Inflation numbers are due out tomorrow for the prior month. Expectations are .2% increase but one interesting thing to note. The Bureau of Labor Statistics is going to include the subsidized Cash for Clunkers program $4500 dollar rebate as a way to reduce auto prices by the same amount. Hmmmmm.... now isn't that aggressive use of accounting techniques? Keep in mind the government is the one releasing these numbers and we are in a severe recession that many are calling over, but I just don't see how that's possible. So with a 1.8 trillion dollar deficit due to heavy borrowing, who would benefit from lower interest rates? Bingo! The government would.
See bonds are sensitive to inflation since bonds tie up investor money for long periods of time; but bonds can be resold on the secondary market and if prices are dropping due to inflation fears, investors lose money. The way bonds are calculated for their value is by using simple time value of money calculations. Its quite simple. A dollar today is worth more than a dollar tomorrow. So if an investor is going tie up their money for a longer time, they want a good return - or at least a return that is suitable for current market conditions. In times like this, investors flee to safety - in the form of bonds - which are usually safe investments. If inflation is higher than expected this is not good for bond holders because now their return - inflation adjusted - is much less than originally anticipated. So by the inflation numbers coming out in line or lower, its to much of the benefit of the government who still has to borrow very heavily in order to service the existing debt payments (interest) and the barrage of entitlement and social programs and wasteful stimulus programs.
But how does all this affect mortgage rates? Quite simple actually. MBS (mortgage-backed securities) compete with other bonds for investor cash and are susceptible to inflation worries just as other bonds are. What happens is MBS bonds are priced over treasuries in order to attract dollars and be competitive. Bonds have risk factors that investors have to take into consideration and credit default is just one such risk. MBS add another risk factor - early payoff. Mortgage loans in a low interest rate environment have a high propensity to pay off early. This eats into the returns of investors and therefore they need to be compensated for that risk. So what happens is MBS bonds are priced at a fixed spread over treasury yields in order to attract investors to assume that extra risk.
With gold hitting yet another high of $1,080 an ounce; the dollar is weak, and oil is up, this spells inflation. There are few schools of thought out there with respect to the definition of inflation but I side with the Austrian view of the vast expansion of the money supply that we've seen from the FED over the last 18 months IS inflation. I just don't see an argument here. When you expand the money supply and aggregate demand does not rise equally, and wages do not rise with this, you have inflation and rising prices - period. The price level has to rise in order to balance the increase of money in the system. Back when we were on the gold standard, massive expansion of the money supply could not be done like this because you could exchange your dollars for a fixed weight of gold keeping the FED and our law makers honest.
The first time homebuyer tax credit will likely be extended and maybe inclusive of all homebuyers not just first time. While I've enjoyed the short term benefit of the increase in volume, I know that we are just prolonging the pain that will eventually come. Housing isn't out of the water yet, however if you are in the market to purchase I suggest doing it now. Rates can't stay this low for long. Just one year ago before the FED intervened, interest rates were at almost 7% on a 30 yr and then plummeted to below 5% making the investment into a new home very attractive at this point.
God Bless, until next time.
1 comment:
Post a Comment