Economic Uncertainty Persists
December 12, 2002
by Frank Nothaft and Amy Crews Cutts
The aftereffects of the Fed's November rate cuts have been mild thus far. The stock market indices and rates on short-term Treasuries are little changed. But yields on long-term Treasuries have increased over the past month as talk of economic recovery has become more positive. Indeed, third quarter GDP growth was revised upward to 4%, and consumer spending came in higher than expected in October. The impact of the rate cut was on the corporate bond spreads relative to Treasury rates, which narrowed significantly after the rate cut. For example, corporate junk bond spreads to the 10-year Treasury bond fell 150 basis points after the rate cut. Corporations in need of capital for investment purposes should find funding more easily, which will lead to much-needed economic growth.
The December Federal Open Market Committee (FOMC) meeting should be a non-event. The Fed has continued to indicate a neutral stance since its November FOMC meeting, and market indicators show no expectations of a change in Fed policy. Combined with currently tame inflation expectations, interest rates are expected to remain at current levels for several more months, a positive sign for housing markets.
Uncertainty, however, is high. The consequences of potential war with Iraq on the political stability of the Middle East and oil supplies are prominent topics for speculation. Added to that, the position of the chairman of the Securities and Exchanges Commission remains unfilled at a time when leadership in accounting standards and investment practices is sorely needed. The replacement of both the head of the U.S. Treasury and the President's top economic advisor, while indicating that the Bush administration sees a problem with the U.S. economy, creates further uncertainty about the economic recovery.
The impact on housing markets from the global uncertainty will be through interest rates and jobs. Volatility in interest rates was high throughout 2002 as investors poured money into the bond markets in search of a safe haven only to pull it back out at the slightest sign of a stock market rally. The volatility is likely to remain for the near term, and could increase if fears of oil shocks (and thus inflation) or worries over corporate malfeasance increase. The impact of the flight to quality in the bond markets has been good for housing by lowering interest rates. An improving employment picture in the U.S., which depends in part on corporate investments and, to a greater extent, on international demand for U.S. products, should continue to support a vibrant housing market.
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- Corporate investment activity has improved in recent reports but a weak forecast for holiday spending by consumers has kept expectations for real GDP at just 1.5% in the 4th quarter. The recent Fed rate cut and continued fiscal-policy stimulus from homeland security spending should help gradually boost the economy. Thus, we project real GDP growth at 3.3% for 2003.
- Inflation is still keeping a low profile, rising 0.3% in September, with year-to-date inflation running at a 2.7% annualized rate. The 2002 year-end value should remain steady at 2.6%, with inflation slowing to 2.0% for 2003.
- The unemployment rate rose back to 6.0% in November reflecting new job losses. On the bright side, although there have been large swings in monthly employment numbers, the net total employment numbers are unchanged year-to-date. Our forecast for the 2002 average unemployment rate is unchanged at 5.8%, and we continue to expect a slow decline in the unemployment rate over the coming year.
- The roller-coaster path of interest rates has continued with the yields on 10-year Treasuries currently 21 basis points (0.21 percentage points) higher than a month ago. However, the average rate on 30-year, fixed-rate, mortgages has only risen 8 basis points over the past month as spreads have narrowed. The Fed's rate cut and low inflation prospects should keep mortgage rates close to 6¼% through the middle of 2003.
- Housing starts fell 11.4% to 1.603 million units (SAAR) in October after hitting a 16-year high in September. Our forecast for year-end total housing starts remains at 1.68 million units (a 5% increase over 2001 total starts), and we continue to project that housing starts in 2003 will be about as high as in 2002.
- Sales of new homes decreased 4% in October from September's record rate, but sales of existing homes jumped higher to the third highest rate ever. Home sales should remain strong in 2003 as the economy improves and interest rates remain low. Sales in 2002 should hit 6.47 million units.
- The refinance tsunami continues, but with slightly moderating volumes. The Mortgage Bankers Association of America reported that the refi share of new mortgage applications fell to 69.5% during the week ended November 29, 2002 due to slightly higher mortgage rates. However, the refi share of new applications has been above 60% for 22 straight weeks. Currently, we anticipate high refi volumes to continue in the 4th quarter (70% share) then gradually decreasing over 2003 to an annual share in 2003 of 43%.
- Because of the volatility in interest rates and slightly higher rates in recent weeks, we have revised our 2002 estimate of total single-family mortgage originations down to $2.31 trillion. We are anticipating volume of $1.7 trillion for 2003, a decrease of about 25% over 2002's record originations volume due to lower refi originations volume. Purchase-money originations volume should be strong in 2003.
Source: Freddie Mac