Although fixed mortgage rates dropped by a dozen basis points this week to land at 6.38%, you shouldn't expect them to wait there for long, according to the latest data from the nation's leading survey of mortgage pricing. Hybrid 5-1 ARMS tripped lower, too, easing 13 basis points to close the survey period at 6.16%. Both figures are close to their year's low.
Rates wended their way down this week in a fairly steady fashion, as each piece of soft economic data seemed to make it more likely that the next Fed move would be to cut interest rates amid a slowing economy. The low point for yields came Wednesday, when the benchmark 10-year Treasury hit 4.57% on news that the Institute for Supply Management (ISM) missed meeting expectations by a fair margin. The ISM index tracks manufacturing activity and denotes a reading of 50 as the breakeven level, so it was little wonder that the markets took notice that October's ISM index fell to 51.2 for the month, the lowest since June 2003. One bright spot in the report was that for the first time in quite a while, the number of companies reporting lower input prices was greater than those reporting higher input prices. While we know that many commodity costs have eased off their highs, this suggests that steady-to-lower inflation has begun to work its way into the production stream.
This should be good news; according to Economics 101, easing growth lowers demand for resources and lower demand for resources cools price pressures, at least for commodities and energy costs. Easing growth should also serve to lower demand for labor, a different kind of resource, but commodities and human capital demands don't necessarily have arcs which start at the same time or progress in the same way. The Fed has expressed concerns about "resource utilization" which obviously includes human capital, and news this week suggests that they should remain concerned.
For example, one question is whether the arc of prior inflation is working its way into wages. It is, according to the quarterly Employment Cost Index, at least to the largest degree since the second quarter of 2004. The ECI for 3Q06 rose by 1.0%, a little above expectations, with the complete cost of having an employee on the books pressed higher by benefit costs. The ECI has risen by 3.3% over the past year; while still mild by most measurements, the direction continues upward.
Buttressing concerns over labor growth and costs was the monthly Employment Report for November. The 92,000 new hires were a little weaker than forecasts, but since layoffs have been slow, hiring should be expected to be as well. However, the markets were unprepared for sizable revisions to both September and, especially, to August payroll growth. September was revised up to 148,000 new hires, which August was pushed up to 230,000. Both revisions point to a much healthier job market than was originally reported, as witness that the nation's unemployment rate slipped to 4.4% -- the lowest reading since 2001. Perhaps hiring is weak not because the economy is weak, but because there are few qualified people available to hire? This would also dovetail nicely with the muted levels of layoffs; it stands to reason that you won't fire someone unless you believe that can replace them.
Layoffs are low, according to the latest Challenger, Gray and Christmas survey which found only 69,177 workers slated to lose their jobs in workforce reductions announced in October. That's down from 100,315 in September, and comparable with the lowest levels of the year. However, during the week ending October 28, there was a slight uptick in applications for new unemployment benefits, with 327,000 new filings, up from 309,000 the week before. Some of those filings are probably related to the fall in homebuilding activity. Construction Spending of all types fell by 0.3% in September, but spending for residential projects fell by 1.1% and has now been posting negative numbers for six months.
There's nothing economically wrong with a strong employment base, provided there are at least some offsets for higher wage and benefit costs. Provided worker productivity is rising, workers can be paid more in wages and benefits without businesses needing to raise prices of goods and services in order to afford them. That said, all-important productivity growth vanished in the third quarter of 2006, where no gain was reported; forecasts hoped for an increase in productivity to 1.3% for the period. The cost of labor per unit produced rose by 3.8% for the quarter, somewhat above the hoped-for level. Less productive workers and rising labor costs are not what the Fed has been hoping to see as they work to contain not only inflation today, but expectations of inflation in the near and not-so-near future. It is because labor costs remain an issue that additional rate increases by the Fed cannot yet be ruled out.
Wage growth helped to move Personal Income growth higher by 0.5% in September, up from August's 0.4% lift. Spending, though, rose by just 0.1% for the month, and the combination of the two helped move the nation's savings rate to -0.2% -- the closest to zero it has been all year. The inflation component of the report revealed a 'core' Personal Consumption Expenditure (PCE) index of 2.4% for the month, still above the range believed to be the Fed's preferred mark.
Having a job amid falling gasoline costs is a recipe for a sunny mood, and according to the weekly ABC News/Washington post survey of Consumer Comfort, consumers are happier than they've been in about three years: the Consumer Comfort index stormed higher to close the week of October 29 at -3. That expansive happiness didn't seem to infect those surveyed by the Conference Board during October, as their reading of Consumer Confidence mostly held steady, sporting a reading of 105.4, about the same as September.
Businesswise, while the ISM manufacturing survey was weaker, the ISM series which follows service-related industries noted a pickup in activity, with the ISM services index climbing to 57.1 in October from 52.9 in September. September's reading was a pretty substantial plummet from August, and the October number recovered all of that decline. As with the manufacturing series, input prices reflected here were on the downside, as well.
It's not unusual for bond and stock markets to get caught leaning the wrong way, but this week was a little unusual. Yields finished the week just a little above where they began, but it's a reasonable expectation that investors are at least a little chagrined for the moment. Hard bets that the economy is heading to free fall keep being dashed, and wagers on a more-docile Fed seem likely to suffer the same fate for at least a while longer. The period of slow growth necessary to fully overwhelm inflation pressures which took several years to build has been with us for only perhaps a quarter, and we are likely to see several more with weak growth but still-tough inflation ahead. Until that weak growth serves to trim payrolls back to produce some human "resource slack" the Fed does remain "in play" to increase rates.
Not next week, though. It's election week, when all manner of confusing messages about the economy will be blathered forth. Next week's a considerably quieter week in terms of new data, but like the ISM service numbers above, will probably see mortgage rates take back all of this week's decline, so we'll probably end up back near 6.5% as a result.
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