At the start of the week it looked like mortgage rates might reverse some of their recent increases. Tuesday’s announcement that President Obama reached an agreement with Republican leaders on a tax package was very unfavorable for mortgage rates, however, and they rose sharply following the news. Despite strong demand for the Treasury auctions later in the week, mortgage rates ended the week at the highest levels since June.
While investors generally expected an extension of the Bush era tax rates for all income levels, the proposed tax deal includes additional spending measures that were more of a surprise. The plan includes a one year payroll tax reduction and an extension of unemployment benefits for the long-term unemployed. As a result, estimates for the size of the tax plan are significantly bigger than expected, leading to the large reaction in mortgage rates. There is some resistance to the deal, but most analysts expect the final version to be similar to the current proposal.
If passed, the proposed tax deal is expected to boost economic growth but also increase the budget deficit, both of which are negative for mortgage rates. Faster economic growth generally increases the outlook for future inflation, and higher inflation leads to higher mortgage rates. An increase in the budget deficit means the government must issue more Treasury securities to pay for the spending. As the supply of Treasuries goes up, yields must rise to attract additional investors, so mortgage rates must rise as well.
Also Notable:
- Consumer Sentiment rose to the highest level since June
- The four-week average of Jobless Claims declined to the lowest level in two years
- Fed Chief Bernanke expressed strong support for the quantitative easing program
Oil prices rose to $90 per barrel, the highest level in two years
Week Ahead
The biggest economic news next week will be Tuesday’s FOMC meeting. Investors will be looking for an update on the Fed’s plans for the quantitative easing program. The most significant economic data next week will be the monthly inflation reports. The Producer Price Index (PPI) focuses on the increase in prices of “intermediate” goods used by companies to produce finished products and will come out on Tuesday. The Consumer Price Index (CPI), the most closely watched monthly inflation report, will come out on Wednesday. CPI looks at the price change for those finished goods which are sold to consumers. In addition, Retail Sales, an important indicator of economic growth, will be released on Tuesday. Retail Sales account for about 70% of economic activity. Industrial Production, another important indicator of economic growth, is scheduled for Wednesday. Housing Starts will come out on Thursday. Empire State, Leading Indicators, and Philly Fed will round out the week.
MICHAEL MCDEVITT 