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Personal Finance Blog By MoneyRates - May 2013

Mortgage rates jump, but is it only the beginning?

May 30, 2013

| MoneyRates.com Senior Financial Analyst, CFA

National housing prices just posted their best year-over-year performance since 2006. Does that mean the housing market has fully recovered? If so, could it mean that today's low mortgage rates may soon be a thing of the past?

According to the Standard and Poors/Case-Shiller Home Price Indices, national home prices rose by 10.2 percent over the 12 months that ended with the first quarter of 2013. That's their best performance since the housing boom. Furthermore, it continues a string of positive performances for housing, and comes amid a run of generally favorable economic news.

Despite all those good signs, it may be too soon to declare the housing market fully recovered. Home prices may have to fight against a couple of headwinds in the months ahead.

Will mortgage rates rise?

Housing prices are not the only thing that has been headed higher lately. Mortgage rates have also been on the rise.

At 3.81 percent, according to today's Freddie Mac mortgage survey, current mortgage rates are nearly half of a percentage point above their low point for 2013. If the economy and the housing market continue to improve, mortgage rates may climb even further.

Here are three reasons why mortgage rates may follow housing prices upward:

  1. Stronger housing and economic growth may bring greater loan demand.
  2. The Federal Reserve may ease its low-interest-rate policies in response to a strengthening economy.
  3. Spending growth may bring a little inflation.

It's important to remember that current mortgage rates are unusually low, brought about by extraordinary circumstances. It would be unrealistic to expect those rates to continue under more normal conditions.

Additional headwinds for housing prices

If mortgage rates rise even further, it will make it more challenging for housing prices to continue their current momentum. The real estate market may continue to strengthen, but perhaps at a more measured pace. After all, rising mortgage rates may not be the only headwind that housing prices will face.

A report released jointly by the U.S. Treasury and Department of Housing and Urban Development shows that while the inventory of houses available for sale appears to be declining, the number of houses being held off the market is unusually high. These are properties that are vacant, but that the owner has chosen not to put up for sale at this time.

Often, this is the result of an investment decision to hold back the property until the housing market is a little stronger. Ultimately though, these properties being held off the market represent an unsold inventory of housing that will have to work its way through the system. When this excess supply is finally introduced into the market, it will put downward pressure on housing prices.

Rising mortgage rates and the unwinding of this pent-up supply of housing may well slow the pace of home prices, but that's not a bad thing. The healthiest thing for the market might be a return to a saner pace, rather than going from boom to bust and back to boom again.

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Is the 'Goldilocks' economy coming back?

May 23, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The biggest economic news of the past week was the release of the inflation number for April. The sight of easing consumer prices in the midst of what seems to be a general strengthening of the economy brought to mind an expression that was often used to describe the economy of the late 1990s: the "Goldilocks" economy.

The Goldilocks economy was not too hot or not too cold, but just right. What that really meant was that the U.S. was able to have steady growth without inflation ever getting overheated. Could the current economy be starting to settle into this type of ideal scenario?

Easing inflation

On May 16, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) declined by 0.4 percent in April. While easing inflation is good, normally such a significant drop in prices would bring concerns of deflation as a sign of economic weakness. However, coming amidst generally positive signs of economic growth, this inflation relief is seen simply as removing a potential problem from the economic equation -- at least for the time being.

The challenge for the Federal Reserve has been to apply aggressive economic stimulus without sparking inflation. Recent indications are that this may finally be working, though there should be one caution about inflation. As is often the case, the key to April's CPI number was the energy sector, which saw generally declining prices in April. So far though, oil prices have risen in May. It remains to be seen to what extent that will carry over to inflation as a whole.

The balancing act

Balancing between growth and inflation is the central challenge the Federal Reserve faces, but it's not the only balancing act the Fed needs to pull off.

Whether or not inflation starts to perk up, the Fed must find away to unwind its monetary easing programs without choking off economic growth. This also means having interest rates rise gradually enough that they don't spook the stock market or real estate, both have which have risen largely on the strength of artificially low interest rates. The key to the balancing act will be to have confidence in the economy grow quickly enough to replace the stimulus of low rates.

A Goldilocks scenario for savings accounts

Having economic growth accelerate while inflation remains moderate would be a Goldilocks scenario for many aspects of the economy, including savings accounts. Such an environment would allow the interest rates on savings accounts to rise without inflation negating the value of those higher rates.

The next couple weeks will bring two more key indicators of how well this is playing out. Next week the Bureau of Economic Analysis will release its second estimate of first-quarter Gross Domestic Product, and the following week the BLS will release its employment report for March. Those growth indicators should provide strong clues on whether the Goldilocks scenario is becoming a reality -- or just another fairy tale.

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Stock market surges on -- but is it sustainable?

May 16, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The stock market rallied to new highs in mid-May, as investors continued to ride the momentum from a surprisingly good jobs report that came out at the beginning of the month.

Investor sentiment has a great deal to do with how news is interpreted, and even reported. Not only have stock market bulls made the most of that recent jobs report, but they are now seizing on anything that can be interpreted as good news as another excuse to push stock prices higher. Unfortunately for more conservative investors in savings accounts and other deposits, banks will not be so quick to embrace this optimism by raising rates.

Bullish news

A widely reported indicator of stock market valuation reached a 58-year high recently. This indicator is the ratio of the earnings yield on stocks to the yield on Treasury bonds, and it is a good proxy for a of couple fundamentals that go into stock valuation, namely:

  1. Prices relative to underlying earnings. Stock prices have gone up by a tremendous amount over the past several decades, but that doesn't mean that stocks keep getting more and more expensive. What matters from a fundamental investing standpoint is how much prices go up relative to the underlying earnings. So, everything else being equal, a stock selling at $20 a share with $2 a share in earnings should look the same to an investor as a stock selling at $40 a share with $4 a share in earnings. Both stocks would have a price-to-earnings (P/E) ratio of 10, and the earnings yield is simply the inverse of that P/E ratio.
  2. The discounting value of interest rates. By comparing the earnings yield on stocks to bond yields, investors are acknowledging that interest rates discount the value of future earnings. The higher interest rates are, the less valuable future earnings appear. However, with interest rates as low as they are now, future earnings are not discounted by much, which makes stocks appear more valuable.

Because fundamental stock valuation is a function of prices, earnings and interest rates, stocks can be hitting new highs and still appear like a good value, as long as earnings have grown and/or interest rates are low.

The sobering facts

While the stock market is quick to celebrate any sign of good news these days, there are some more sobering facts about the current economy -- chiefly the fact that unemployment remains stubbornly high.

On the global front, it was recently announced that the European Union has entered its sixth quarter of recession -- with France now one of the countries in the union that is officially in recession.

The economy's lingering problems are the reason why depositors will have to wait a while longer for higher rates on savings accounts. The banking environment is closely linked to the grassroots of the American economy, and until economic improvement becomes more widespread reality than isolated stories, expect banks to keep rates on savings accounts and other deposits as low as possible.

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April jobs report: a prelude to higher rates?

May 9, 2013

| MoneyRates.com Senior Financial Analyst, CFA

One thing that has made the recent economy so challenging is its unpredictability. The latest twist was actually a positive one -- a surprisingly encouraging jobs report at a time when the economic recovery seemed to have lost momentum.

On March 3, the Bureau of Labor Statistics reported that 279,000 new jobs had been created, between the employment growth for April and upward revisions for previous months. Employment growth in April was responsible for 165,000 of those new jobs.

Upward momentum for jobs

While 165,000 is slightly below the monthly average of 169,000 for the past year, the number was encouraging because it exceeded expectations and represented a strong improvement over the original figure for March, which was just 88,000 new jobs.

That original March figure was revised upward by 50,000 in the latest report, and February's figure was revised upward by 64,000 new jobs. Add these revisions to April's job creation, and the total comes to over a quarter million new jobs in the latest report.

The stock market climbed to new highs within days of the job news, and the bond market also reacted to the renewed hopes for the economy. Bond yields jumped immediately on the employment news, and then continued to climb in the days that followed.

For bank customers, this could have a variety of long-term ramifications. It raises hopes for savings accounts because stronger economic growth should eventually mean higher interest rates. By the same token, the prospect of higher rates means that current mortgage rates may be a limited-time-only bargain for potential home buyers, as well as homeowners who want to refinance.

The economic road ahead

Is this the turning point that will see economic growth finally accelerate? Given that unpredictability has been the one true defining feature of this economic recovery, it is too early to say. However, it is not too early to prepare for what might happen if that's the case.

Stocks may continue to rise if growth strengthens further, but keep in mind that if interest rates start to rise, it will create a bit of a headwind for stocks. With the market having already rallied by 15 percent so far this year, it's biggest move may have come in anticipation of better news, leaving less potential for further gains should the economy actually improve.

Savings accounts should eventually see higher rates if bond yields continue to rise, but expect banks to lag behind the bond market at a cautious distance. Banks may be quicker to raise mortgage rates, since current mortgage rates are so low they represent a risk to banks if interest rates start rising.

Before any of this plays out, however, the economy will have to prove it can sustain this momentum. The next jobs report, due in early June, will be a key indicator. In the meantime, the latest news remains a positive twist rather than a definitive turning point.

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A reality check on real estate

May 3, 2013

| MoneyRates.com Senior Financial Analyst, CFA

New statistics on the real estate market show home prices have risen by about 9 percent over the past year. Does this mean that real estate is back?

On April 30, the Standard & Poors/Case-Shiller Home Price Indices release showed that a composite of real estate prices in 20 major metropolitan markets had increased by 9.3 percent over the past year, the best annual gain since May 2006. Does that mean the housing market is back to the heady days of the real estate boom? A quick reality check shows that not to be the case -- which may be good news for would-be home buyers.

A dose of reality

The first reality check is to look at how far home prices are still down from their peak levels. Despite the recent increase, home prices are still about 30 percent below the peak reached in the summer of 2006. Those prices have only recovered to the level first reached in the fall of 2003, meaning that homeowners on average have gone nearly a decade without seeing any increase in the value of their homes.

The second reality check is to recognize how much housing prices are dependent on current mortgage rates. Thirty-year fixed rate mortgages ended April at 3.40 percent. That means current mortgage rates are about 49 percent lower than they were when housing prices peaked in the summer of 2006, and about 43 percent lower than they were in the fall of 2003 when home prices were comparable to today's levels.

When you factor in those lower interest rates, people are paying far less for housing than they did at the peak of the real estate market, and even considerably less than they did when prices were at a similar level back in 2003. Take away the extraordinarily low level of current interest rates, and it is likely that the housing market would still be getting worse -- not better.

Winners and losers

Naturally, people who are in a position to buy a house in the near future are the winners in this situation. Despite some recent improvement, housing prices are still well below peak levels, and mortgage rates are at or near record lows. That adds up to greatly reduced costs for home buyers.

Less fortunate are people who bought their houses around the peak of the real estate boom. Property values are still well below what these homeowners paid, and as a result they may not have been able to take advantage of today's attractive refinance rates.

Also among the losers of the housing situation is anyone with a stake in the U.S. economy. Housing prices are widely followed as an indicator of the economy's health. Given the fact that record-low interest rates have so far fueled only a modest recovery in housing prices, the latest real estate news is hardly a sign of robust economic growth.

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