THE BASIS POINT

WeeklyBasis 5/22/10: May 6 ‘Flash Crash’ Incites Two Week Refi Boom

Zero-point rates on 30yr fixed Conforming loans (up to $729k) ended last week at their lowest levels since official records began in 1971, and Jumbo 30yr fixed loans (above $729k) touched the low-5% range. By the time last week’s rate levels are officially announced by Freddie Mac on May 27, rates are likely to be higher. Below is a recap of how rates got here and rationale for why rates may rise next week.

Why Rates & Stocks Have Dropped
The Dow dropped 1000 points before closing down 348 points on May 6. The press has dubbed it a “Flash Crash,” but let’s go beyond the clever label to understand what happened that day, why the Dow is down 675 points since that day, and why mortgage rates are down .25% since then.

May 6 Stock Crash
Europe’s troubles started with Greece facing default on its bonds due to insufficient tax revenue, so they were granted a $140b bailout package by the IMF and fellow members of the European Union. As a condition of the bailout, they were forced to cut salaries of Greek citizens and raise taxes, measures which Greek parliament voted into law May 6. The vote caused rioting and death on the streets near the Greek parliament in Athens, and it tipped off the so-called Flash Crash here in U.S. stock markets.

Sidenote: there’s been lots of talk that the stock selloff was caused by automated program trading errors (for example, Accenture traded to $.01 momentarily then bounced back and closed at $41.09 which is in line with its normal trading levels), but few question that the impetus was unrest in Greece.

May 9 To Present
U.S. and non-U.S. stock markets continued down Friday May 7, on fears that more EU countries were in similar trouble. On Sunday May 9, the EU announced a nearly $1t bailout (similar to the U.S. TARP program) to support the debt of all member countries. But since then, investors have been unconvinced, so they’ve been heavily shorting European stocks and government bonds even if they don’t own the securities. This ‘naked shorting’ was banned by Germany last week to little effect, as the market still finds ways to punish securities it deems overvalued.

Rate Impact
As investors have sold out of (or shorted) stocks and European debt, they have purchased safer U.S. Treasury and mortgage bonds, driving prices on both to 2010 highs. When mortgage bond prices rally like this, yields (or rates) drop, and that’s exactly what has brought us to record lows on conforming 30yr fixed rates. We touched these same record lows once in April 2009 and again in November 2009, but these three dips are the lowest rates have gotten since official records began in 1971.

Why Rates May Rise May 24-28
Whenever there’s talk of a “stock market crash” or “record low rates,” we can be sure volatility is the central theme. As such, those phrases can quickly change to “rally” or “rate spike.” On top of ongoing Eurozone issues and U.S. regulatory reform, there’s a full slate of economic data contributing to the volatility mix next week. The biggest market movers are highlighted below.

Tuesday is the March S&P Case Shiller existing home price report. Last month’s report showed year-over-year home prices going positive for the first time since December 2006. If this trend continues, rates would likely rise.

Thursday is the second of three Q1 GDP readings that will show us if +3.2% GDP growth holds from the first reading in April. If it does, this will solidify a third consecutive quarter of positive economic growth, fueling positive stock sentiment so bonds would sell off, pushing rates higher.

Tuesday through Friday, bond markets will get $113b in new Treasury auctions—$42b in 2yr notes, $40b in 5yr notes, $31b in 7yr notes—and this will be a big test for whether the Treasury and mortgage safe haven from Europe will continue, or new supply will spook bonds and push rates up.

Friday is the Fed’s favorite inflation measure, the Personal Consumption Expenditures Index, and also April Personal Income and Spending will show us whether consumers, who account for two-thirds of GDP, are gaining strength. Tame inflation and better spending could be a net neutral for rates.

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CONFORMING RATES ($200,000 – $417,000) – 0 POINT
30 Year: 4.75% (4.87% APR)
FHA 30 Year: 4.75% (4.89% APR)
5/1 ARM: 3.25% (3.37% APR)

SUPER-CONFORMING RATES ($417,001 to $729,750 cap by county) – 0 POINT
30 Year: 5.0% (5.12% APR)
FHA 30 Year: 5.0% (5.13% APR)
5/1 ARM: 4.25% (4.37% APR)

JUMBO RATES ($729,751 – $2,00,000) – 1 POINT
30 Year: 5.375% (5.49% APR)
5/1 ARM: 4.5% (4.62% APR)