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PMI’S MONTHLY ANALYSIS OF ECONOMIC,HOUSING, AND MORTGAGE MARKET CONDITIONS

Inside this Issue

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The Outlook

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Special Topic: HaveHome Prices FullyCorrected?

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Housing MarketIndicators

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Mortgage MarketIndicators

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Regional Roundup

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Region in Focus:The West

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The PMI Forecast

ISSUE 9 VOLUME 2 Oct 2009

098765432 109876544002000-200-400-600-800

T h o u s an d s

Change in Payroll Employment(RightAxis)Civilian Unemployment Rate(Left Axis)

P e r c e n t

The Outlook

While the economy continues to expand, recent economic data suggest that the pace of growth willbe slow and the trend will only be unevenly upward. As a result, the slow growth “U” shaped orperhaps even the double-dip “W” shaped outlooks appear to be more likely than the fast growth“V” shaped one. Most of the data still show that the economy is moving forward, however, so theU shaped recovery is still more likely than the W – at least for now. A huge drop in businessinventories, as a result of uncertainty about the severity of the financial bust, has been a keyingredient in the severity of the economic downturn. But now that financial markets arebeginning to heal and sales to stabilize, the inventory correction should end – giving a boost to theeconomy over the second half of this year. Indeed, this is likely one of the primary reasons for the jump in the various purchasing manager indices over the past several months. For growth tocontinue in 2010 at a reasonable pace, however, we will need to see a pickup in consumerspending, business fixed investment spending, or further gains in trade.

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Special Topic: Have Home Prices Fully Corrected?

Home prices surged over the 2001-2007 period, rising far beyond a sustainable pace. But howmuch did these prices get out of line with historical trends? Moreover, how close are they now,after having fallen substantially, to what could be considered a normal level? Most importantly,have home prices fallen sufficiently so that we can say that they are fairly valued today? And if not, how much more do they still have to decline?

Figure 1: Job Losses Have Slowed Sharply,but Unemployment is Still Rising

Source: Bureau of Labor Statistics/Haver Analytics

(Continued on page 12)

Contributors

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David W. Berson.Ph.D., Chief Economistand Strategist

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Brett G. Soares,Economic Analyst

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Marguerite Nicholson,Executive Assistant II

Nonfarm payroll employment fell by 263,000 inSeptember, the twenty-first consecutive monthly declineand a jump from the previous month (see figure 1). Thedetails of the report were not especially positive:

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The unemployment rate rose to 9.8 percent (thehighest level since mid-1983).

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Average hours worked (a leading indicator of thedirection of hiring) slipped to a cyclical low of 33.0 (the same as in May 2009).

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Average hourly earnings increased by a weak 0.1percent.

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But positively, the August drop in payrolls wasrevised from 216,000 to 201,000 – the smallestdecline in a year.Even with the worsening reflected in the Septemberemployment report, the trend in the job market remainspositive. We expect nonfarm payrolls to finally stop fallingin the first quarter of next year, but gains after that arelikely to be grudging. The four-week average of weeklyunemployment claims (a smoothed leading indicator of themonthly employment readings) has continued to slowlyimprove. The beginning-of-October figure of 539,750 wasthe lowest since, and is significantly better than, early-April’s 658,750 – the peak for this cycle. Still, sustainedweekly unemployment claims above about 450,000 suggestfurther labor market declines.Two of the most improved measures of business activityslipped last month – although both still signal anexpansion. The manufacturing survey index from theInstitute for Supply Management (ISM) edged down to52.6 in September, the first decline this year. That is stillabove the 50.0 level that indicates an expandingmanufacturing sector, however, and much higher than the43.0 reading that denotes an expanding economy.Moreover, the ISM’s non-manufacturing survey index roseto 50.9 in September – its first plus-50 reading since lastSeptember. This is the highest level in three years and thefirst time it had been over 50 since January 2008. Neworders for non-defense capital goods excluding aircraft – aproxy for future business capital spending – fell by 0.9percent in August. Even with this decline, the average thusfar for the third quarter is 2.1 percent above the secondquarter. And equivalent data on shipments – a proxy forcurrent capital spending – show little change in the thirdquarter despite a 2.0 percent drop in August.

We have slightly lowered our forecast for real GDPgrowth in the second half of 2009 to a range of 2.0-3.0percent. Once the inventory affect is finished, growthmay cool a bit unless other sectors of the economyexpand more quickly. Fiscal policy will certainlyremain expansionary next year, if not more than thisyear, helping keep growth up – and the Fed is unlikelyto tighten monetary policy if economic activity slowsappreciably. Consumer and business fixed investmentspending should increase next year, keeping theexpansion going – but ongoing deleveraging shouldkeep growth modest. We continue to project a below-trend pace of growth of around 2.5 percent growth fornext year, before finally getting to a slightly above-trend pace of 3.0-3.5 percent in 2011. This will allowthe unemployment rate to slowly decline and creditmarkets to improve further, but these growth rateswould still be slower than usual coming out of arecession.Housing:

Home sales were mixed for August, matchingthe more mixed data for the overall economy. New home

The Outlook

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sales rose by 0.7 percent to 429,000 units (seasonallyadjusted annual rate, or SAAR), the fifth consecutivemonthly gain and the highest sales pace since September2008. New sales were only 3.4 percent below their year-earlier levels in August. On the other hand, total existinghome sales (single-family plus condominiums) fell for thefirst time in five months, down by 2.7 percent to 5.10million units (SAAR) – but up by 3.5 percent from a yearearlier. According to the National Association of Realtors(NAR), while existing sales continue to be aided by strongforeclosure and short sales, their share of the market hasfallen to around 30 percent – indicating that most of therecent pickup in sales is for “normal” home sales.Increasingly, first-time buyers are finding purchasing ahome is competitive with renting, given the sharp rise inaffordability. Single-family housing starts slipped for thefirst time since January – down by 3.0 percent to 479,000units (SAAR). Multifamily starts are still severelydepressed, and continued their zigzag pattern with anincrease of 25.3 percent to 119,000 units (SAAR).Leading indicators of home sales rose again over the pastmonth, suggesting that the near-term trend in home saleswill be upward. NAR’s pending home sales index climbedfor a seventh consecutive month in August, and is at thehighest level since March 2007. The National Associationof Homebuilders’ (NAHB) housing market index inched upto 19 in August, the highest level (albeit still quite low)since May 2008. Finally, purchase activity in the MortgageBankers Association’s (MBA) weekly applications surveyedged up again in September. Moreover, it jumped in earlyOctober to the highest level since early January, althoughpurchase applications are the only one of the leadingindicators that is below year-earlier levels.Repeat-transaction home price indices (HPIs) all rose in themost recent month, suggesting that house price declinesare, at worst, moderating and perhaps have bottomed(although we think the former is more likely for now). The20-city S&P/Case-Shiller HPI rose for a secondconsecutive month in July, up by 1.2 percent – although itis down by 13.3 percent from a year earlier. The FederalHousing Finance Agency’s (FHFA) purchase-only HPIrose for a third consecutive month in July, up by 0.4percent – and it is down by 4.2 percent from a year earlier.Finally, the First American CoreLogic Loan PerformanceHPI (LP HPI), the broadest of all of these measures, rosefor a fifth consecutive month in July – up by 0.6 percent,but down by 5.9 percent from a year earlier.

We continue to project modest increases in home salesover the course of the year in response to high levels of affordability, investors and first-time buyers takingadvantage of distressed sales, improving demographics,and a pickup in the economy. There is a risk that thepickup in sales could stall, or worse, if the temporaryfirst-time homebuyer tax credit is allowed to expire atthe end of November 2009. Despite the sharp dropearly in the year, we project existing home sales to belittle changed from last year (although to rise by nearly11 percent on a fourth-quarter-to-fourth quarter basis,reflecting improving sales over the course of the year).New home sales, which have to compete withforeclosures, are projected to decline by 18.6 percent in2009 (but to rise by 12.5 percent measured fourth-quarter-to-fourth-quarter). Sales should rise morestrongly in 2010, especially in the second half of theyear, when the job market finally starts to improve andcredit markets function better – with existing salesclimbing by 9.5 percent and new sales up by 24.1percent.

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P e r c e n t a g e P oi n t s

P e r c e n t a g e

The Outlook

(continued from page 2)

The ongoing oversupply of homes on the marketcontinues to put downward pressure on house prices,although the pickup in sales has tempered this. Weproject median existing home prices to fall by another12.1 percent this year, although the biggest declines arelikely behind us. House prices should finally stabilizenext year as excess inventories are drawn down,resulting in little change in prices over the course of 2010.Interest Rates and Financial Markets:

In response tosigns that the Federal Reserve will leave monetary policyunchanged for an extended period of time but removeliquidity and raise rates more quickly than expected when itdoes finally tighten, long-term interest rates have edgeddownward. More mixed signs of a pickup in the economyalso helped push rates down, despite a huge supply of newTreasury debt in the market. With yields on shorter termdebt fixed by unchanged Fed policy, longer-term yields havefallen by 20 basis points since early September and now aredown by about 50 basis points from early August. Evenwith this recent sharp drop in rates, yields on 10-yearTreasury notes are still approximately 50 basis points abovethe levels of last March.Yields on riskier assets also continue to drop. For example,yields on Moody’s BAA-rated corporate bonds have fallenby about 335 basis points from their peak last October – asfixed-income investors continue to shift out of safer assets inresponse to expectations of continued economic growth, andthus lower probabilities of default. Spreads between BAA-rated bonds and 10-year Treasury notes have declined to thelowest levels since January 2008, and probably will fallfurther as they remain historically high.

With no change in Fed policy anticipated in the near-term,short-term rates should remain close to current levels fora while. Long-term rates, however, are projected to edgeupward over the next year in response to a pickup inborrowing demand and expectations of eventual Fedtightening, although low inflation should moderate anyincreases and rates are starting from a lower level than weanticipated. Ultimately, both long- and (especially) short-term rates will rise substantially once the Fed begins totighten in earnest – with the yield curve beginning toflatten at that time. Yields on riskier assets shouldcontinue to slip over the coming year as investors reducetheir default expectations in a growing economy.Mortgage Markets:

Along with the drop in other long-terminterest rates, yields on 30-year fixed-rate mortgages(FRMs) have also declined. Data from the weekly FreddieMac Primary Mortgage Market Survey show that rates havedropped to under 5.00 percent – the lowest levels since lastMay. These declines in rates have spurred an increase inboth purchase and refinance mortgage applications, althoughthe latter has been bigger. Rates are only about 20 basispoints above their all-time lows of last spring, and declinesto that level would likely generate another surge inrefinancing – as well as help spur more home sales.As with interest rates in general, and riskier assets inparticular, yields on jumbo mortgages have also fallen.From their peak last October, jumbo mortgage rates havedeclined by about 140 basis points. The spread betweenconforming and jumbo rates has also dropped – from a peak of about 160 basis points in the spring to around 120 basispoints today (see figure 2). While a substantial decline, thisspread is still extremely wide – with a spread in normalmarkets of around 25 basis points. As a result, instead of jumbo rates at around 5.25 percent, given the current levelof conforming rates, they are at about 6.20 percent today –and this is one of the reasons why the jumbo market remainsmoribund. Until a functioning secondary market for jumboloans redevelops, or depository institutions have sufficientcapital to add jumbo mortgages to their portfolios, the jumbomarket will lag behind the rest of the mortgage market.

We project a rise of about 27 percent in mortgageoriginations in 2009 to $2.30 trillion, although anincrease in the refinance share to 64 percent of themarket means that more than all of the gain is forrefinancings. Purchase activity is expected to declinethis year by 4.7 percent. In 2010, however, while totaloriginations are projected to decline by 17.4 percent,purchase activity is expected to increase by 14.7 percent.The refi share is expected to drop to 50 percent as homesales rise, and home prices finally stabilize. Purchaseoriginations are expected to rise for several years, as thehousing market continues to recover. The ARM shareof originations should stay in single-digits this year, butfinally edge up to around 10 percent by the end of 2010as the jumbo market begins to recover and FRM-ARMspreads widen relative to 2009.

Figure 2: Jumbo/Conforming Spreads Falling

(But Still High)

P o i n t s

Source: Wall Street Journal / Haver Analytics