Breathing Room

Fixed mortgage interest rates fell slightly this week, with the average 30-year fixed rate mortgage (FRM) decreasing by two basis points (.02%) to 6.62%, according to the nation's widest survey of mortgage prices. Five-one Hybrid ARMs finished the week at an average 6.35%, unchanged from last week.

The Federal Reserve decided not to raise short-term interest rates last week, noting that moderating economic growth is helping to restrain inflation. This week's crop of data not only confirms that decision, but bolsters expectations that the Fed will stay its hand at its September meeting.

Housing starts fell by 2.5% in July, more than expected, to just fewer than 1.8 million units, but more notable is that housing permits -- the precursor to starts -- dropped 6.5%. And while housing starts are off 13% from a year ago, permits have plummeted by 21% in that period. Builders are holding off on new construction due to the increasing inventory of unsold homes, which the National Association of Home Builders attributed to the "wait-and-see attitude" of potential buyers. Unsurprisingly, the NAHB's Housing Market Index, which measures builder optimism, fell for the seventh straight month to land at a pessimistic 32, its lowest point in 15 years. Next week's report on home sales will tell us more about the softening of the nation's housing market.

The much-anticipated reports on inflation showed that the Producer Price Index rose a modest 0.1% in July, due largely to rising energy prices. Excluding food and energy costs, the PPI's 'core' number fell by an unexpected 0.3% last month, which was the first decline since last October. Inflation at the retail level also brought good news, as the Consumer Price Index rose an as-predicted 0.4% in July, again mostly due to the higher cost of energy, after a 0.2% increase in June. The CPI's 'core' index rose 0.2% in July, down from 0.3% seen over the past several months. Taken together, the two figures suggest that inflation slowed, but of course one month doesn't make a trend. It's also worth keeping in mind that while the PPI figures reflect the items you see on store shelves, the cost of the materials needed to make them (what economists call 'crude goods') are climbing, some sharply, behind the scenes. The question is when, or whether, those more-expensive goods will make their impact known in the prices at the store; there may come a time when producers can no longer absorb those rising costs.

Back on the producer side, Industrial Production rose by 0.4% in July, where a gain of 0.6% was predicted due to the temporary increase in the demand for electricity during last month's heat wave. Factory capacity utilization rose 82.4%, up a notch from a downward revised 82.3% for June; it was the highest level in six years and more than 2% higher than a year ago. Along those lines, the survey of manufacturing conditions from the Federal Reserve bank in Philadelphia rang in at 18.5, up from just 6 a month ago -- the highest level since April 2005. Its New York counterpart pegged its index at 10.3, indicating that activity is still growing in the area, although at a slower pace than evidenced by last month's upwardly revised reading of 16.6.

What does the man on the street think about the big picture? High (if somewhat stable) energy prices, a slowdown in the housing market exacerbated by uncertainty about interest rates, personal finances and such may not be enough to offset decent news on the inflation front. The weekly ABC News/Washington Post survey of consumer comfort fell to -15 for the week ended August 13, a drop of 3 points. Meanwhile, the University of Michigan Consumer Sentiment Index fell more than expected, to 78.7 from 84.7 last month, largely due to concerns about higher gas prices but also reflective of consumers' expectations for the coming months. Since the figure is preliminary, it's not unusual for later revisions to improve it.

On the jobs front, initial jobless claims fell by 10,000 to a seasonally adjusted 312,000 for the week ending August 12. Although fewer people filed for the first time, the Labor Department also reported that continuing jobless claims rose by 34,000 to 2.51 million in the week ending August 5.

Finally, the index of leading economic indicators released by the Conference Board fell 0.1% in July, erasing June's increase. Of the 10 indicators that comprise the index, half were better than last month but the rest, which includes housing permits, were worse off. Overall, the index seems to suggest that the economy might start to cool in the months ahead.

Taken together, this week's data will strengthen those members who voted to forego a rate increase at their last meeting. It will also give the Fed a little breathing room before their next meeting in September; at the moment, the betting is that the Fed won't have to raise rates.

Next week will be light on economic data, but as noted, the latest report on home sales (and appreciation) will be closely watched. Both new and existing homes are predicted to show a slight decline, but we won't know the whole story until Wednesday.

The better-than-expected reports on core inflation, coupled with the softening of the housing market, helped the yield on ten-year Treasury to drop from 5% midweek to 4.84% at the close of business Friday. Based on that, I'd expect to see a decline of a few basis points in mortgage rates next week.