The May Employment report revealed the largest monthly increase in jobs since March 2000, but nearly all of the gains came from the hiring of temporary census workers. Without the census workers, the data fell short of expectations. A total of 431K jobs were added in May, below the consensus forecast of 500K. 411K jobs came from census hiring, leaving a net gain of just 20K jobs when those workers are excluded. The Unemployment Rate dropped to 9.7% from 9.9% in April, but this was mostly due to people dropping out of the labor force. Investors had expected stronger results from private sector job growth, and the stock market fell after the news. Weak labor market figures generally lead to lower inflation and are favorable for mortgage markets.

The news from the housing sector was more positive. April Pending Home Sales rose 6% from March, which was stronger than expected, to the highest level since October 2009. Pending sales are a leading indicator of future housing market activity. The April 30 expiration of the homebuyer tax credit likely pulled some pending sales forward which otherwise might have taken place later in the year. The benefits, though, of extremely low mortgage rates and very affordable home prices are in place to promote home buying activity even without the homebuyer tax credit.

Global financial markets remained focused on the economic troubles of Greece. Greek workers responded to proposed austerity measures with strikes and riots, and investors grew increasingly concerned that other smaller European countries will face similar problems cutting their budget deficits. As a result, US mortgage markets were helped in two primary ways. First, in response to the uncertainty in Europe, investors shifted funds to safer investments, including US Treasuries and mortgage-backed securities (MBS). Second, investors expect that continued economic turmoil in Europe will reduce US exports to the region, slowing US economic growth and reducing inflationary pressures. Increased demand for MBS and lower future inflation are both positive for mortgage markets.

The April Employment report exceeded expectations in nearly every area. Against a consensus forecast of 190K, the economy added 290K jobs in April, the most since March 2006, and the data from prior months was revised higher by an additional 121K. The April figures include 66K temporary census employees hired by the government, but this was fewer than expected. The manufacturing sector added the most jobs since 1998. The Unemployment Rate rose to 9.9% from 9.7%, but that was due to unexpectedly large growth in the labor force as more people began to seek jobs.

For months, investors have been concerned that the enormous supply of debt needed to fund US government spending would force yields on US Treasury securities to rise to attract purchasers. This is what took place this week. Demand was surprisingly weak at all of this week’s record Treasury auctions, especially from foreign investors, and yields were pushed higher. Since mortgage-backed securities (MBS) compete for investors with Treasuries, MBS yields rose as well, pushing Austin mortgage rates higher.

In a speech on Thursday, Fed Chief Bernanke added to the volatility in mortgage markets with his comments about the possible timing of future sales of MBS from the Fed’s portfolio. To support the economy, the Fed has purchased almost $1.25 trillion of MBS since the start of 2009. The Fed has made clear from the start that it was a temporary measure and that it would eventually sell its MBS holdings when the economy was healthy enough. Earlier this month, Bernanke stated that he did not expect the Fed to sell assets “in the near term”. On Thursday, however, his language changed a little. While Bernanke assured investors that MBS sales would be gradual and that they would only take place if the economy were strong enough to handle it, he opened the door for the start of Fed MBS sales at an earlier date than previously anticipated.

A majority of economists in the National Association of Business Economists’ semiannual survey found the Fed’s current stance of rates near zero percent is appropriate. A growing number, however, believe the U.S. central bank’s policy’s are too stimulative, according to a poll of 203 members taken Feb. 4-22.

“A majority believes that a rise in interest rates is both likely and appropriate in the next several months,” said NABE President Lynn Reaser.

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INFO THAT HITS US WHERE WE LIVE New home sales fell 11.2% in January to a record low level. Existing home sales weren’t very pretty either, down 7.2%, though they’re UP 11.5% over a year ago. Let’s remember that last Fall we all thought the tax credit was going away at the end of November. Many sales got pushed into October and November, causing sales drops the next two months. But the median new home price is down just 2.4% year over year and the average price is now UP 3.7%. For an existing home, the median price is unchanged from a year ago and the average price is UP 2.6%. More evidence home prices are stabilizing, with some analysts expecting modest gains for the year. Supporting this, the Case-Shiller home price index was UP 0.3% in December, its seventh straight monthly rise.

Even more interesting was the news that this has actually been a very good decade for home prices. From January 2000 to December 2009, prices were UP 46%, making residential real estate a clearly profitable investment. And that’s not even factoring in the mortgage interest and real estate tax deductions homeowners get!

Finally, we’ve reported that the Fed will stop buying mortgage bonds at the end of this month and experts feared rates may edge up. Now analysts say mortgage rates might not move much at all. This stems from the fairly calm market reaction to last week’s hike of the Fed’s discount lending rate (which is NOT the key Fed funds rate). Seeing little or no move in today’s low mortgage rates is good news for the near term.

>> Review of Last Week

MINOR SLIP… Another volatile week on Wall Street, as investors drove stock prices down two days, then up two days, with all three major indexes slipping just slightly for the week. Things got off to a weak economic start with Consumer Confidence dropping sharply in February, much like the temporary drop in January 1996 when, curiously, there was another big blizzard on the East Coast.

Folks didn’t much like the drop in new home sales either, but good news did come with the Richmond Fed Index, which showed that manufacturing in the mid-Atlantic region went from -2 in January to +2 in February. Then there was Fed Chairman Ben Bernanke’s monetary policy report to Congress, which he serves up every six months. Bernanke assured everyone rates will remain low, a message loved by investors.

The up-and-down news continued with durable goods UP a solid 3.0% for January, showing business is investing in equipment, usually a precursor to their investing in jobs. Not just yet, though, as weekly unemployment claims edged up a tad. Then Friday we had the blockbuster news that real GDP for Q4 was revised UP to a 5.9% annual growth rate. People who still can’t see a recovery should also look at the Chicago PMI. This gauge of Midwest manufacturing hit a five-year high of 62.6 for February.

For the week, the Dow was down 0.7%, to 10325.26; the S&P 500 was down 0.4%, to 1104.49; while the Nasdaq skidded down 0.3%, to 2238.26.

Bonds ended the week pretty nicely as investors sought safety in a week featuring strong Treasury auctions. The FNMA 30-year 4.5% bond we watch ended UP 87 basis points, closing at $101.09. As a national average, mortgage rates inched up a little, but still remain at very low levels.

>> This Week’s Forecast

INFLATION, MANUFACTURING, HOMES, JOBS… This week has everything! We start off with PCE, the Fed’s favorite reading on inflation, followed by the ISM take on the state of manufacturing, a sector that’s been leading the recovery. Thursday, Pending Home Sales looks to the near future of the housing market. Then the week ends with the all-important February jobs report. We will be looking for some encouraging signs on that front.

>> The Week’s Economic Indicator Calendar

Weaker than expected economic data tends to send bond prices up and interest rates down, while positive data points to lower bond prices and rising loan rates.

Economic Calendar for the Week of March 1 – March 5

>> Federal Reserve Watch

Forecasting Federal Reserve policy changes in coming months In Congressional testimony last week, Fed Chairman Bernanke recited his familiar mantra that interest rates should stay low for “an extended period of time.” Now very few economists feel the Fed funds rate will rise during the first half of this year. Note: In the lower chart, a 1% probability of change is a 99% certainty the rate will stay the same.

Current Fed Funds Rate: 0%–0.25%

Probability of change from current policy:

While it is rarely a big market mover, this week’s Consumer Confidence report shocked investors. The index declined to 46.0, far below the consensus forecast of 55.0, and the lowest level in nine months. Consumers are clearly worried about the labor market, and an increase in Jobless Claims in recent weeks has amplified the issue. The decline in confidence has potentially negative consequences for the economy. Consumer spending accounts for about 70% of economic activity, and this data raises concerns about the level of future spending. Also, home sales suffer during periods of low consumer confidence, and the housing data released this week reflected consumer insecurity. Of course, slower economic growth is favorable for Austin mortgage rates, which fell after the report came out.

In contrast to the weakness seen in many of the consumer-driven economic reports, the manufacturing sector has been demonstrating strong performance in recent months. Fourth quarter Gross Domestic Product (GDP), the broadest measure of economic activity, rose at a brisk 5.9% annual rate, largely due to a pickup in manufacturing. The added boost from manufacturing may be temporary, however. During the financial crisis, companies drew down inventories as much as possible to conserve capital. As the economy has shown improvement, companies have been increasing inventories closer to pre-crisis levels. When the inventory rebuilding is complete, manufacturing is expected to return to more normal levels.

Week Ahead

The biggest economic event next week will be the important Employment report on Friday. As usual, this data on the number of jobs, the Unemployment Rate, and wage inflation will be the most highly anticipated economic data of the month. Early estimates are for a decrease of about -20K jobs in February. Before the employment data, Personal Income and the ISM manufacturing index will be released on Monday. ISM Services and the Fed’s Beige Book will be released on Wednesday. Pending Home Sales, a leading indicator for the housing market, will come out on Thursday. Productivity, Construction Spending and Factory Orders will round out the schedule. In addition, the Treasury will announce the size of upcoming auctions on Thursday.

While investors began the week watching for fresh information about Greece and China, the Fed stole the spotlight on Wednesday with news that was unfavorable for mortgage markets, and Austin mortgage rates ended the week moderately higher.

The Fed currently has significant influence on mortgage rates. Over the last year, the Fed pushed mortgage rates lower by purchasing over $1 trillion in mortgage-backed securities (MBS). Wednesday, the Fed’s Plosser suggested that the Fed should begin selling those MBS “sooner rather than later.” Later that day, the Fed released the detailed minutes from the January 27 Fed meeting. The minutes revealed that “several” Fed officials favored starting the sale of the Fed’s MBS portfolio “in the near future.” Investors were not expecting that Fed MBS sales would begin any time soon. Quite simply, adding to the supply of MBS being sold means that yields would need to move higher to attract buyers. Since mortgage rates are largely determined by MBS yields, mortgage rates rose after the news.

Thursday, the Fed announced an increase in the discount rate, the emergency rate at which banks borrow money from the Fed. The Fed made clear that this in no way reflected a change in broader monetary policy or its economic outlook. This was simply a return to more normal levels for one Fed tool now that the financial crisis has eased. As a result, there was very little impact on mortgage rates. According to Fed officials, a move to begin to tighten overall monetary policy, which almost certainly would cause a significant reaction, is still expected to be at least several months away. The inflation data released this week continued to show low levels of current inflation, providing little pressure for the Fed to rush to take action.

As expected, the Fed made no change in the fed funds rate on Wednesday. The biggest surprise was that the Fed’s Hoenig dissented from the decision, as he believes that economic conditions have improved enough that the Fed should begin to tighten policy. The Fed’s outlook for the economy was slightly more positive than in the prior statement. The statement repeated that the mortgage-backed security (MBS) purchase program will be concluded by the end of March. Some investors were disappointed that the Fed didn’t show more support for a possible expansion of the MBS purchase program, and mortgage rates rose after the news.

There is a wide range of expectations in the investment community about the impact of the end of the MBS purchase program on mortgage rates. The Fed has been purchasing roughly 75% of new MBS issuance, and a decline in demand from one source normally leads to higher yields to attract other buyers. One argument, however, is that the end of the program has been expected for quite a while, so mortgage rates already reflect the news, and there could be little reaction over coming months. Other analysts predict an increase in mortgage rates of as much as one percent. The Fed itself expects a small increase in mortgage rates as a result of the end of the program.

One primary long-term concern for mortgage investors is that the enormous level of stimulus intended to boost the economy will lead to higher inflation. Inflation erodes the value of fixed income investments, so future inflation expectations are a major determinant of bond values, including mortgage-backed securities (MBS). Inflation has not been a factor in the short-term, however, as virtually all of the data in recent months has shown it to be low. This week, the Consumer Price Index (CPI), the most widely watched inflation indicator, showed that core inflation rose only 1.8% from one year ago. The Fed’s comfort zone is for core inflation to rise at a 1.0% to 2.0% annual rate, and Fed forecasts are for low core inflation this year. Mortgage investors will be watching these levels closely, and any surprises down the road could push Austin mortgage rates higher.

A second major long-term issue for mortgage investors is that the vast increase in the supply of government debt will exceed the demand. So far, both foreign and domestic demand has remained strong. This week’s Treasury auctions saw very solid demand, particularly for the longer-term 10-yr and 30-yr securities, which are the most comparable to MBS. The cause for concern is that some important buyers, including China, have been hinting that they will reduce their Treasury purchases if the US doesn’t display more fiscal discipline. If demand were to fall, then yields would need to rise to attract investors, which would not be good for mortgage rates.