Bernanke Backtracks on Stimulus as the Specter of Stagflation Looms

Bernanke Backtracks on Stimulus as the Specter of Stagflation Looms – 7/15/11

Mortgage pricing retreated yesterday on several positive economic reports, and on Fed Chariman Bernanke’s second day of testimony before Congress. On Wednesday, the Chairman had suggested that the Fed would be willing to consider additional steps to support economic growth and, especially, job gains. In Thursday’s testimony, he reiterated that willingness, but he also made it very clear that he doesn’t perceive that the current situation justifies that step at this time. Economic reports added to this, showing an increase in core inflation and retail sales and a modest decline in unemployment claims.

This morning the news has started already with the Consumer Price Index, which mirrored yesterday’s Producer Price Index with a -0.2% reading, as a significant fall in gasoline prices helped consumers. The Core CPI, which ignores more volatile food and energy numbers, increased by 0.3% for the 2^nd straight month. This increase is disturbing, as it is indicative of inflation at a pace faster than the Fed’s current target of 2% per year, or slightly below 0.2% per month. The quicker inflation moves, the less ability the Fed will have to keep interest rates low, as it will need to raise rates to contain inflation. For the moment, the current pace is not out of control, and, considering we’re looking at only two months of outsize price increases, it is unlikely the Fed will act yet. Still, this is a trend that could prove problematic should it continue.

The Empire Fed index, a survey conducted by the Federal Reserve Bank of New York on manufacturing businesses in New York State, was also released this morning, and showed that growth remains negative in that region for the 2^nd month in a row. This index is seen as an indicator of growth nationwide, however, due to the limited sample size, it can be more reflective of state-specific problems in New York. The future outlook of those businesses improved, suggesting they believe economic growth will be better in future months.

A few moments ago, the University of Michigan released its Consumer Sentiment survey. The index made a surprising turn south, declining to 63.8 versus the previously month’s 71.5 reading, and an expected increase to 72.2. This survey is widely watched, but is somewhat volatile, and subject to significant swings. Still, this change was shocking, and has propelled mortgage pricing out of the hole dug by the earlier CPI report to climb to near positive territory. Consumer sentiment is important, as consumer spending represents roughly 70% of GDP.

Other issues affecting mortgages today are bank stress tests in Europe, the results of which will show the expected health of 90 large European banks in the hypothetical event of a debt default in an impactful country, Greece, for example. The results will be published around Noon Eastern time today, and have the potential to be a significant market mover, especially if they reflect poorly on the banks. The last round of stress tests passed almost all banks, including several Irish banks which required bailouts only a few months later. As many as 15 banks are expected to fail this round of tests and require additional capital reserves. Finally, the US debt limit debate rages on, as the President has punted the issue back to Congress for them to present a new solution. He will give a press conference at 11:00 on the status of the issue.

Mortgage pricing was looking weak earlier, but has recovered on the weak consumer sentiment results. There are still some volatility risks out there, but I don’t see anything causing a significant worsening in mortgage prices. If anything, the stress test results could move things in the right direction. At the moment, I feel comfortable suggesting we take the free 3-day extension to a Monday review of rate locks. Have a great weekend!

Rate lock recommendations, by time to funding:

<15 days: consider locking

15-30 days: float

30+ days: float

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