Sunday, June 7, 2009

Is the wicked witch dead?

The unemployment number that came out Friday was so far off the charts that one would think it came from “OZ” or “Never Land”. For the first time in five months, the market failed to rally on the unemployment data. Why? The talking heads have declared that the recession is over, in fact, one talking head said that it ended Friday. He made his projection that the recession was over on Friday based on data that was one month old. So, did the recession end on Friday, June 5 or Friday, May 1?

I said in my last Blog that you need to follow two things about the recovery in the economy, employment and housing. Just to re-iterate, employment means new jobs being created and housing means new and old homes are being sold to the plus side. So far this year we have lost in excess of 2 million jobs in the United States. The unemployment rate stands at least 9.4% and is at the highest level since 1983.

I was speaking to a client over this past weekend and we talked about how misleading the talking heads are to the public. The Chairman of the Fed testified this past week before congress and he felt the rate of the decline in the economy was slowing-- he did not believe that unemployment has peaked nor are we over the hump in housing. I also mentioned in my last Blog that it would be difficult for the President to get housing moving anytime soon if interest rates continue to rise on longer dated maturities. On Friday FNMA 30-year conforming home loan had a rate of 5.29%.

The chart above shows a major reversal in mortgage interest rates over the last month. Starting later this year and continuing into 2010 we have billions of dollars of adjustable rate mortgages that will come up for rate resets. Homeowners will find it difficult to refinance their loans if interest rates continue to go higher. If I am right and unemployment continues to increase, we will see more and more mortgage defaults bring more and more supply on the markets.

I truly believe that interest rates on the long end of the yield curve are too high considering the no growth and high unemployment in the economy. I do think there is a battle currently going on between the Fed and the bond traders for control of the fixed income markets. The bond traders, for now have the upper hand, have moved up yields because they want the Fed to step in and buy more bonds. If the Fed becomes more aggressive in buying more bonds then the prices for bonds will rise and the bond traders will make a great deal of money when they sell their bonds to the Fed at higher prices than they paid.

Many of us have seen the movie “The Wizard of OZ” and at the end, Dorothy kills the wicked witch by accidentally spilling water on her. I’m melting” the witch says as she disappears. Today we have a play on Broadway called “Wicked”. It also is about Oz yet it has a different ending. I think the outcome on the direction of the American economy is not, as the munchkins say, the witch is dead everything is great and good, however the recession is more like the ending of “Wicked”, you haven't seen the last of me.

Dan Perkins

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