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Posts Tagged ‘refinancing activity’

About Those Interest Rates

Posted by Larry Doyle on June 6th, 2009 9:49 AM |

A sharp move higher in interest rates has received a lot of attention lately. In fact, I now believe the focus on interest rates will move to center stage in our Brave New World of the Uncle Sam Economy. Allow me to comment.

I spent my entire career on Wall Street within the bond market, so my professional life has been consumed by interest rates. I don’t know if that is necessarily a good thing, but that’s for another day.

What are interest rates?
Very simply, the interest rate – for whatever financial product – is the “price of money.”

What are the components of interest rates for respective financial products?
Interest rates are determined by three factors:

1. a general level of rates of return in the economy and market: this level is typically viewed by focusing on the shorter maturity U.S. government securities. Uncle Sam is viewed as the benchmark from which all other interest rates are compared. Uncle Sam’s own creditworthiness is coming into question, but that can be a topic for a separate post.

2. a risk component: this factor addresses the creditworthiness of the borrower (be it a global government, a corporation, a municipality, or an individual).  Additionally, while most bonds focus on the risk component as being a function of creditworthiness, there are other risk factors as well, including prepayment risk for mortgages.

3. inflation/deflation: this factor addresses how fixed future returns on bonds are impacted by the general change of prices in the economy. The presence of inflation (a rising level of prices) erodes the value of fixed future returns. In a similar fashion, the presence of deflation (a declining level of prices) increases the value of fixed future returns.

Utilizing these three factors, one is prepared to more effectively understand the nature of interest rates, both from a static standpoint and in a dynamic environment.

Utilizing these components, how and why do interest rates change in a dynamic economy?

Let’s recall that the valuation of any financial product (a stock, bond, currency, commodity) is determined in a dynamic market setting by buyers and sellers assessing three variables:

1. fundamental analysis: from our trusty Investing primer (right sidebar), we see this variable defined as:

an investor can perform fundamental analysis on a bond’s value by looking at economic factors, such as interest rates and the overall state of the economy, and information about the bond issuer, such as potential changes in credit ratings.

2. technical analysis: again using our Investing primer:

A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

3. market psychology: the Investing primer educates us on this variable as well:

The overall sentiment or feeling that the market is experiencing at any particular time. Greed, fear, expectations and circumstances are all factors that contribute to the group’s overall investing mentality or sentiment.

While conventional financial theory describes situations in which all the players in the market  behave rationally, not accounting for the emotional aspect of the market can sometimes lead to unexpected outcomes that can’t be predicted by simply looking at the fundamentals.

Utilizing these tools, let’s review the prevailing level of interest rates in our economy from a chart provided on a daily basis at the WSJ Market Data page linked here at Sense on Cents.

We can assess how all the short term interest rates have come down over the last three years in response to the recession. We are now faced, though, with a move higher in rates given the increased risks of inflation, along with massive demand by global governments, corporations, municipalities, and individuals for credit. That demand, like any demand, is driving the price of money (the interest rate) higher. Is this demand being generated by improvements in the economy, the need to refinance existing debt, or a combination of the two?

Welcome to the word of interest rate analysis for fixed income investments (bonds).

Please share your thoughts, questions and concerns so we can all most effectively navigate the economic landscape.

For more on this topic:

Is The Government Bond Bubble Getting Ready to Burst?
May 21, 2009

Mortgage Refi Activity Is Driving Rates Higher
May 26, 2009

The Wheels Have Come Off Barack’s Bond Bus
May 27, 2009

I will also address the dynamics driving interest rates extensively during my NQR Sense on Cents radio show Sunday evening June 7th from 8-9pm.


P.S. If you like what you see here at Sense on Cents, please add the site to your favorites, share with your friends, and visit/comment often!! Thanks!!

Economic Update: Housing and Retail Sales

Posted by Larry Doyle on May 13th, 2009 8:39 AM |

Ultimately, all economic roads lead back to the housing market. The breakdown in the integrity of housing finance led us into this economic mess and any self-respecting economist (or financial commentator) will tell you that a healthy housing market will lead us out. Let’s check the patient.

The Fed has supported housing by effectively “overpaying” for refinancings. Mortgage rates relative to rates on U.S. government debt are at 17 year narrows. This development is great for homeowners who can and have refinanced. However, the pool of eligible homeowners is finite and seems to have run its course for now as recent data indicates that refinancing filings have declined while purchase activity has been unchanged. This data is reflected in the U.S. MBA Mortgage Applications Index Fell 8.6% Last Week, as reported by Bloomberg.
How about new supply of homes coming onto the market? Well, certainly home building has come to a virtual standstill with over a year’s worth of homes currently on the market. As new housing starts occur this supply can be gradually absorbed. Thus, we once again are back to the concept of needing time for the patient to heal. However, are we subject to another bout of housing sickness to hit our economy? I believe we are. Why? Two reasons:

   1. government programs forestalled but did not eliminate a number of “sick” mortgages. These mortgages would likely have defaulted with banks forcing foreclosures a few months ago.

   2. a large supply of adjustable rate mortgages will soon reset to a considerably higher rate leading to payment problems for homeowners and likely foreclsoures. Data indicating increased rates of delinquency (late payments) clearly points to increased foreclosures.

In fact, foreclosure filings just hit a record level of 342k  as reported by RealtyTrac which monitors this data nationwide. Foreclosure activity also seems to be spreading from California, Florida, Nevada, and Arizona to other parts of the country.  In fact, Idaho has recently had a surge in foreclosure activity as the unemployment rate in and around Boise has spiked.

What about home prices? The declines in home prices have certainly sparked renewed interest in prospective homebuyers. Will they enter the market at this stage? Data indicates prospective buyers continue to be patient as Bloomberg reports, Home Prices In U.S. Drop Most On Record In Quarter.

When may consumers feel confident enough to enter into the market and purchase a home? The largest factor in that decision is consumer’s confidence in their employment situation. In my opinion, with the rate of unemployment nationwide likely to hit double digits by year end, housing will remain under pressure. 

On a separate economic note, the retail sales figures for April were just released and declined .4%, and excluding auto sales, declined by .5%. The market expected April retail sales to be unchanged. This report is a clear indication the economy remains on life support. Not surprising to me, March retail sales were revised even lower from a decline of 1.1% to a decline of 1.3%.

With all due respect to credible journalists, analysts, and financial commentators, I personally do not see enough green shoots in the midst of reviewing the entire economic landscape.    

The equity markets are moving sharply lower on this news.


P.S. Sense on Cents welcomes feedback. Let us know what you are seeing in your local economies.

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