U.S. stocks extended the latest losing streak to three sessions as traders showed their dismay that the Fed isn’t actually printing more money via their latest policy action – Bernanke & Co. will just shift the duration of their balance sheet along with holding more mortgage-related positions than would have been the case prior to this latest move.  I didn’t think anything more than simply shifting maturities was expected, so not sure why we’d trade down on that news.  Maybe it was the more negative tone in the statement that drove the market lower, but the fact that this economy is in real trouble is no surprise either.  In any event, The Bernank seems to have disappointed stocks for the first time.

Tech, utility and consumer staples outperformed – although these groups closed lower too.  Financials, basic materials and industrials got wacked by more than 4%.

The much anticipated Fed decision arrived and their traditional statement that follows each meeting portrayed what we should already have known: The economy remains anemic and there are significant downside risks to an already low economic situation.

So that’s the economic statement, but what the market was really watching was the degree to which Bernanke would employ Operation Twist (officially called “maturity extension” by the Fed).  And, it will involve outright selling < 3yr Treasury bills/notes and buying > 6yr Treasury notes/bonds ($400 billion worth of this “twist” through June 2012).  In addition, principal payments from its agency and mortgage-backed security holdings will be reinvested back into mortgage-related positions – previously these pay downs were to be going into the Treasury market.  (The same three Committee members that dissented to the August decision to state that fed funds will remain at the zero bound also dissented to this latest move.)

This action is primarily focused at the housing market as they hope to drive mortgage rate even lower via the longer-dated Treasury purchases and by holding the current level of mortgage securities constant.  Is it an interest rate issue that plagues the housing market though?  Well, I think we all know the answer to that by now.

Of course, Operation Twist has been in effect for a while now as the bond market has expected this action and already begun positioning to that expectation.  See:

More on this below…

Market Activity for September 21, 2011

Sector Activity for September 21, 2011

So is The Twist the Fed’s last dance?  Nope, they’ll make several more stabs in the dark (and that’s exactly what they’re doing) over the next 12-18 months in their attempt to revive this economy.  Sorry that it won’t work because monetary elixirs aren’t efficacious during overly indebted periods of time.

What’s needed is a lower, broader and thus simpler tax code, a common sense regulatory regime, and time.  All the Fed is doing right now is setting up the possibility of all kinds of unintended consequences down the road as an awkward and incoherent central bank fails to understand they don’t’ have what the economy requires.

I often wonder how an economy that’s become conditioned to ultra-low rates will respond once those rates begin to normalize – granted it will be a while before this occurs.  We shall see.  No matter what occurs, you can be sure an arrogant committee of FOMC members will accept zero blame for the troubles they wrought.  If we’re going to stick to dance names when describing Fed policy, maybe their next desperate attempt at short-term stimulus should be termed The Jerk.

Mortgage Apps

The Mortgage Bankers Association’s applications index rose 0.6% last week, but it was all due to refinancing activity as purchases declined – which has been the trend over the past three months at least.

Applications to refinance a mortgage rose 2.2% as the average contract interest rate on the 30-year fixed mortgage held at 4.29%.  (Now, last week the report showed that the market rate was 4.17% -- which would have been a new record low – but now it’s showing 4.29%.  Don’t know what’s up with that – just about every bank is offering a 4.25% 30-year fixed rate without points – but that’s what the screen reads.  Apps to purchase a home remain pretty much dead as they fell 4.7% during the week ended September 16.

Below is the chart of purchase applications, which most readers will know that I like to illustrate each week.  Unfortunately, I will no longer be able to post the chart (at least regarding any historical length of time that is meaningful) as the MBA has gone to a new sample.  What I may do is show the old chart and plot where the new sample’s number is during any given week. MBA says the old and new samples have a high correlation so plotting the “new” number with the old chart may still be relevant.

Existing Home Sales

Previously-owned home sales rose 7.7% in August to 5.03 million at a seasonally-adjusted annual rate (SAAR) – beating the 4.75 million SAAR sales that were expected.  This latest result is just about smack dab in line with the average sales rate since the housing market began to crumble in 2007.

It’s important to keep in mind that August 2010 sales data was close to the 15-year low hit in July 2010 – that is, this 7.7% increase from the year-ago period is up from a very low base.  Still a 7.7% increase seems quite robust considering that stocks and consumer confidence were crashing in August.  But remember that these sales are from contracts signed back in June/July.  The September figure will reflect the elevated angst of August.

The chart below is for single-family sales only so as to offer a longer look at the data (the total sales figure includes condos/co-ops, which didn’t begin to be calculated until 1999).

The number of previously-owned homes officially available for sale fell to 3.577 million from the 3.686 recorded in July.  This results in 8.5 months’ worth of supply at the current sales rate.  But remember, as we touched on yesterday, when one includes the four million mortgages that are seriously delinquent (90+ days late or already in foreclosure) and the 3.5 million mortgages that have been modified (of which there is nearly a 50% re-default rate) the shadow inventory increases overall inventory to 9.327 million homes.  This puts the months’ worth of supply figure at 22.3 months’ worth.

Appropriately, the median price of a home fell 3.4% to $168,300 and is down 5.1% year-over-year – off by 27% from the peak hit in July 2006.  Considering the supply issues we face, that median price is very likely to come lower still and at the least retest the nine-year low hit in February.

The cancellation rate remained elevated at 18% (contracts signed getting canceled before the close, a number that is normally at 4-5%) as appraisals are not matching up with the contracted sales price.  This is a function (at least in some part) of sellers needing a price than the house is presently worth because the mortgage is underwater.  Prices will come down and when that occurs we’ll have sales either lock up (because the current occupant cant’ sell) or we’ll see more strategic defaults and thus more distressed properties on the market.  Sorry for the negativity, but this is the reality of the marketplace.

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900