Daily Insight

U.S. stocks recouped the prior session’s losses, reversing course following the Federal Open Market Committee’s meeting after spending most of the day in negative territory. And the S&P 500 breached that 1090 level we’ve been talking about, without causing additional deterioration as it closed meaningfully above that mark.

The market’s about-face occurred shortly after the release of the FOMC statement. The Committee’s comment on how employers remain reluctant to hire suggested the Fed will keep rates floored into 2011. However, there was a change in the language that also implied they may move to slightly tighten on a faster timeline – we’ll touch on this below. I doubt this will be the case, but if you’re really looking for something, it seems to be there. Further, one member of the Committee did dissent, so we’ll watch to see if these voices in the wilderness build.

I also notice people were talking about the possibility that the President will ditch the populism and private-sector bashing that has clearly increased since the MA election results and turn to talking about increasing jobs and the economy via his State of the Union address. As a result, this may also have helped the turnaround as some may have seen a buying opportunity.

Now that the SOTU has been delivered, we see that this view didn’t exactly come to fruition, particularly clear to those who stuck around for the entire 90-plus minute speech. I’m not going to comment further on the SOTU address. We’ll watch and see how things turn out.

Financials and tech led the advance. The S&P 500 index that tracks telecom shares also performed well thanks to the boost AT&T shares received from the unveiling of the iPad. I don’t know, maybe pants will be redesigned to offer just one humongous back pocket with which to carry this oversized iPhone. Oh gosh, I’ve done it now. How dare I trespass upon the sacrosanctity of this new religion.

Market Activity for January 27, 2010
Mortgage Applications

The Mortgage Bankers Association reported that its applications index fell 10.9% in the week ended January 22 after a 9.1% increase in the prior week that was fueled by both purchases and refinancing activity. In this latest week, both aspects of the report weighed on the index as purchases fell 3.3% and refis dropped 15.1%. The average rate on the 30-year fixed mortgage was 5.02% last week, basically unchanged from the prior week.

As you can see, the purchases index remains pinned. The rebound in sales during the spring and summer were helped by a variety of government support, which we’ll get into below. However, as we’ve talked about, that activity was short-lived as policy cannot completely overcome a double-digit unemployment rate and historically high debt burdens.

New Home Sales

The Commerce Department reported that new home sales tumbled for a second-straight month in December, falling 7.6% to 342,000 units at a seasonally-adjusted annual rate (SAAR). That follows a 9.3% decline in November (which was revised higher from the previously reported 11.3% decline) and completely erases the bounce in sales that ran May-October. The current level of new home sales now stands just 4% above the cycle and all-time low hit in January.

The ubiquitously talked about rebound in housing was phantasmal -- boosted only by a multitude of government intervention: rock-bottom interest rates, the buyers tax credit, an enormously increased role by the FHA (guaranteeing many more mortgages at their harmfully low 3.5% down payment standard). The existing home sales data do not look much better as they have been slammed back down as well, but that was Monday’s discussion.

The only pure market force that took place was the decline in price, which also played a role in the transitory rebound in home sales – distressed and foreclosed on properties made up 33% of sales during the period.

The problem is that this intervention could not ultimately overcome the troubled labor market, the double-digit jobless rate, and it has surely prolonged the housing correction as it interfered with the proper liquidation of homes and allocation of resources. (Should first-time homebuyers have been buying homes, often times with very little money down, taking advantage of that tax credit, when the foundation would have been better off renting and saving for a period of time). This intervention has not allowed supply and demand to find its necessary equilibrium and hence the rebound is not durable. It is important to understand that this is true for the economy as a whole as well.

In terms of region, the Northeast and West saw new home sales increase, up 42% and 5%, respectively – the Northeast accounts for just 10% of the new-home market, so its not significant. The Midwest and South (the largest aspect of the new-home market) saw sales fall 41% and 7.3%, respectively.

The median price of a new home rose 5.2% in December, which proved to be quite unhelpful. We saw the same occur within the existing home data. Sellers improperly assessed the market conditions, thinking they could boost prices; they were wrong.

The supply of new homes at the current sales pace rose back to 8.1 months’ worth. That figure got down to 7.1 as of October as the temporary increase in sales combined with what has been a 60% decline in new homes available for sale. The figure is still well-off the highs, but since the sales were not durable the supply figures were destined to rise again. The 40-year average is 6.3 months’ worth.

FOMC Meeting – The Lonely Voice

The FOMC did massage their latest statement, and the statement is the only thing that matters since they continue to keep the fed funds rate floored. As everyone expected, they held to the phrase “economic conditions…are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

The members stated the following. I’ve put the key changes from the prior statement in parentheses:

• “Information received since the December meeting suggests that economic activity continued to strengthen”
  
• “Household spending is expanding at a moderate pace but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit”
  
• “Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls” (Prior statement: business are still cutting back)
  
• “Firms have brought inventory stocks into better alignment with sales”
  
• “While bank lending continues to contract, financial market conditions remain supportive of economic growth”
  
• “Although the pace of economic recovery is likely to moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability” (prior statement concentrated on fiscal and monetary actions as the key contributions to the strengthening of economic growth) My note: this was the biggest change in the statement. This could be viewed as an indication they are thinking about a mild rate increase. Why would they drop the key point that monetary stimulus is a necessary condition to the economic improvement if they didn’t mean to float this message?
  
• “And finally, in usual Keynesian form, they mentioned that substantial resource slack continues to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time” (Prior statement: inflation will remain subdued) My note: this also subtly points to the thought of some tightening. Additional note: While inflation is likely to remain subdued for a while, as we’ve been talking about, the Fed better take the focus off of resource slack and focus more on commodity prices and bank credit. When bank credit begins to expand, inflation will roll in short order, regardless of the unused plant, equipment and labor resources.)

There was a dissenting vote this go around with KC Fed Bank President Thomas Hoenig believing the time has come to stop promising ultra-low rates. It would have been a shock to the market if the Committee would have stated this in unison as they have not telegraphed the move via speeches -- even though I agree with Hoenig’s point of view, the emergency level of rates must be removed.

They stuck to their March 31 timeline of ending the MBS and agency debt purchase program, just as expected.


Have a great day!

Brent Vondera, Senior Analyst