Freddie Mac's Office of the Chief Economist has issued its
monthly Economic & Housing Outlook report for the month
Much of the report is given to a discussion of Federal Reserve Chairman
Alan Greenspan's semi-annual report to Congress in which he noted
the "conundrum" of the rising federal fund rate while, at the same
time, long term rates are declining (a situation which may have begun to reverse
itself since the Chairman's remarks.)
The Freddie Mac report discounted the simple answers to this "conundrum
that inflation appears to be under control and thus the Federal Reserve has
stated it would shift its monetary policy to a "neutral" stance, thus putting
downward pressure on rates and that foreign investors are buying more US fixed-income
assets, driving up prices and holding down rates. "There is a more complex answer,"
the report said, one that "deals with the risks to the economy."
The report went on to describe what it called three delicately balanced risks
that, if they become unbalanced, could cause long-term interest rates to climb
further and faster than expected and cause a substantial economic slowdown.
The first risk is inflation, particularly the possibility
that it might be driven by increasingly expensive energy coupled with the declining
The second risk is the current account deficit which represented
6 percent of Gross Domestic Product at the end of 2004. Much of the deficit
is currently financed by foreign purchases of U.S. Treasury securities and other
financial assets. If this source of funding dries up, bond prices would fall
and rates would rise.
The third risk is the federal budget deficit. Freddie noted
that most estimates show a sizable deficit through the end of the decade but
anticipate a gradual decline. "If Congress fails to shrink the deficit, long-term
rates may be pushed up further and faster than the market is expecting."
The economists' monthly predictions, however, are apparently based on
the "delicate balance" continuing. It would be interesting to see
some forecasting based on a slightly less optimistic scenario.
While raising its predictions 10 basis points since its February report, Freddie
still expects mortgage rates to average just over 6 percent throughout
the year, with ARMs becoming more expensive faster than long-term fixed rate
products. Thus borrowers will find mortgage lenders offering further initial
discounts below indices as incentives in order to move their ARMs. This should
serve to keep the market ARM share around one-third of the market. According
to the Mortgage Banker's Association last week, it was already down to 30 percent
of mortgages written.
Housing starts and home sales are both expected to taper off
during the year. Starts are projected to be around 1.9 million (with a strong
multi-family component) down from 1.96 in 2004. Total home sales (both new and
existing) will be around 6.96 million with a further decrease to 6.48 million
in 2006. Sales totaled 7.16 million last year.
House price appreciation which Freddie put at 10.7 percent nationally during
2004, will drop to 8.0 percent this year and 6.7 percent in 2006.
Freddie expects that mortgage originations will decline from
$2.7 trillion in 2004 to $2.4 trillion this year and $2.2 trillion in 2006.
This will be driven, not only by the drop in home sales, but also by a decline
in refinancing. The later is expected to comprise 41 percent of mortgage originations
this year and 31 percent in 2006.