The Economy is Looking Up!

On Monday, June 1, the Commerce Department reported total construction spending unexpectedly rose 0.8% in April. Economists had expected a 1.2% decline. It was the biggest gain since August 2008 and marked the second straight month that construction spending has risen after a 0.4% increase in March.

The Institute for Supply Management reported the monthly index of manufacturing activity rose in May to 42.8 from 40.1 in April. Though any reading below 50 signals contraction, it was the fifth consecutive monthly increase from a record low of 32.9 in December. Most importantly, the index of new orders rose to 51.1. This is the first expansion since November 2007, one month before the recession began.

The National Association of Realtors reported that its pending home sales index, a forward-looking indicator based on signed contracts, rose 6.7% to 90.3 in April from 84.6 in March. It was the biggest monthly jump since October 2001 and the third consecutive monthly increase after the index hit a record low in January. The reading is 3.2% above the April 2008 level.

The Commerce Department reported factory orders rose 0.7% in April, after a revised 0.9% drop in March. The report reflected increased demand for automobiles, electrical equipment and construction machinery.

The Institute for Supply Management reported the monthly index of non-manufacturing activity rose in May to 44 from 43.7 in April. Economists had expected a reading of 42. Figures below 50 indicate contraction.

Initial claims for unemployment benefits fell by 4,000 to 621,000 in the week ending May 30 from a revised figure of 625,000 in the previous week. The number of people continuing to claim jobless benefits in the week ending May 23 fell to 6.74 million. It was the first decrease in almost five months of uninterrupted weekly gains.

All good news….any movement in the upward direction, however small, is the right direction. Things are looking up!

This article was reprinted with permission from David Bolton, Loan Officer, Prospect Mortgage.

Why Rates Change

How often have you heard of the Federal Reserve cutting rates only to find that mortgage rates haven’t moved? One common mortgage industry misconception is the correlation between the Federal Reserve Board's announcements to raise or lower interest rates and the direct effect on fixed mortgage rates. While the two are connected, they don't always go hand-in-hand.

Kinds of Rates
To better understand why mortgage rates change, we must first look at why interest rates change. First, it is important to realize that there is not just one interest rate, but many:

Prime Rate: The rate offered to a bank's best customers and subject to change monthly.

Treasury Bill Rates: Treasury Bills are short-term debt instruments used by the U.S. Government to finance their debt. Commonly know as T-Bills, they come in denominations of 3 months, 6 months and 1 year. Each Treasury bill has a corresponding interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate).

Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance their debt. They come in denominations of 2 years, 5 years and 10 years.

Treasury Bonds: Long-debt instruments used by the U.S. Government to finance its debt.

Federal Funds Rate: Rates that banks charge each other for overnight loans.

Federal Discount Rate: Rate that the Federal Reserve charges to member banks.

LIBOR: London Interbank Offered Rates. Average London Eurodollar rates.

6-month CD Rate: The average rate that you get when you invest in a 6-month Certificate of Deposit.

11th District Cost of Funds: Rate determined by averaging a composite of depository rates at Savings & Loan institutions in the Western United States.

Fannie Mae-Backed Security Rates: Fannie Mae pools large quantities of mortgages, creates securities with them, and sells them as Fannie Mae-backed securities. The rates on these securities strongly influence mortgage rates.

Ginnie Mae-Backed Security Rates: Ginnie Mae pools large quantities of mortgages, secures them and sells them as Ginnie Mae-backed securities. The rates on these securities influence mortgage rates on FHA and VA loans.

Mortgage Rates Refresher
Fixed interest-rate fluctuations are based on the concept of supply and demand. If demand for credit (loans) increases, so do interest rates. More buyers mean sellers can command a better price (i.e., higher rates). If demand for credit reduces, then so do interest rates. This is because there are more sellers, so buyers can command a lower better price (i.e., lower rates). When the economy expands, there is higher demand for credit, so rates increase. When the economy slows, the demand for credit decreases and so do rates.

Effects of Inflation
A major factor driving interest rates is inflation. Higher inflation is associated with a growing economy. When the economy grows too strongly, the Federal Reserve increases interest rates to slow the economy down and reduce inflationary risk. Inflation results from prices of goods and services increasing. When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can increase prices. A strong economy therefore results in higher mortgage rates.

Mortgage Rates vs. Interest Rates
Fixed mortgage rates tend to move in the same direction as interest rates. However, actual mortgage rates are also based on supply and demand for mortgages. The supply/demand equation for mortgage rates may be different from the supply/demand equation for interest rates. This may result in mortgage rates moving somewhat differently from other rates.

Significance of Bond Prices
There is an inverse relationship between bond prices and bond yields. This can be confusing. When bond prices move up, interest rates move down and vice versa. This is because bonds tend to have a fixed price at maturity--typically $1000. If the price of the bond is currently $900 with 10 years left until maturity, and interest rates start moving higher, the price of the bond starts dropping. The higher interest rates accumulate over the next five years, meaning that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.

This article was reprinted with permission from David Bolton, Loan Officer, Prospect Mortgage.