Morning Report: Fed week 9/14

Markets are flattish this morning as overseas markets stabilize. Bonds and MBS are up.

No economic data today. We will have some important economic data this week retail sales and industrial production on Tuesday, with housing starts on Wednesday.

The big event this week will be the FOMC meeting on Wednesday and Thursday. The announcement will come on Thursday. For mortgage bankers, the focus will be in the Fed Funds rate, and also “reinvestment tapering.” Reinvestment tapering has to do with the Fed’s re-investment of maturing Treasuries and MBS that it bought during QE. Currently, the proceeds from any maturing MBS are re-invested back into the MBS market, in order to keep the Fed’s balance sheet constant. At some point, they will stop doing that, and you may see mortgage spreads widen. This means that mortgage rates could increase, even if the 10 year goes nowhere. Note that they probably will taper, meaning they won’t stop re-investing maturing proceeds all at once. They’ll probably cut it by $5 billion a month, similar to how they executed the tapering in the first place.

The Fed Funds futures are currently projecting about a 30% chance the Fed will tighten this week. Fed Vice Chairman Stanley Fischer is advocating moving before the inflation numbers begin to rise. “There is always uncertainty and we just have to recognize it,” he told CNBC television on Aug. 28. Asked if the Fed should delay an increase until it had an “unimpeachable case” that a move was warranted, Fischer replied, “If you wait that long, you will be waiting too long.” On the other side of the coin, many in the Fed are worried about repeating the mistake of 1937, where the Fed tightened (really only by a little bit) and the economy dove back into recession.

Exhibit (A) in the “ZIRP is not free” argument: Petrobras sold 100 year (!) bonds last June, and as oil has dropped so have these bonds. They dropped into the 60s recently. What does this have to do with ZIRP? Everything. When central banks hold down rates artificially, the price signals the market uses to assign risk (interest rates) become distorted and investors are forced to reach for yield. You see it mainly with pension funds and insurance companies, which have to hit a return bogey based on longevity and health care inflation. Yes, getting 6.85% in this interest rate environment is attractive, but, you are lending to a Brazilian oil producer for 100 years and only getting 6.85% a year! The last 3 times the Fed raised rates (94,99, and 05) they blew up the MBS market, the stock market bubble and the residential real estate bubble. This bond issue shows how much of a credit bubble we currently have. The Fed may have painted themselves into a corner, but until inflation comes back, they can wait.

Presidential candidates are beginning to put out their tax and spending plans. Jeb Bush recently put out his tax plan, and there are some items that will directly affect those in the real estate business. First, his plan reduces rates and limits deductions. State and local taxes will no longer be deductible. Second, there will be a cap on itemized deductions, which means people who have a large mortgage and pay a lot of mortgage interest will find themselves with a higher tax bill. This will probably have a negative effect on the jumbo side of the market, although it will present an opportunity for LOs to try and pitch refinancing from 30 year mortgages to 15 year mortgages. While the mortgage interest deduction is as American as apple pie and may in fact be a political third rail, economists believe that it hasn’t really increased the homeownership percentage, as it was intended to do – it just encouraged people to buy bigger houses.

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