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Unemployment Down: Is The Fed In Trouble?

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The latest news on the unemployment front is good for just about everyone: The  government says 203,000 jobs were added to the economy in November and that the unemployment rate is down from 7.0 percent to 6.7 percent.

How does this impact real estate investors and those who want to finance and refinance property? In a weird way more jobs may not be a positive omen.

More people with jobs is normally considered evidence of a successful and surging economy, but the November figures are a form of numerical hokum.

The unemployment rate is far greater than 6.7 percent. The reason is that we do not count as unemployed the 2.1 million people marginally attached to the labor force, individuals who want work but have not found a job during the past year. No doubt if you took a survey these folks would say they are unemployed by every possible measure, except the standards used by government bean counters.

More Jobs, Higher Mortgage Rates
Falling unemployment levels, whether contrived or not, are a problem for the Federal Reserve. It has told the public that once the unemployment rate falls below 6.5 percent that it will begin to increase the federal funds rate, a rate which now rests securely at, well, virtually nothing. No kidding. The rate is 0.00 to 0.25 percent. That’s the cost for banks to borrow from one another overnight.

So, if the federal fund rate zooms to .50 percent or more, it means banks will charge more for loans. In particular, one might reasonably expect that mortgage rates will rise.

One can also expect the Fed to stall any rate increase as long as possible. That’s what  they’ve done with quantitative easing, the $85 billion a month they spend on the purchase of long-term debt and mortgage-backed securities. Many financial “experts” argued that the Fed would begin to wind down such purchases beginning in September, but the Fed did nothing of the sort. Again, if there is a reduction in the Fed’s purchase of long-term securities one can expect interest rates to rise because an assured buyer of such financial instruments will be making fewer purchases.

None of this should seem surprising. The forecast for 2014 is higher mortgage rates. 

“We expect mortgage rates will increase above 5 percent in 2014 and then increase further to 5.5 percent by the end of 2015,” says the Mortgage Bankers Association. “As a result, mortgage refinancing will continue to drop, and borrowers seeking to tap the equity in their homes will be more likely to rely on home equity seconds rather than cash-out refinances.” 

The prediction from the National Association of Realtors is pretty much the same: It expects interest rates to reach 5.4 percent by the end of 2014.

The wild card is that no one knows what the Fed will do. It could, for example, change its mind and just keep buying mortgage-backed securities. The Fed, an organization which apparently is prohibited from using simple sentences, explains that “asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases.”

If  interest rates rise then one group that will be directly impacted are bond and note holders. As rates increase the value of bonds declines. If you have a  $1,000 bond that pays 4 percent and rates rise to 5 percent, the bond no longer has a market value of $1,000 because investors with such cash can get a better return elsewhere. In a market with rising rates bond holders are best served keeping their paper until maturity so they can recover their full principal.

Because of the way the market works the Fed has every reason to stall rate increases for as long as possible. Why? Because as of December 5th it held mortgage-backed securities worth $1,440 trillion as well as notes and bonds worth more than $2 trillion. If rates rise the Fed’s own hoard of securities will become less liquid and arguably much less valuable, no doubt an issue of efficacy and costs which cannot be ignored.

Related News
Federal Reserve to Taper in  January
Is The Real Estate Recovery  Real?
Has The Fed Opened A Black Hole  of Debt?


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