MBA May Economic and Mortgage Finance Commentary: Fed Watch

After the April Federal Open Market Committee meeting, the Federal Reserve announced that the fed funds rate would be held in the range of 0.25 percent to 0.50 percent, based on a weaker outlook on economic growth in the first quarter, although job market was judged to be healthy and global risks had mitigated slightly.

Minutes from the meeting have implied that a June rate hike is very much on the table given the improving outlook, strong labor market, and rising inflation. The minutes indicated a desire for clearer communication to the market, and there has been clear intent in recent speeches and remarks by key Fed officials that several rate hikes this year remain feasible. Oil prices have stabilized and the dollar has depreciated slightly as well.

There still remains uncertainty over Britain’s exit from the European (commonly called “Brexit”), both in terms of the actual outcome and in terms of what impact that might have on financial markets and British and European businesses. Regardless, we anticipate that the Fed will see enough strength in the U.S. economy to raise rates in June and December this year.

Overall growth in the U.S. remains positive as real GDP continues to grow at a slow and steady pace. The main drivers of growth were consumer spending and residential fixed investment, but exports and business fixed investment were drags to growth. We expect GDP growth will average close to 2 percent or higher annually through 2018.

Job growth slowed in April to 160,000 new jobs added, compared to a March total of 208,000 jobs. This was the lowest reading of 2016 thus far, but with the economy close to or already at full employment, it was not a weak number by any means. Unemployment stayed at 5.0 percent and labor force participation decreased for the first time since September 2015 to 62.8 percent.

Over the past 12 months, construction, arts and entertainment and professional and technical led payroll growth in percentage terms, while mining and logging, which includes oil extraction, showed the largest decline. The decline mining and logging employment has tracked the fall in oil prices starting in late 2014. In contrast, construction employment has been growing and with reports of labor shortages among builders, we expect that hiring in the sector will continue to grow, and that there will be a more meaningful increase in wages around the corner if shortages persist. More domestically focused industries, like construction, have been faring better than those tied to global trade, like manufacturing and mining and logging.

Labor force participation had been rising since the third quarter of last year, but fell in April, and remains close to levels last seen in the late 1970s. Participation in the labor force by 16‐19 year old workers also remains near historically low levels. As wages rise, we expect more workers to return to the labor force, which will boost the participation rate but also hold the unemployment rate a little higher.

Our expectation is that the unemployment rate will slowly decrease to 4.7 percent by the second half of 2016 and remain at that level for a year or so. The spread between the U6 underutilization measure, which accounts for discouraged and part time workers, and the unemployment rate has narrowed/improved significantly since the end of the recession. However, the spread still remains larger than pre‐recessionary levels, and will likely narrow if part time workers are able to shift to full time jobs and as the labor force grows.

Overall CPI inflation ticked up slightly to 1.1 percent on a year over year basis as oil prices rose and the energy component showed less of a year over year drop. Core inflation, which excludes food and energy, dropped slightly to 2.1 percent. Motor fuel prices decreased 21.1 percent compared to a year ago, a trend that has persisted since late 2014. Prices paid by consumers for shelter maintained annual growth of over 3 percent, as vacancy rates remained low and kept upward pressure on rental rates. We expect that oil prices will continue to rise slowly through 2016 and for core inflation to continue to firm at over 2 percent.

Shifting to the housing market, we saw an increase in housing starts in April, with both single family and multifamily starts increasing over the month. Multifamily starts jumped by nearly 50,000 units to 394,000 units, the highest level in four months. Single-family starts, at 778,000 units, remained well below historical average of around one million units. We continue to forecast an increase in single family housing starts as inventory is still low and household demand firms, driven by a strong labor market.

Multifamily starts are expected to increase as well, but will likely not be too far above the 400,000 unit mark, which is only slightly lower than the historical average for this measure.

Mortgage delinquencies continued to improve in the first quarter of 2016. The overall delinquency rate, which excludes loans in the foreclosure process, remained at 4.77 percent of all loans. This was the lowest level since third quarter 2006. The delinquency rate was 77 basis points lower than one year ago, according the most recent data from MBA’s National Delinquency Survey. The percentage of loans on which foreclosure actions were started during the first quarter was 0.35 percent, a decrease of one basis point from the previous quarter, and down 10 basis points from one year ago. This foreclosure starts rate was at the lowest level since the second quarter of 2000.

The percentage of loans in the foreclosure process at the end of the first quarter was 1.74 percent, down three basis points from the previous quarter and 48 basis points lower than one year ago. With fewer new delinquent loans and greater ability to get these distressed loans resolved, we expect some downward pressure on loans in foreclosure. Credit quality of recent loan vintages has also been higher, as evidence by lower serious delinquency rates in the post 2012 cohorts. There is still the issue of long foreclosure timelines in certain states due to the judicial process and other mediation efforts, so the foreclosure inventory may not return to pre‐crisis levels quite yet, but will be lower nevertheless.

Foreclosure inventory rates continued to decline in both judicial and non‐judicial states this quarter. However, about two‐thirds of the 20 states with foreclosure inventory rates above the national average were judicial states.

As featured in our Chart of the Week on May 6 (https://www.mba.org/news-research-and-resources/forecasts-data-and-reports/forecasts-and-commentary/chart-of-the-week), mortgage applications for home purchase loans increased across all loan sizes, based on loan count on a year over year basis, according to data from MBA’s March Monthly Profile of State and National Mortgage Activity.

Loan sizes of $300,000 and higher continue to grow at a faster pace, and while the lower loan size buckets still lag, their growth rates were a significant improvement compared to the past two years, and an important indicator that first-time buyers may be returning to the market in greater numbers. In both March 2014 and 2015, applications for purchase loans of $150,000 and less were contracting compared to previous years. Two‐thirds of all purchase applications are less than $300,000, and these are typically loans made to entry level and first time home buyers. Due to various factors including tight inventories of lower priced homes, access to credit, below normal rates of household formation and the increased propensity to rent, this segment of the market has been slow to recover.

Our estimates for mortgage originations have increased only slight compared to last month’s forecast, as rates in recent months were lower than expected, which will likely lead to more refinancing activity. We expect $1.6 trillion in total mortgage originations in 2016, with around $970 billion coming from purchase and $585 billion from refinances. Purchase originations are expected to increase in 2017 and 2018, as continued economic growth and a strong job market will help support household formation.

Household formation in turn is likely to boost housing demand. Additionally, rising rents may also push some households to purchase homes. Refinance originations will continue to decline as rates eventually rise, causing overall industry originations to show a decrease in 2017 and 2018.

(Joel Kan associate vice president of economic forecasting with MBA; he can be reached at jkan@mortgagebankers.org. Each month MBA Research provides commentary on the current mortgage finance and economic climates. For more information, contact Forecasts@mortgagebankers.org.)