise yield demands (in this case, mortgage rates) and cause a slowing in the economy before it's warranted, as higher borrowing costs trim loan demand from consumers and businesses.

However, the Fed's own "Survey of Regional Economic Conditions," known as the 'beige book', weighed in this week as well. Covering the period of late February through early April, the report had this to say: "Labor markets tightened somewhat with modest wage increases... most districts indicated significant increases in numerous commodities and input costs... rising materials costs a common theme [among manufacturers] with mixed ability to pass along higher prices."

While this explicit acknowledgement of growing price pressures should serve as a warning, it doesn't answer the question of whether price increases are temporary or not. Until it is clear one way or the other -- or perhaps just that broad inflation is returning to a more normal (and anticipated) level -- markets will err on the side of caution, and that means a greater likelihood of higher rates ahead.

With April nearly over, reports that March was a pretty strong month continue to point to just how strong it was. Orders for Durable Goods rose by a stout 3.4%, on the order of seven times the expected increase, and the February gain was revised upward as well. The Index of Leading Economic Indicators rose by 0.3%, a nice rebound after Februrary's flat position.

More recent data, though, don't seem as sanguine as March's does. Weekly State Unemployment Claims this month have been higher this month than last, and the 353,000 new applications last week aren't indicative of a sharply-improving labor situation. In fact, looking over the month, we're left with the impression that a blowout employment number is becoming considerably more unlikely when the next report is released in early May.

More inflation, or not? We believe that more will emerge as we return to a more normal pattern. That return will be accompanied by somewhat higher mortgage rates. Next week has a lot of new data scheduled to be released, including the Employment Cost Index, so it could be a bit of a rough and tumble week.

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