by Calculated Risk on 10/13/2005 08:30:00 AM

UPDATE: As always on Trade Deficit / Current Account issues, Dr. Setser has some great insights (on other issues too!): Relative prices do matter

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis released the monthly trade balance report today for August:

"... total August exports of $108.2 billion and imports of $167.2 billion resulted in a goods and services deficit of $59.0 billion, compared with $58.0 billion in July, revised.

August exports were $1.8 billion more than July exports of $106.4 billion. August imports were $2.9 billion more than July imports of $164.3 Billion."

Note: all numbers are seasonally adjusted.


Click on graph for larger image.

August 2005 was 15% worse than August 2004. For the first eight months of 2005, the trade deficits is up 17% over the same period in 2004.

Imports from China set another record of $22,365 Billion. Imports from Japan were up slightly to $11,552 Billion.


The average contract price for oil set a new record of $52.65 per barrel breaking the old record of $49.03 in July.

The SA petroleum trade deficit set another record of $20.6 Billion.

With record imports from China and a record petroleum deficit, I'm surprised that the overall trade deficit wasn't a record; but it was close. The September deficit will be impacted by Katrina and most likely be another record.

by Calculated Risk on 10/13/2005 01:54:00 AM

Some more reading ...

Dr. Thoma reviews a new Fed Study: The Dallas Fed: Has the Housing Boom Increased Mortgage Risk?

CNN reports: Mortgages: Bracing for 6%

30-year mortgage rates look set to rise above 6 percent for the first time since July 2004, potentially helping set the stage for a slowdown in home sales.

And from the LA Times: Life on Financial Edge to Get Tougher

by Calculated Risk on 10/12/2005 06:21:00 PM

Economist Dr. Arturo Estrella of the NY FED provides some answers to Frequently Asked Questions about the yield curve in "The Yield Curve as a Leading Indicator"

Q. What does the evidence say, in short?

A. The difference between long-term and short-term interest rates ("the slope of the yield curve" or "the term spread") has borne a consistent negative relationship with subsequent real economic activity in the United States, with a lead time of about four to six quarters. The measures of the yield curve most frequently employed are based on differences between interest rates on Treasury securities of contrasting maturities, for instance, ten years minus three months. The measures of real activity for which predictive power has been found include GNP and GDP growth, growth in consumption, investment and industrial production, and economic recessions as dated by the National Bureau of Economic Research (NBER). The specific accuracy of these predictions depends on the particular measures employed, as well as on the estimation and prediction periods. However, the results are generally statistically significant and compare favorably with other variables employed as leading indicators. For instance, models that predict real GDP growth or recessions tend to explain 30 percent or more of the variation in the measure of real activity. See Estrella and Hardouvelis (1991). The yield curve has predicted essentially every U.S. recession since 1950 with only one "false" signal, which preceded the credit crunch and slowdown in production in 1967. There is also evidence that the predictive relationships exist in other countries, notably Germany, Canada, and the United Kingdom. See Estrella and Mishkin (1997) and Bernard and Gerlach (1998).

See the link for more FAQs. Dr. Estrella provides this graph to compare the yield curve to previous recessions.

Click on graph for larger image.

Yield curve inversions have preceded each of the last six recessions. To illustrate, the top figure shows the spread between ten‐year and three‐month Treasury securities since 1960, with shading to indicate NBER dated recessions. The bottom panel shows the probability of recession one year ahead, obtained by applying a probit model to the term spread as defined above.

The yield curve is still positive, but the spread has been decreasing. Therefore, according to Dr. Estrella, the probability of a recession is increasing.

by Calculated Risk on 10/12/2005 12:29:00 PM

UPDATE: Dr. Thoma excerpts speeches from Greenspan and Kohn too.

Reuters reports:

Bies warns on risky lending practices Federal Reserve Board Governor Susan Bies issued a warning on Wednesday on risky real-estate lending practices, saying banks could be hurt by higher interest rates or a decline in home prices.

"Banking supervisors have become concerned recently about apparent increased risk-taking in both commercial and real estate lending," Bies said in remarks prepared for delivery to the National Bankers Association annual convention in Beverly Hills, California.
...
"There is some concern that banks' home equity loan portfolios may be vulnerable to a rise in interest rates and, in some markets, a decline in home values," she said.
...
She said regulators were conducting a survey of banks' so-called affordability lending practices and said they might offer regulatory guidance on the subject in the near future.

Bies noted U.S. housing prices had jumped 13.4 percent in the second quarter from a year ago -- the biggest gain in more than a quarter century -- and said speculative buying appeared to be a factor behind the increase.

Here is the text of Governor Susan Bies speech: Regulatory Issues.

by Calculated Risk on 10/12/2005 11:36:00 AM

Bloomberg reports: U.S. MBA's Mortgage Applications Index Fell 2.6% Last Week

U.S. mortgage applications fell last week to the lowest level since April as higher interest rates slowed both refinancing and home purchases, according to a private group's survey released today.

The Mortgage Bankers Association's gauge of applications declined 2.6 percent to 694.8 in the week ended Oct. 7 from 713.5 the previous week. The last time the index was as low was April 15, when it was 672.6.

The average 30-year fixed mortgage increased to 5.98 percent, the highest since the end of March and the fifth straight rise, according to the bankers group. Higher borrowing costs have caused purchase applications to decline in each of the last four weeks, suggesting home sales are starting to cool.

According to the Mortgage Bankers Association (MBA) the refinance share of activity declined as did the share of ARMs:

The refinance share of mortgage activity decreased to 43.5 percent of total applications from 44.5 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 29.5 percent of total applications from 29.8 percent the previous week.
...
The average contract interest rate for one-year ARMs increased to 5.26 percent from 5.13 percent one week earlier.

The spread between the 30 year interest rate and the 1 year ARM is now 0.72 basis points; the lowest spread since March 9, 2001.

The Riddles

With rising interest rates, why is the refinance activity so high?

With the narrow spread between fixed rate loans and ARMs (and rising rates) why is anyone using an ARM?

From Bloomberg: Bob Walters, chief economist at Quicken Loans Inc. said they are seeing more people refinance out of their adjustable rate mortgages to fixed-rate mortgages in anticipation of higher borrowing costs. That is a similar explanation as in the LA Times article, "Thinking long-term" that described similar motives of homeowners refinancing their variable rate loans to lock in the security of a fixed rate loan.

This can at least partially explain why refinance activity remains so strong, but I expect that activity to diminish rapidly. With both adjustable and fixed rates rising (and widely advertised to keep rising), those homeowners motivated by locking in a fixed rated will probably refinance soon.

But that doesn't explain the high level of ARM activity. Why is anyone using an ARM today?

Here are two possible explanations: 1) new homebuyers are continuing to stretch to buy a home and 2) existing ARM users are refinancing with ARMs to get a new low teaser rate.

If new homebuyers are using ARMs that is most likely a sign of speculation. With the current spread and direction of rates, I would expect new buyers to use fixed rate loans if they could afford the payments.

The second explanation was described in this LA Times article: Risky 'Exotic' Loans Fostering a Refi Cycle. Apparently many borrowers are desperately replacing existing ARMs and IOs with new ARMs and IOs to forestall higher payments. They are hoping the price appreciation in their homes will bail them out. This is a short term strategy and the day of reckoning is probably soon.

If the riddles are solved, the solutions are not healthy for the housing market. I expect the refinance activity to diminish rapidly and speculation (ARM users) to almost disappear as short term rates rise and the housing market slows.