Erik Black, top mortgage broker for River Valley Bank in Wisconsin, offers some key insights into why interest rates and the current real estate market have combined to create conditions perfect for buying....and why they won't last forever.

Any school kid knows the old saying that March comes in like a lion and goes out like a lamb.  But since this is the last month of the Feds Mortgage Backed Security purchase program, interest rates in March could very well come in like a lamb, and go out like a lion. 

There has been considerable jawboning about how there will be no negative reaction for interest rates when the Fed buying stops.  This whistling past the graveyard just does not make sense.  Rates will move higher although gradually.  However rates will be adversely affected in the absence of the Fed purchasing.  And we all hear the question, Do you think rates will go higher once the Fed stops purchasing?  The answer is they already have.  Rates are .25 - .375% above where they were just a few months ago. 

In fact, rather than being a buyer of Mortgage Backed Securities, the Fed said at the last Fed Meeting on Jan 27th that they will in fact gradually become a seller of MBS and other government debt, in order to trim their balance sheet.  At the moment, the Fed has $777B in Treasuries, $166B in agency debt and will have a whopping $1.25T total in Mortgage Bonds on their books.  When you consider this enormous supply of paper that will be unloaded over time, in conjunction with the new Treasury supply coming to market every two weeks – there is only one way to attract buyers to purchase this massive government debt supply...and that is by offering higher rates.  Bottom line – if you still have fence sitters or people holding out for a lower rate…now is an ideal time to talk to them about what is happening in the Bond market, and why this is a good time to take action.

There are also a couple of other factors that have been helping rates which will eventually come to an end.  The Carry Trade, will unwind once the Fed begins to tighten and chances are high that the tightening will begin later this year.  Bonds have also been greatly helped by a flight to quality, over fears of a Greek sovereign debt default.  Again, I have discussed this topic at length with you in my limited reports, and I feel strongly that there will be a bailout.  Once that bailout is announced, the safe haven trade will reverse, which should push Bond prices lower and interest rates higher.

For now – as we begin this first week of March, Mortgage Bonds are trading in lamb-like fashion, presently near unchanged levels, thanks to some tame consumer inflation data.  The January Core Personal Consumption Expenditure Index, PCE, which measures consumer inflation, came in at 0.0% matching expectations.  This left the year-over-year Core PCE rate at a modest 1.4%, and at the moment, well within the Fed's comfort zone.

Consumers made less, saved less and spent more during January.  Personal Income rose 0.1%, well below expectations of 0.4%.  But that didn't stop the consumer from spending a little more, as Personal Spending increased by 0.5%, above expectations of 0.4%.  And the bump in spending appears to have come at the expense of saving, as the Personal Savings Rate fell to 3.3% from 4.2% in December, marking the lowest savings rate since October 2008.

The manufacturing sector measuring Institute of Supply Management Index came in near expectations, and the market had little reaction in response.

Rates are going to move higher, this is not just a prediction, it is a fact you can take to the bank. They have been low for so long that clients almost have this mindset that they will always be there. I have had some folks even complain a rate is “too high” when they happen to pop in at 5.5%. I guess these folks quickly forget about some of the old days in the early 80’s when 18% was a “GREAT RATE”

By The Number$

1.   NICE JOB - The S&P 500 stock index was up +3.1% (total return) in February 2010, its best February performance since 1998.  The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market (source: BTN Research).   

2.   MARCH MADNESS - The S&P 500 has averaged a gain of +1.2% (total return) over the last 20 years (i.e., 1990-2009), ranking March as the 5th best performing month during the 2-decade period (source: BTN Research).   

3.   TAKING CONTROL - 37% of American workers age 45-59 have increased their retirement savings percentage and anticipate working longer before retirement as a result of the 2007-09 bear market for stocks (source: Center for Retirement Research).   

4.   WE’RE SPENDING LESS - Total retail sales in the USA in calendar year 2009 were $4.1 trillion, down 6.2% from its total in 2008.  That’s equal to a drop of $274 billion of annual retail sales or $1 million less in retail sales every 2 minutes.  Most of the categories that make up retail sales were down for the year including motor vehicles (down 12.3%), furnishings (down 11.1%), clothing stores (down 3.1%), electronic equipment (down 7.8%), and building materials (down 11.6%).  Grocery store sales were up +0.3% and pharmacy/drug store sales were up +3.3% (source: Census Bureau).        

5.   NOT A GREAT OPTION - If every government department reduced their actual expenditures by 40% in fiscal year 2009, the nation would have had a balanced budget.  Instead, our deficit last year was $1.4 trillion (source: Treasury Department).    

6.   JUST FIVE YEARS OFF - Our government’s projected tax receipts of $2.6 trillion in fiscal year 2011 (i.e., the 12 months beginning 10/01/10) is essentially equal to our government’s actual spending of $2.7 trillion in fiscal year 2006 (source White House).    

7.   BUDGET TRIVIA - In the first 186 years of our nation’s history where financial records were maintained (i.e., the period from 1789-1974), the USA spent $3.8 trillion in aggregate.  The total of projected government outlays during the current 2010 fiscal year is $3.7 trillion (source: Office of Management and Budget).    

8.   NO KIDDING?! - 5 years ago tomorrow (3/02/05), then Fed Chairman Alan Greenspan told the House Budget Committee that the US government needed to undertake “major deficit-reducing actions.”  Greenspan said “I fear we may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver” (source: House of Representatives).   

9.   PER HOUSEHOLD - The average American household has $7,800 of credit card debt as of the end of last year.  Credit card issuers collected $20.5 billion in penalty fees in 2009, up from $10.7 billion in 2003 (source: Federal Reserve).   

10.       BAD BANKS - The 20 bank failures that have occurred in the USA through 2/22/10 (i.e., a week ago today) will cost taxpayers $4.3 billion or an average fee of $215 million per failed bank.  The biggest outlay for taxpayers YTD was the failure of La Jolla Bank (La Jolla, CA), estimated to cost $882 million (source: FDIC).   

11.       LACKING TRUST - 55% of more than 1,000 American adults surveyed in mid-January 2010 believe “quite a few” of the politicians running the government in Washington are “crooked” (source: Gallup Poll).  

12.       HARD WORKER - The average productivity of the American worker (defined as output per hour of work) has increased +30% over the last decade (i.e., 2000-2009).  Mathematically this means the quantity of work done in 1999 during a 40-hour work week could now be completed in less than 31 hours (source: Department of Labor).  

13.       NO CARS TO SELL – An average of 4.9 automobile dealerships went out of business each day during calendar year 2009.  1,772 dealerships went out of business last year (source: National Automobile Dealers Association).     

14.       FEW MORE BUCKS - NBC paid $820 million for the television rights to broadcast 835 hours of coverage from the 2010 Winter Olympics in Vancouver, British Columbia.  50 years earlier, CBS paid $50,000 for the rights to broadcast 15 hours of television coverage from the 1960 Winter Olympics in Squaw Valley, CA (source: NBC).   

15.       WHAT A DEAL - Outfielder Corey Hart of the MLB Milwaukee Brewers made $3.25 million last season.  The Brewers offered Hart a +28% pay raise (to $4.15 million) after Hart hit .260 last year with 12 home runs and 48 RBIs.  Hart took the club to arbitration and won, receiving a +48% hike in pay to $4.8 million (source: Major League Baseball).