The Week Ahead in the Capital Markets  -   February 2, 2009

The 10-year Treasury yield is up 0.50% in two weeks, but deflation – not inflation – remains the biggest risk.  Rates are up mostly because the Fed whipsawed the market.  The Fed hinted that it was going to buy longer-term Treasury debt, but it did not follow through with any purchases, and traders hit the market hard.

The recent run-up in rates has throttled the mortgage refinance boom.  Mortgage rates are pushing in to the mid-5% range.  Volume has slowed and origination profit margins have backed off from record highs.  The purest measure of margin, the spread between mortgage rates to the consumer and mortgage securities yields, has shrunk by 0.125% in recent weeks.

But don’t give up on low rates just yet.  Deflation has the potential to get some very real traction going forward. Why? Because all over the world, we built too much of almost everything. Too many houses, too many manufacturing plants, too many retail stores – just too much stuff, reports John Mauldin. 

Industries have no pricing power, as they can make a lot more “stuff” than they can sell. For example, global output capacity for automobiles is 92 million cars, but sales will probably be around 60 million. Consumer spending is plummeting and 70,000 retail stores are due to close in the next six months.  We are in the first serious consumer recession in 26 years.  In the 4^th quarter, consumer spending plunged at a 3.5% annual rate, residential investment collapsed at a 23.6% rate and real business spending plummeted 19.1%.  Exports fell at a 20% annual rate as the recession spread abroad.  When demand drops, prices fall as producers try to stay in business. 

We’re in the worst economy in at least fifty years.  Nearly five million people are drawing unemployment insurance.  Some 75,000 layoffs were announced last week; 23,000 more may be whacked from the New York City payrolls alone.  Payrolls contracted every month in 2008 for a cumulative loss of 2.6 million jobs – the largest yearly drop since the end of World War II.

No wonder the Fed is scared of deflation. 

No wonder the S&P 500 had its worst January ever.  The S&P declined 9% for the month, exceeding the 8% record drop in January 1970.  From its peak on January 6^th, the S&P is down 12%.  It feels like Groundhog Day – the version that Bill Murray made popular. 

Freddie Mac reports that home prices declined 18% over the 12 months ending November 30, 2008, with declines as much as 33% in some areas.  Home values fell 2% from October to November – the largest recorded month-to-month decline since the index began in 1991. All industry indicators point to these significant declines continuing through 2009.  Ouch.

According to a new study, there’s been an increase in the number of illegal Mexican immigrants living in Canada. Yeah. You got to hand it to them. That must be some tunnel.   – Conan O’Brien

Thanks for your business and have a good week.            — Tom Millon

About Capital Markets Cooperative
Capital Markets Cooperative (CMC) provides mortgage bankers with the economies of scale and the expertise to reduce risk and maximize profit in the secondary market. Regarded as the premier secondary marketing specialist in the industry, CMC has worked with financial institutions nationwide to break traditional barriers in capital markets and take performance and profits to the next level. To date, CMC executives have managed more than $500 billion of mortgage volume. CMC board members are Tom Millon, Jeff Harry, and Harold Koegler.  For more information about Capital Markets Cooperative, visit www.capmkts.org or call 904.543.0052 or e-mail [email protected].