Mortgage rates continued to move higher yesterday following a warmer than expected read on inflation at the producer level and a better than anticipated industrial production report. After the data was released, benchmark Treasury yields moved higher and prices of mortgage backed securities fell, forcing lenders to reduce rate sheet rebate which pushed consumer borrowing costs up. For the most part, the majority of the market was in a holding pattern ahead of today's FOMC statement release. Trading volumes were reported to be low and conditions "illiquid", making price action more erratic than usual.

We do have economic data to discuss today. 

First out was the Mortgage Bankers Associations Weekly Application Index. This survey tracks the weekly change in the amount of mortgage applications submitted at major lenders.  An increasing trend of purchase apps suggests more home purchases which would lead to other buys such as furniture, appliances, etc.. which is positive for our overall economic activity.  An increasing trend in refinance activity is also positive for the economy since consumers would be refinancing to lower rates and lower payments giving them additional cash to spend.    The report indicated that purchase activity declined last week by 0.1% while the refinance activity posted a 0.9% increase thanks to near record low mortgage rates. 

Next was another reading on the housing sector, the New Construction Report which covers Housing Starts and Building Permits.  New home construction rose slightly less than expected by 8.9% to an annualized pace of 574,000.   Offsetting the slightly worse housing starts numbers was the more important, forward looking read on Building Permits, which recorded its highest level of activity since November 2008. Building Permits are running at an annualized pace of 584,000, which beat expectations of for 570,000.    To show you how far housing has fallen, during the height of the housing boom, new home construction in January 2006 was on an annualized pace of over 2.2million starts.  For more on this report, read the MND STORY.

Lastly, we recieved the second report of the week on inflation, this time at the Consumer level. The Consumer Price Index measures the average monthly price change of a fixed basket of goods and services purchased by consumers.  Yesterday’s PPI(measures inflation on the producer level) indicated producer prices increased much more than expected, thanks to rising energy costs. This is one cost that is usually passed down to consumers, so many were expecting today’s CPI report to show an uptick in consumer prices.

The overall CPI number, which includes food and energy prices, came in right on expectations with a monthly increase of 0.4. The core rate, which strips out food and energy, came in lower than expected at 0.0%.  The flat reading on the core rate was the first month without an increase since December 2008.  On a year over year basis, the overall CPI is up 1.9% while the core rate is up 1.7%, matching last month’s number.

The bond market is slightly improved following these economic reports. It appears that much weakness was already priced into yields, thus today we are seeing some corrective buying by "real money accounts", which AQ described in MBS MORNING.

Reports from fellow mortgage professionals indicate mortgage rates to be unchanged from yesterday.  The par 30 year conventional rate mortgage remains in the 4.875% to 5.125% range for well qualified consumers with a couple lenders still offering 4.75%.  To secure a par interest rate you must have a FICO credit score of 740 or higher, a loan to value at 80% or less and pay all closing costs including an estimated one point loan origination/discount/broker fee.  If you are looking to access home equity, you should expect either additional fees or a higher interest rate.

The short term direction of mortgage rates will be determined later today with the 2:15pm release of the Fed statement.   I can guarantee you that one of three things will occur.  Mortgage rates will improve, stay the same or get worse.

While it is widely accepted that the Fed will keep the current Fed Funds rate at 0 to .25%, many market participants are hoping for minor changes to the text, specifically the rhetoric which gives a timeline on current Fed Funds rate strategy: rates will be low for an “extended period”. Most want to see the Fed provide a clearer outlook on when to expect an interest rate hike.   Others expect the Fed to be slightly more upbeat about the economy and more defensive of inflationary pressures. We are looking for limited changes as Bernanke is not likely to spook the markets in an illiquid environment. In the short run, AQ says the recent trend of rising rates may be due a short term correction if the Fed sends a more downbeat economic message and re-iterates that inflation remains subdued due to considerable "resource slack" in the economy. More than anything, we do not want to hear that inflation concerns are growing at the Federal Reserve, this would be the worst case scenario for mortgage rates.

An example of resource slack is high levels of unemployment. The resource being human labor. The slack being a large percentage of human labor not being put to work. Beyond that, we still feel rates will rise in Q1 2010.

The statement will be released at 2:15pm, Matt and AQ will cover it in detail on the MBS Commentary blog. 

If you are a risk taker, floating could pay off.  My opinion is the Fed statement will, at worst, hold rates steady later today.  With double digit unemployment, I cannot see how the Fed will paint a rosy picture for future economic growth.  I also believe that they will say that inflation remains in check and the wording of the low fed fund rate will not change.   If you cannot afford to be wrong meaning accept a higher rate if wrong, lock before the statement. 

I would like to hear from you.  What do you think the Fed statement will say and what result will it have on mortgage rates?

PS. I would like to congratulate Ben Bernanke on winning Time Magazine’s Person of the Year Award.