Freddie Mac's Office of the Chief Economist has issued its monthly Economic & Housing Outlook report for the month of March.

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 dollar.

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.