THE BASIS POINT

WeeklyBasis 12/17: Big Housing Week Ahead

Rates were down .125% last week, hitting record lows: 30yr loans to $417k closed at 3.75%.

Below I explain why rates dropped, and preview a housing-focused week ahead. It’s divided in sections for easy reference. Of particular note is the ‘Existing Home Sales Controversy’ section. Scroll to ‘Bottom Line’ if you just need the quick take.

RECAP DECEMBER 12-16 MARKET WEEK

Europe Fears Set Tone All Week: Markets were optimistic Friday 12/9 following an EU summit that promised more centralized budget controls and more pressure on member nations to balance budgets. But sentiment reversed last week as the IMF said Greece was shirking its promises to reform economic policy and cut government spending. Also IMF managing director Christine Lagarde said Europe’s crisis is escalating, and deputy assistant Treasury secretary Mark Sobel told congress about U.S. economic risks stemming from Europe. Then Fitch became the third major ratings agency to downgrade several large banks on European contagion concerns, plus they issued a negative outlook on France. It all led investors toward safe bets like U.S. mortgage bonds and Treasuries, which helps U.S. rates.

No Fed Surprises: The final Fed meeting of 2011 stuck with the plan: near-zero overnight rates and using the Fed’s mortgage bond proceeds to buy new mortgage bonds which helps hold long-term rates down.

Retail Sales Disappoint: Estimates called for November retail sales to rise as much as 0.8% following +0.5% for October and+1.1% in September. But November was only +0.2%, fueling the lower rate trend.

Manufacturing Much Better: Two key U.S. manufacturing reports, both of which have 0 as dividing line between expansion/contraction, were better for December. Empire State Manufacturing was 9.5, highest since May and second straight monthly gain. Philly Fed was 10.3, highest since April and third straight monthly gain after three months of contraction. But it wasn’t enough to outweigh other negative news pushing rates down.

Lowest Jobless Claims Since May 2008: Claims for unemployment insurance were 366,000 for week ended December 10, down 19,000 from previous week, and the lowest since May 2008. Also the 4-week moving average 387,750. Below 400k signals improving jobs picture and the average since 2000 is 390,000, so if it holds, this is a positive trend. More in next week’s preview below.

Inflation Flat: Rates also stayed low because of flat producer (PPI) and consumer (CPI) inflation. November’s annual PPI was 5.7% total and 2.9% excluding food and energy. Annual CPI was 3.4% total and 2.2% excluding food and energy. All of these November annual figures were flat versus last month’s annual figures, and same for all monthly figures.

PREVIEW DECEMBER 19-23 MARKET WEEK

Next week’s economic calendar is full of housing data. Below are highlights and rate impacts.

Housing Starts Improving?: Construction began on .3% fewer new homes in October; the annualized rate was 628k vs. the 1.5m needed to keep pace with population growth and the January 2006 peak of 2.27m. November’s figures are Tuesday, and estimates call for a slight decline in the annualized rate. Rates even.

Existing Home Sales Controversy: November’s existing home sales are Wednesday. They were up 1.4% September to October and up 13.5% since October 2010. This was seen as OK for housing but cancelled deals spiked: 33% of realtors reported cancelled contracts in October, up from18% in September (and August), and up from 9% in Sept 2010. Definitely a stat I’m living. But the kicker will be the NAR revising down all figures since 2007. CoreLogic revealed NAR’s overstating of sales 10 months ago, so rate markets may not respond sharply since it’s accounted for. Still, it’ll be hot media story.

Final 3Q GDP: The third of three GDP readings for 3Q20111 is expected to be 2% on Thursday, same as second reading but lower than the 2.5% first reading. Rates even unless this economic growth figure surprises or previous quarters are revised.

Jobless Claims Trend: Still no upward rate movement despite declining jobless claims discussed in last week’s recap above. Before rates rise on jobs improvement, it must be confirmed by more declining claims (reported Thursdays) plus the December jobs report January 6.

Treasury Auctions: There was high demand for last week’s Treasury auctions, which also contributed to strength on mortgage bonds, pushing rates down. Next week brings $99b more in supply with these auctions: $35b 2yr Notes Monday, $35b in 5yr TIPS Tuesday, $29b 7yr Notes Wednesday.

Stock & Bond Technicals: Looking at stocks, the S&P 500 closed at at 1220, down 2.79% on the week, below two key support levels: 50-day moving average of 1229 and 200-day moving average of 1261. Big change from last week when it rose above the 200-day moving average three days but never closed above it. Overall S&P stocks aren’t overbought nor oversold, so reclaiming of the 50-day moving average is likely, but not enough data to support a big rally. As for mortgage bonds (MBS), rates rise when MBS sell, and rates haven’t risen for three weeks because the 3.5% Fannie Mae coupon—a key benchmark lenders use to price consumer rates—are at 102.64, which is a comfortable 92 basis points above the 50-day moving average that’s been a concrete floor of support even when stocks rally.

Bottom Line For Rates: This MBS technical strength (keeping rates at record lows) could have to do with rumors about MBS-focused QE3 coming in the first quarter. But interestingly, MBS prices (and low rates) hold the line in recent weeks even when stocks rally on better Europe sentiment or improving U.S. economic data. So the bond market is proving to be the stronger signal of true risks in Europe. MBS prices are close to September highs hit after the Fed’s latest rate stimulus plan, so rates won’t drop next week unless there was a huge surprise from Europe or the Fed–unlikely. Besides jobless claims, next week may not show much improving U.S. data, so rates should be even to up .125% as MBS drop a bit and stocks rise a bit.