Thursday, September 12, 2013

Echo Bubble Springs a Leak

by Pater Tenebrarum

US Mortgage Applications and 'QE Tapering'

30 year fixed mortgage rates have soared lately in the wake of the wave of selling in treasury bonds. As we have noted on previous occasions, we believe that much of that selling was occasioned by the fact that many players have taken on ever more leverage the lower bond yields went so as to get the 'same yield bang for their buck', so to speak. Apparently the Fed successfully convinced them that its interventions would guarantee both low yields and low volatility in the bond market. Once the selling started, convexity selling set in as well (we briefly discussed convexity selling when the rise in yields had just begun) and exacerbated the move.

The result is that the 30 year fixed mortgage rate has shot up, in spite of the fact that market-based measures of 'inflation expectations' remain quite low:


30-year fixed mortgage rate

30 year fixed mortgage rate – eclipsing the all the levels recorded during 'Operation Twist' and 'QE Inf.' – click to enlarge.


As Ramsey Su has frequently remarked in these pages, the bulk of mortgage activity has taken place in refinancing, and this particular activity naturally stops dead as soon as mortgage rates rise.

According to a Reuters report:

“Applications for U.S. home loans plunged as mortgage rates matched their high of the year, with refinancing activity falling to its lowest in more than four years, data from an industry group showed on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, sank 13.5 percent in the week ended Sept. 6, after rising 1.3 percent the prior week.

That puts the index at its lowest since November 2008 and the depths of the financial crisis.

The data come just a week before U.S. Federal Reserve policymakers meet to consider slowing a massive bond-buying program, which includes purchases of mortgage-backed securities.

The Fed's support has been a major factor in boosting home prices in the United States after a slump during the crisis, and many economists worry that a pullback now may set back the housing market's nascent recovery. Borrowing costs have soared by more than a percentage point since late May on views the Fed will soon taper its $85 billion per month in buying of MBS and Treasuries.

MBA data showed 30-year mortgage rates rose 7 basis points to 4.80 percent, matching an earlier high for 2013. The refinancing index slumped 20.2 percent to 1,528.5, off 71 percent since its 2013 high in May and now at its lowest since June 2009, another sign that higher interest rates are starting to hit homeowners.

The effect of higher interest rates on home buying has been a worry for economists and bankers alike recently. Bank of America, in fact, is laying off thousands of positions because of weak refinancing activity.  And Wells Fargo & Co, the largest U.S. mortgage lender, expects to make 30 percent fewer home loans this quarter due to rising interest rates, its financial chief said on Monday.”

(emphasis added)

Obviously, the echo boom in housing is standing on rather wobbly feet with rates rising.

The 'Taper' Meme

One thing we keep wondering about is why everybody blithely assumes that the Fed meets in September to 'consider tapering QE'. When and where exactly has the Fed said that? Here is the pertinent passage from the last FOMC statement issued in late July about the 'QE' program – it talks about the possibility of both reducing and enlarging the program, depending on the economic statistics of the recent past:

“The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”

(emphasis added)

As Steven Saville recently remarked, the main 'economic objective' of the program has been and is to bail out the banks. Since early 2009 banks no longer have to mark their securities holdings to market, and 'QE' is designed to bring the actual prices of these securities closer to the fantasy values on bank balance sheets. This is achieved by transferring wealth from savers and ultimately all users of the dollar. As we have mentioned before, the broad true US money supply has increased from $5.3 trillion in 2008 to $9.5 trillion today. In addition, bank reserves have increased from basically nothing to about $2.5 trillion, so that a larger proportion of the outstanding money supply nowadays consists of covered money substitutes than previously. Banks will be better able to withstand bank runs as a result. The following chart of US money TMS-2 shows the total US money supply according to economic categorizations (currency, covered and uncovered money substitutes):


US-TMS-2

US money supply TMS-2 to the end of June 2013: currency, covered and uncovered money substitutes – click to enlarge.


It should be clear that this vast expansion of the money supply will continue to percolate through the economy and affect prices. It is an illusion to believe that the value of the monetary unit will remain 'stable'. As noted before, relative prices have already been distorted, a fact that can be proved indirectly by showing the proportion of capital to consumer goods production (this shows that the prices of goods further removed from the final goods stage must have risen more than those of consumer goods; the enormous rise of the stock market also shows this, as stocks are titles to capital).

The problem from the point of view of the central bank is of course that as soon as the inflation is stopped, all the effects it has brought about are apt to go into reverse. That would presumably also affect the securities held by banks – in fact, we know already that unrealized gains from securities held for sale (these are the only ones that are still marked to market) have in the meantime turned into losses. A 'QE tapering' would likely have a noticeable effect on the very bank balance sheets 'QE' is supposed to repair – although banks can on the other hand make much more 'risk free' money thee days by 'riding the curve' in light of the recent sharp increase in one and two year treasury yields. With the effective Federal Funds rate at 8 basis points, and the Fed's promise to keep ZIRP in place for another two years at a minimum, it pays to lend to the treasury at 47 basis points over the same stretch:


2-year treasury yield

Yield of the US 2 year t-note – click to enlarge.


On the other hand, the normal bank lending business is dead as a door nail – the rate of growth of total bank lending has been in retreat for quite some time now.

In any case, we conclude that the so-called 'tapering' is as of yet not the sure thing it is being presented as. Recently several banks, including Goldman Sachs, have argued that one should sell gold because 'tapering' of QE is on its way (presumably that call was one of the main reasons why gold has sold off sharply since Tuesday. People remember what happened last time Goldman turned bearish on gold).

The logic behind this call is hard to fathom: gold did not rise when the Fed decided to enlarge 'QE' to $85 billion per month. Why should it fall when this amount is slightly reduced? How come gold rose by 300% before the Fed embarked on its very first 'QE' adventure? In fact, it is to be expected that when the negative effects of the inflation that has already taken place to date become evident, the gold price will be boosted.

Moreover, there is a broad consensus that the “global economy will recover, but inflation will fail to accelerate”. In other words, mainstream analysts are simply extrapolating what has happened over the past year or so (excluding all the economies currently under duress, that is). There is a blue-eyed, utterly na├»ve faith that money printing actually 'works'. We think it is far more likely that the exact opposite will happen.

Addendum: Mortgage Applications Charts

Below are two charts showing US mortgage applications for refinances and new purchases superimposed over the 30 year fixed mortgage rate, via Mortgage News Daily:


30-year fixed mortgage rate

Mortgage applications: refinance and purchase indexes – click to enlarge.

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