August 18th, 2009 9:32 AM by Mel Samick
It is significant to note that signs of renewed life in many emerging economies are even stronger than in the developed world and no wonder... their stock market is showing a turbo-charged movement. For example, despite recent weakness in Chinese equities, the Shanghai index is still up 58 percent this year, making it one of the world's best-performing markets. Much of its recent sharp drop stems from its outperformance this year compared with other markets. At one point, the index was up 91 percent for the year. Back home, the Federal Reserve Open Market Committee held its regular meeting this week, and while there was no change to policy, they did detail a few items for the market to digest. The Fed described economic activity as "leveling out," noting improvement in financial markets, while expecting activity to remain weak "for a time." Essentially, the worst of the economic decline may be largely behind us, but improvement isn't happening rapidly, if at all.
The Federal Open Market Committee acknowledged the tentative state of U.S. recovery prospects in both words and actions this week while recognizing the improvement that has occurred. In terms of words, activity is "leveling out" rather than bottoming out, "weak income growth" is now seen as an impediment to consumer recovery, and the attitudes on inflation have not changed at all. In terms of actions, policy settings remain unchanged, with merely an indication that the $300 billion Treasury purchase program will phase out a bit more gradually in coming weeks. A bigger issue is that the labor market still poses a major obstacle to consumer recovery. Initial jobless claims remain high, and declines in continuing claims mostly reflect the exhaustion of regular benefits rather than improving job availability. As a result, confidence remains depressed as well. The MBS purchase program seems unlikely to expand, but probably will be stretched out past year end. A transition approach seems most likely, similar to the policy the Fed announced on Treasury purchases yesterday. In fact, the recent slowdown in the pace of net purchases might indicate that a transition has already begun. Recently, net purchases have declined and at the current pace, the program will not hit its $1.25 trillion target until late January or early February.
The economic data released this week continues to point to an adjusting pattern for the economy, contributing to the "leveling out" the Fed observed. Some positive news can have side effects too, such as the sharp increase in worker productivity for the second quarter of 2009, where the 6.4 percent gain beat even the optimistic forecasts. The jump in worker output means that inflation measured in the form of per unit labor costs showed a 5.8 percent decline for the period. Rising productivity means that workers can be paid more without any undue effect on inflation, which is a good thing for those with jobs; however, it also means that businesses are meeting production goals without needing to add workers, and that's detrimental to those looking for jobs. For the week ending August 8, another 558,000 new applications for unemployment assistance were filed, a number that is below 2009 peaks but still pointing to a contracting labor market. Of course, one of the positive effects of an unfortunately high available labor pool is that wage-fostered inflation pressures cannot form. It also means that price pressures coming from other areas such as commodities and services may actually act as a kind of tax, further damping economic growth.
More turbulent news in mortgage banking came on Friday as Colonial BancGroup, located in Montgomery, AL, was seized by FDIC and sold to BB&T. Earlier this month, Taylor Bean & Whitaker was shut down, leading to massive warehouse loan problems and job losses. Colonial is not only the largest seizure this year with $25 billion in assets and $20 billion in deposits, but the sixth largest bank failure in U.S. history. This is unfortunate for many smaller mortgage banks who were using Colonial for warehouse lending, so that leaves many independents scrambling for warehouse lines. The FDIC's trust fund, used in covering bank failures, took another hit in the range of $3-7 billion by some estimates. The Indy Mac failure last year has been the most expensive for FDIC with almost an $11 billion hit.
A fair drop in Treasury yields last week brought down the Fixed-Rate Mortgage below 5.5 percent level. The fixed counterpart, hybrid 5/1 ARM originations seem to be gaining momentum, as their rates are getting below the 4.75 percent level. The secondary market for hybrid ARMs is showing some activity and spreads have narrowed down similar to the TED spread, which is the difference between 3 month borrowing rates for banks versus the Treasury (an indicator of market credit risk). This spread has recently moved to 0.27 percent, its tightest levels since March, 2007.
In economic releases this week, the market will be watching Tuesday's July housing starts (expected +2.7 percent), and Thursday's initial jobless claims report (expected to decline -8,000 to 550,000). Meanwhile, enjoy the remaining summer and don't forget to trade in all of your "clunkers."
Information provided by Amtrust Banks Capital Markets