Probably the big news in the December 2006 Economic Outlook published by Freddie
Mac's Office of the Chief Economist last Friday was that the office has
finally changed its interest rate projection for the year.
The monthly forecast since late last year has clung to a projection that the
30-year mortgage rate would average 6.5 percent for the year. This number went
up to 6.6 for a few months in late summer when rates did rise steadily but only
now, with recent rates off of July highs by 69 basis points has Freddie revised
its projection to 6.3 percent for the 4th Quarter and 6.4 percent for the year.
The average rate for 2007 is projected at 6.3 percent which is a substantial
improvement over the 6.7 average forecast earlier in the year.
The main thrust of the December Outlook, however, was answering two questions:
"What will a housing recovery
look like?" and "when will it
Freddie Mac harkened back to history to answer these questions.
The report compared the current housing downturn to earlier ones following peak
growth in 1973 and 1978. In those years residential investment as a share of
GDP rose to nearly 6 percent and then slid to 4 percent over the following six
to eight quarters compared to a long-run average of 4.5 percent. After bottoming
out, investment rose in the following four quarters. Price appreciation did
not turn negative on a national basis after these booms but did show extended
sluggish price gains.
During the most recent boom residential investment rose to
6.25 percent in the second half of 2005 but has been declining rapidly since
then. It fell at an 18 percent annual rate (adjusted for inflation) in the third
quarter and looks to do the same in the fourth quarter. This would reduce residential
investment relative to GDP to 4.5 percent - in line with earlier referenced
declines and over a similar six-to-eight quarter time frame.
However, should the 18 percent annualized decline continue through the end
of 2008 the drop in residential investment would be 50 percent greater than
what occurred during the 2003-2004 recession and send the investment/GDP relationship
to 3 percent.
The Office of the Chief Economist, however, does not foresee such an outcome.
It cites the rapid response of builders who have cut back housing starts as
one factor contributing to falling inventories while buyer traffic seems to
be on an upswing in response to declining prices and interest
rates. The market, the report states, should stabilize some time during
the first half of 2007.
Do not, however, expect the new market to be a return to what we have watched
with fascination over the last several years. Rather, we should see more "normal"
conditions starting next year; housing starts and sales will gradually pick
up and then grow at a modest pace and house prices will appreciate at a rate
in line with inflation although some hard-hit areas will not recover until the
local economy does. "With smaller price gains and reduced opportunities to extract
equity, mortgage debt will grow more slowly. In short, housing
markets will move off center stage, but will resume quietly providing homes
and opportunities to build a nest egg for millions of American households."
Other projections in the report include:
- Home price appreciation will slow further in the fourth quarter to
2 percent from 5.2 percent in the second quarter and 4 percent in the third.
Prices should "trough" in the fourth quarter and appreciate 3.4
percent in the first half of next year.
- Refinancing will see the highest market share of the year in the current
quarter, reaching 48 percent of all mortgage applications. This is forecast
to continue through the first quarter of 2007 and then to moderate to 36 percent
by the middle of the year. At the same time, delinquency rates recently increased
to 1.7 percent, the highest level since 2003 but only marginally higher than
in 2004 and 2005. The number is still well below the delinquency rates in the
- Adjustable rate mortgages will have a slightly higher share of the
market than was thought a few months ago - 16 percent vs. 14 percent -
still, the inverted yield curve (where short term rates tend to be only slight
lower or even the same as long term) will make ARMs unattractive to borrowers
who can afford to make the choice.