by: Tim McLaughlin

With high water marks on the radar screen for 2011 (the end of the Treasury purchase program, Fed induced inflation measures, and employment/economic recovery concerns), we will be watching the early warning signs from the Federal Open Market Committee even more closely than we have in the past for indications of what’s to come and the Fed’s mindset on how they react.

On Wednesday, as expected, the first FOMC meeting of the year was uneventful but it still gave everyone in the press something to jabber about. The statement was almost identical to last month’s (which was identical to the month before). The Fed acknowledged stronger economic data and that commodity prices has risen (a new addition to the verbiage). The statement continued to reference that “[core] inflation is somewhat low” relative to the mandate and an unemployment that is “elevated.” The recovery is continuing, but remains “too slow to sufficiently improve the labor market.” Business spending in software and equipment is rising and household spending has increased. In addition, the “money statement” that the benchmark rate will be “exceptionally low for an extended period” remained in the verbiage as well.
The takeaways for our trading desk were as follows:
• Bottom line: No real surprise. The statement shows that the Fed has set a very high hurdle for conditions under which they would change their policy rhetoric and we’re still a long way from a “hawkish Fed”. Just see the opening sentence “economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions”

• Maintained rates unchanged 0% to 0.25%, unanimously 11-0 with no dissents (first time in a while there were no dissents)

• Maintained QE2 plan unchanged at $600B until June including MBS reinvestment (MBS reinvestment a key for our industry).

• Economy recovery is continuing but recovery has been “insufficient” to reduce joblessness

What this means to us? All in all, positive. Stay the course. Maintain interest rates. As the economy and employment improves and/or as inflation starts to ramp up, that is when we will need to watch closely to see how that impacts Fed decisioning, which in turn impacts interest rates.

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by:Tim McLaughlin

There was a web based discussion a couple of weeks back; the talking points which were shared with me by trading partners on the street, which was entitled “Is Real Estate Finally a Good Investment”? Essentially, the moderators of the discussion pointed to three underlying reasons why Real Estate Investment, in certain scenarios, makes feasible sense right now (taking a traders mindset into account):

• Hatred of the “Asset”: Hatred of an asset is often the precursor to contrarian interest, and being contrarian is at the heart of many investment strategies. To paraphrase Warren Buffett, “be fearful when others are greedy and greedy when others are fearful”. Mr. Buffett backed that idea when he invested in the stock market in the teeth of the financial crisis in late 2008 and early 2009. Remember, Gold was hated for years (termed as “dead money”) before it recently became an attractive asset class once again and skyrocketed in value.
• Smart Money is Buying: John Paulson, the hedge fund manager who made $20 billion betting against the housing bubble in 2007-2010, stated in a speech late last year: “If you don’t own a home buy one. If you own one home, buy another one, and if you own two homes buy a third and lend your relatives the money to buy a home.” Why is Mr. Paulson so adamant? Because he believes long term interest rates are not going to get much lower. They have, in fact, risen since he gave that speech, but they remain remarkably low by historic standards. Low rates and the expectation that home prices will rise is his basis of this sound argument
• Demand is Coming Back: Supply isn’t as out of whack as it was at the height of the crisis. At the end of Nov, home builders reported 197K new homes on the market, the lowest level since 1968, according to Yardeni Research. The National Association of Realtors reports that the inventory of existing homes for sale fell 4% to 3.71M homes, which represents a 9.5 month supply at the current sales pace, down from a 10.5 month supply in October. And that timeline appears to be falling.

Albeit, no one will really know when the “best” point in time is/was to buy or invest until it has already come and gone. But with “value” inventory and low interest rates, more and more observers think the time is now.

The Housing Market in 2011
by: Tim McLaughlin

As we enter the New Year, the two biggest questions we hear are “what will happen on the housing front in 2011” and “what are the expectations for interest rates”? There is a lot of chatter about this, not only in our industry, but in the broader markets as well.

Strictly speaking from a market perspective, there are five general factors that appear to be driving how the housing market will develop in 2011:

• Employment:Certainly, it stands to reason that the higher the employment rate in this country, the healthy the housing market will be with new, willing entrants. Today’s employment data report was a good start to the year, with the headline unemployment rate dipping down to 9.4% (down 0.4%). Some noise in the data release, but hopefully a positive sign of things to come.

• The Foreclosure Process: How long it will take to process, list, sell, and clear all the pending foreclosures will have a direct impact on the housing sectors inventory level. “Robogate” stalled the process in 4Q10, but with foreclosures once again being processed at the beginning of the year, the sooner we clear the existing inventory of foreclosures, the quicker we normalize the housing market.

• Regulatory Changes:The future of Fannie/Freddie, the Dodd/Frank Act, Risk Retention, Compensation Rules -> all items that you may have heard about directly or on the periphery that will shape the way business is conducted and will indirectly impact the Real Estate sector in the year ahead.

• Underwriting Guidelines: 90+% of production is now connected to some type of government agency. In order for that to change, private lenders are going to have to step up lending within (or outside) the existing box we now work within.

• Interest Rates: A lot of interest rate projections are based on what the economy does in 2011, and there is an inverse relationship between the recovery in the market and rates. Most economists project that if the economy stays cool, interest rates will trend lower. The hotter/quicker the economy recovers, the more interest rates will rise. The important takeaway is that rates are still at historical lows, with Fixed Rates loans starting with a 4 in many cases, and hybrid ARM’s still in the 3+% range.

by: Tim McLaughlin

We expected a lot of news, and a great deal of market
uncertainty this week, and that’s what we got. Here is a
recap from the most action packed market week of the year:
Election Tuesday: Pretty much went as projected.
Republicans took back the House, Democrats held on the
Senate by the narrowest of margins, and President Obama
publically took responsibility for the “shellacking” Democrats
endured on Election Day.

With the election behind us, what does this mean for the
future? Republican’s will take a look at redoing/undoing
Dodd/Frank, Health Care, Consumer Protection oversight,
however, it is long shot that they will be able to make a
significant dent in any of these. Wall Street is happier, but
we will see if that translates into anything positive in the
mortgage space. I am sure the volume around the future of
Fannie Mae/Freddie Mac becomes louder in congressional
chambers over the next six months. Election, as a whole,
was good for moral and the markets, which is good for rates
and housing, but Wednesday was really the key…
Bernanke Wednesday: Did and said all the right things.
The FOMC came out with a package that, for the most part,
met the expectations of the marketplace. $600B in new
Treasury purchases targeted ($100B more than projected),
but over a longer timeframe (by the end of Q2 as opposed to
the end of Q1), thus an artificial cap of $75B a month as
opposed to the projected cap of $100B per month.
From a market perspective, all sectors liked/loved the
news. No real knee jerk reaction on Wednesday afternoon
post announcement, so, initially, there were thoughts that
the market had potentially fully priced the whole
announcement into various asset classes in advance, but
Thursday saw rallies in all sectors (Equities, Fixed Income,
Commodities), so, obviously, there is still some room for the
market to capitalize on this.

The game plan related to the FOMC’s moves are simple:
by driving down the dollar, reducing interest rates, and
hopefully create just enough (but not too much) inflation, that
should positively impact investments, exports, consumer
goods, and the economy as a whole, which, in turn, also
helps job creation and employment. The goal of the stimulus
plan (QEII) is straightforward: to not let existing roadblocks
continue to encumber the economic recovery. While the
initial response (from the market) regarding the
announcement is good, we will have to trend the results over
the next few months to come.

by: Tim McLaughlin 

The focus for next week is undoubtedly the FOMC meeting on Tuesday/Wednesday, and what the Fed chooses (or chooses not) to unveil. Many traders/economists are of the opinion that what the Fed may do is already priced into the current stock and bond market levels, to some degree.

When the US government, who prints money, wants inflation, it is not a wise strategy to bet against them. The QE II that the press is consumed with is a form of government monetary policy used to increase the money supply, when necessary, by buying government securities or other securities from the market. This, in turn, increases the money supply by giving financial institutions with capital an opportunity to promote increased lending and liquidity. Quantitative easing appears when the banks interest rates (overnight Fed Funds, discount rates, etc.) have already been lowered to near 0% levels and have failed to produce the desired effect.

The major risk of quantitative easing is that although more money is floating around, there is still a fixed amount of goods for sale. With more cash and the same amount of goods, inflation usually increases, which in turn pushes rates (like mortgage rates) higher. And the end game for the Fed at this point is to increase inflation (and therefore jolt the economy, as detailed last week).

On the downside, if the FOMC does nothing, or not as much as the market would like or expects, that could adversely impact the markets, with equities probably being more negatively impacted then bonds. Weds afternoon will undoubtedly be an important time in the marketplace.

by: Tim McLaughlin

As we near the end of 2010, all eyes are focused on how the markets will finish out the year, and how the rumored effects of “QE2” will further jumpstart the economy.

“QE2”, in this case, is not the Queen Elizabeth II, the cruise ship, but, rather, “Quantitative Easing, Part II”, the Treasury and Fed’s collaborative efforts to fuel the recovery, improve the economy, aide employment, and help push inflation rates up a touch. If you remember in part one, the Fed and Treasury purchased over billions (actually, over a trillion) in Mortgage Backed Securities and Treasuries combine to drive interest rates down. Let’s explore what the government is hoping to accomplish in part two:

QE2 should help growth via three main channels. First, lower long term interest rates should stimulate various forms of credit sensitive spending such as housing, other consumer goods, capital goods, and state and local construction, as well as further help households reduce interest expense via refinancing. Secondly, higher equity prices should boost consumer spending via the wealth effect and capital spending via a lower cost of equity capital. And third/last, a lower dollar should help narrow the trade deficit.

While most of these channels have open questions about their effectiveness in the current situation, they are apt to have a positive net effect. In summary, Goldman Sachs has estimated that QE2 would boost real GDP growth by 0.5 percentage point per $1 trillion of Treasury security purchases.

Lower long-term real rates should stimulate:

More housing demand

More consumer demand for durable goods

Improved employment picture

More capital spending

More construction by state and local governments

Further refinancing of mortgage

A lower cost of equity capital

Higher equity prices, which helps economic activity in two ways:

o A positive wealth effect

o A lower cost of equity capital

Certainly, a lot to digest. From a mortgage and housing standpoint, we can see many benefits high level and by digging deeper: more housing demand, more refinancing, improvement in employment which makes borrowers more apt to purchase, higher equity prices = positive wealth = more confidence by real estate consumers. “QE2” is something to watch closely as it evolves in Q4 and 1Q11.

by: Tim McLaughlin

 Interesting takeaways from the Fed minutes last Tuesday regarding “what do we do next”:

At the last FOMC meeting, it was clear that Fed officials considered making bond purchases and taking other steps to avoid falling prices, as a way to ignite the economy. Minutes from the last meeting (Sept. 21) showed officials remained divided; however, most thinking new measures to jump start growth would be needed, given that inflation is too low and unemployment too high.

Over the course of the last few weeks, many investors have been focusing on what the Fed’s new bond purchase program may look like (an anticipated tool in their revival strategy). All expectations are that the Treasury will purchase additional longer term Treasury securities to bolster the economy beginning in 1Q11.

But the minutes showed Fed officials were also looking at several strategies for inflation. The Fed is analyzing the best steps to increase inflation (yes, increase). Higher inflation, in theory, will force consumers to purchase more now to avoid higher prices later, thus further fueling the economy. Due to the economy’s weakness, inflation is currently running at 1.4% (below the Fed’s informal target of between 1.7% and 2.0%, according to Fed officials). Fed officials would like it higher than 2% (closer to 3%) for the short term to prompt spending.

Ways to artificially increase inflation:

o Reduce the Fed Funds rate (accomplished)

o Decrease personal income taxes (more disposable income; would need the help of Congress)

o Infuse additional capital into the monetary system

o Continued Bond/Treasury purchases

The most interesting statement, in my opinion -> “Participants noted a number of possible strategies for affecting short term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its mandate…as a general matter, participants felt that any needed policy accommodation would be most effective if enacted within a framework that was clearly communicated to the public. The minutes of FOMC meetings were seen as an important channel for communicating participants’ views about monetary policy.” The takeaway: look for the Fed to clearly layout what their strategy is, in simple terms, to promote inflation in future Fed releases in the months to come.