Banks are finding it difficult to build reserves fast enough to keep the ratio of reserves to non-performing assets static and that causes concern about loan activity and the degree of economic recovery. Frankly, based on the numbers we’re seeing on the delinquency front across a broad base of loans the stock market is taking the news remarkably well.
This is something we’ve talked about for a while, credit-card default rates -- along with commercial real estate losses that may not yet be halfway through the cycle – are going to cause trouble for some time. The very positively sloped yield curve (banks borrow near zero and lend much higher) will keep interest-income margins elevated, but I don’t see how it offsets these other major challenges.
As credit-card lines continue to be cut (exacerbated by legislation capping late fees and interest rates) it will put additional pressure on consumer activity. Consumer spending as a percentage of GDP will work its way from 72% of GDP back to the historic average of 65%, which will mean slower growth rates. If government policy were focused on spurring the business side of the economy, we’d be able to offset this drag a bit, but policies are doing nothing but scaring business and keeping managers cautious – not helpful.
And speaking of that positively sloped yield curve the spread between Treasury two and 10-year notes widened to a record on concern massive government debt issuance will overwhelm those Fed efforts to keep borrowing costs low. The degree of the slope generally portends the magnitude of the economic rebound (the more positive the better), but these are not normal times and if long-end interest rates spike because traders are worried about enormous levels of debt issuance rather than because the prospects of recovery has increased, you can forget about a meaningful recovery. The Treasury auctioned $35 billion of five-year notes and traders sent long-end yields much higher as a result.
The latest home sales data failed to offer a counterbalance to the aforementioned weights. Existing home sales did rise, as we’ll discuss below, but only from very depressed levels – there’s a difference between stabilizing at very low levels and a pure rebound.
Housing needs economic growth to rebound, not the other way around. Economists continually state a necessary condition for economic recovery is a housing rebound. This is backwards; until the labor market improves substantially you can’t have a significant bounce in housing and until the economy recovers you can’t have labor market improvement. The Fed can work on pushing mortgage rates down all they want, and it will certainly help - although not without longer-term ramifications – but when the economy continues to shed 500k-600k payroll positions a month there’s not much anyone can do. It just takes time.
Market Activity for May 27, 2009
Crude Oil
The price of crude for July delivery rose to a six-month high yesterday, now nicely ensconced above $60, closing at $63.13 per barrel. Signs of increasing demand out of Asia (China’s stimulus is beginning to take root and they are also surely stockpiling commodities for fear of future price spikes), word OPEC will cut production and speculation that the weekly energy report will show a drawdown in gasoline inventories all helped push the price higher. (We now know this morning the worry of an OPEC production cut was not necessary as the cartel has decided to leave production unchanged; crude prices have barely budged though, don just a nickel this morning)
One wonders how the consumer will react to higher gasoline prices this summer. The plunge in pump prices from last summer’s spike definitely helped cushion the blow of reduced incomes. If the retail price of gasoline holds below $2.50 per gallon (roughly $2.00 wholesale) it shouldn’t present a problem. However, if we push to $3.00 at the pump…well, that’s just one more obstacle.
Mortgage Applications
The Mortgage Bankers Association reported its mortgage applications index fell 14.2% during the week ended May 22, which followed a 2.3% increase for the previous week.
Refinancing activity, which currently makes up 70% of the index, slid 18.9% last week after a 4.5% uptick in the prior period. Purchases managed a 1.0% gain after falling 4.4% in the previous week. It appears the refinancing wave that took place in March and April has pretty much run its course. Either that or those who have not yet refied, and have the equity to do so, are waiting for a 4.5% fixed 30-year mortgage rate before pulling the trigger – not sure they’re going to get that number, but one never knows; if the Fed increases its mortgage-backed securities purchases it could happen. As the market has recently overwhelmed the Fed’s work in driving rates lower one can bet Bernanke & Co. will be increasing their Treasury and mortgage-backed purchases.
As discussed above, it will take some meaningful improvement in the labor markets to get home buying fired up again. The affordability index is at an all-time high – meaning it has never been a better time based on the combination of prices and mortgage rates – but the labor market is the prevailing factor; if potential home buyers loss their job, or the probability of this occurring is elevated – and it clearly is – they’ll hold off. As we move closer to the summer months it is becoming increasingly evident there really is nothing the Fed can do to spark home sales.
In the meantime, let’s hope their attempt does not cause additional problems 18-24 months down the road that then results in an economic double-dip – the chances of this occurring, another recession after, say, four quarters of GDP growth, are definitely elevated.
Existing Home Sales
The National Association of Realtors reported that existing home sales rose 2.9% in April, beating the expectation, to an annual rate of 4.68 million units. The data was driven by a 6.4% pop in multi-family units (condos and co-ops). Single-family sales rose 2.5% after falling 3.3% in March.
The median price for total existing homes slid 15.4% from the year-ago period, it currently sits at $170,200; the price for single-family units alone is down 14.9% compared to April 2008, currently at $169,800 – the peak of $230,900 was hit in July 2006.
Distressed properties (much of which involves foreclosures) made up 45% of all sales last month – only the most intense bargain hunting is occurring. First-time buyers accounted for 40% of sales, driven by tax-credits.
It appears we’ve hit bottom in the housing market, but one can’t say much beyond that. Existing home sales remain below the February reading. I focus on the Feb. number because that month was surrounded by ultra-low record readings of 4.5 million units (again, at an annual rate) for January and March – this latest data only appears to be an improvement based on those extremely depressed levels. Same is true when looking at only the single-family units.
By region, the Northeast and West posted sales gains of 11.8% and 11.1%, respectively. Sales in the Midwest and South were flat.
The supply figures continue to show there are a lot of properties to work off still. The single-family homes available for sale jumped a bit last month, rising to 3.34 million units from 3.06 million.
When matching supply against the current sales rate the glut continues at there are still 9.6 months’ worth of single-family existing homes on the market. Same is true when we add in multi-family units, as the total existing home inventory/sales ratio moved back up to 10.2 months’ worth.
Have a great day!
Brent Vondera, Senior Analyst
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