The Bond Market

It might be a good idea to take a look at what the bond market is, what makes it move, what some of the jargon is and how the bond market affects mortgage rates. Please appreciate that this is a complex topic which we are dealing with in a manner to cast some light on why and how it affects mortgage rates.

Bonds are the main way that municipal agencies and corporations borrow money. When we talk about the "bond market" we are restricting our discussion to the issues of the United States Treasury Department. The government, for a reason that I have never quite understood, spends a lot more money than it takes it. It makes up the difference by selling bonds which then constitute short and long-term debt.

The Treasury Department borrows with maturities of 3 and 6 months and 1, 2, 3, 5, 10 and 30 years. The short term ones (1 year or less maturity) are called "Bills" the 2-10 year versions are called "Notes" and the 30 year is called a "Bond." Bonds are auctioned. Before the auction, a "coupon" rate is set. When the auctions occur there are 2 types of bids: competitive and noncompetitive. Most individual investors purchase Treasury Securities by submitting a non-competitive bid. By placing a noncompetitive bid, you are guaranteed average yield and equivalent price determined at the "competitive" auction. Competitive bidding is generally done by large financial institutions and brokers who are familiar with the securities market. As a competitive bidder, you must submit a sealed bid specifying the rate you are willing to accept. This is specified out to 3 decimal places. All noncompetitive bids will be accepted for that auction. The remaining balance of the offering is allocated among competitive bidders, beginning with the lowest yield until the total amount needed is satisfied.

So Then What?

These notes and bonds are usually purchased by brokers who then retail them. Once they are distributed, the fun begins. The Treasury Department issues new Treasury debt. Once they are issued investors then buy and sell these bonds on a cash market. When you see on-line price quotations there are 3 figures: "bid" (what someone is offering to pay), "ask" (what someone is offering to sell) and "strike" (what the last transaction actually took place at).

For example, the 30 year bond issued 2/15/01 had a "coupon" of 5.375%. If it closed trading at 110 19/32 bid, then for every $1,000 of bonds someone was offering $1,106. Divide the 5.373% face by 1.106 and you get 4.86% yield. So, the bond yield would be 4.86%. Note that this is why the price and the yield move in opposite directions. When the price (the divisor), moves up and the quotient (the yield) moves down.

Futures vs. Cash

The StoMaster Rate forecast deals not with cash purchases of bonds but with bond futures. Cash and futures prices move in virtual lockstep. Note that mortgages move more in harmony with the 10-year Treasury but we look at the 30-year bond future as tidal. It is the best indication of where rates (including mortgages) are going.

The Federal Reserve

One of the strongest tools that the Federal Reserve has in regulating the economy is buying and selling Federal debt on the open market. This enables the Federal Reserve to control money supply. By buying Treasury debt on the open market the Fed increases money supply. The prior holders of the Treasury debt purchased by the Fed now have cash. By selling Treasury debt on the open market the Fed decreases money supply., The Fed now has the cash which the buyers held and that cash is no longer part of money supply.

Why Does This Thing Move Around So Much?

Bond prices go up only for one reason: because there are more buyers than sellers. Similarly, they go down because there are more sellers than buyers. But, every day, thousands of people need to explain why the imbalance is occurring. Since the bonds have a fixed coupon rate, their value moves significantly according to the perception of inflation. If there were no inflation at all, the value of a 30 year term 6.625% bond backed by the United States Treasury department would be very large. If inflation is, say, 5% the value would be much smaller. Thus, every little bit of economic news is analyzed to see how it affects the overall picture of what inflation is and what it is going to be. The sick thing about this is that we folks who are hoping for lower interest rates are like the undertaker in one of those Clint Eastwood Westerns. When bad news comes to town our business picks up. Conversely, good economic news is bad news for rates. On March 8, 1996 the Bureau of Labor Statistics announced that non-farm payrolls were up 705,000. The price of the 30 year bond fell more that 3 points and interest rates went up 0.25%.

Bond prices have, in recent years, proved to be quite volatile compared to 20 years ago.

So What?

The problem with the volatility of the 30 year bond is that it is the basis for all other interest rates. The interest rate on a 30 year, fixed rate conforming loan is going to be around 1.125-1.5% higher than the bond yield. When the bond yield goes up the yield on Mortgage Backed Securities goes up and fixed rates go up.

The Yield Curve

Almost always longer maturities provide higher yields. The "shape" of the yield curve is always changing. At a time when there is a small difference between the yield of 10 year and 30 year issues it makes no sense to incur the greater price risk of the long issue for a tiny increase in yield. Sometimes the longer issue yields enough more than the intermediate term issue that it may justify the increased price risk that goes along with it. Sometimes, the yield curve itself reveals potential risk. When it is "inverted" (when short term yields are actually higher than long term)it is telling you that the "market" expects a decrease in rates. When steeply positive (yielding much more in the long end than in the short end) it is telling you that the market expects rising rates in the future. Recessions are almost always preceded by an inverted, or at least flat, yield curve.

At times when the Federal Reserve is moving the Fed Funds rate up or down the effect will be seen more on the shorter duration Treasuries than on the long end. Practically speaking, the Fed controls the short end but the market controls the long end.

Rate Watch #896 Manufacturing Jobs and Income Inequality

September 13, 2013

by Dick Lepre  

[email protected]
www.loanmine.com

 

You can now follow my daily posts on the economy on Twitter @dicklepre

 

Manufacturing Jobs

A topic of discussion lately has been income inequality. The United States has aspired to be a country with a well-off middle class. Something has gone wrong. What has happened is that jobs are migrating away from the center. High-paying and low-paying jobs have increased in numbers while middle class jobs, based to a significant part on manufacturing, have decreased. The effect is that people who in the past may have gotten a manufacturing job may now be working at McDonald's or Wal-Mart. One response has been to mandate a higher minimum wage with the thought that this would somehow improve the economy.

I do not believe that paying people who work at McDonalds or Wal-Mart $2 more an hour is the best solution. I think that we need to take an overview of jobs and especially manufacturing jobs.

From 2010-2012 there was an increase in manufacturing jobs. That increase has stalled in the past year.

The idea offered here is that a way to restore income equality and increase the health of the U.S. economy in general is to significantly increase U.S. manufacturing jobs.

A manufacturing job is a job with a manufacturing company. If you are a bookkeeper, a janitor or an IT person for a manufacturing company then your job is defined as a manufacturing job. Manufacturing industries and jobs are defined by the North American Industry Classification System (NAICS) a standard used by Federal statistical agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy.

Manufacturing jobs are important because they have a large jobs multiplier. According to Paul Jacobs, chairman and CEO of Qualcomm each new manufacturing job creates an additional 4.6 support jobs. In high-tech manufacturing this multiplier is as high as 16.

Domestic manufacturing jobs now are much more tech-based than those of, say, 1960 or even 1980. In 2012 94,000 people working in the steelmaking industry produced 14% more steel than nearly 400,000 workers did in 1980. As manufacturing jobs have become tech-based it has become evident that there is an underlying failure of our society and our education system. We simply are not educating enough engineers or other people with tech skills to perform these jobs. Only 7.1% of Bachelor's Degrees in the U.S go to engineering majors. Internationally the number is 18.4%. A remarkable thing about the state of education is that the cost has increased dramatically at a time when one of the desired results of an education - getting a good job - has become less frequent.

Here it is important to note that the same rules may not apply to the demand for items manufactured domestically and to items imported. Domestic items may, in the future, be driven by limits to demand. People are less likely to purchase a new tech-intense item if it is not a considerable improvement on what they have presently. The same this is not necessarily true of imported items. Women's shoes are an obvious example. There needs to be a significant enough increase in the perceived value of, say, a new smartphone compared to what the potential buyer already has to warrant purchase of a tech device. In a sense the question is this: do I replace my smartphone every 2 years or every 10 years?

For lower tech, imported items the cost of labor is still important. The difference in labor cost between China and the U.S. is not nearly as large as it once was. More importantly, labor in the U.S. is more productive at least for higher-end goods. High-end goods need skilled workers, precision assembly, and sophisticated technology. This makes American workers about three times more productive (GDP/hour) than Chinese workers.

From WSJ of 8/29/2013: "We are on a long-term adjustment, as China, in particular, but all developing countries, get their wages closer to ours," said Richard Freeman, an economist at Harvard University. According to Boston Consulting Group, there will be only a roughly 10% cost difference between the U.S. and China in making products such as machinery, furniture and plastics by 2015."

There are other issues as well. As the dollar gains strength, exports become more expensive and less manufactured goods will be exported meaning fewer jobs. The Fed's low interest rates are keeping low the cost of capital which helps create manufacturing jobs here.

The difference between the domestic manufacturing jobs of the past and those of the future is likely to be that the manufacturing jobs of the future may be more diffuse. More people will not be making cars, tires and steel but instead making goods which perhaps do not yet exist. The somewhat unnerving problem is that we are not sure exactly what the manufacturing jobs of the future will be manufacturing.

The manufacturing jobs of the future will require a much different skill set than the manufacturing jobs of the past. Less muscle will be required, but more jobs will require computer skills. One thing this will likely mean is a larger percentage of women in manufacturing in the future.

The Unites States will probably never be able to be cost competitive with Asian nations when it comes to non-tech, labor intensive products such as clothing. The United States should be able to compete by manufacturing innovative products. I think that there are a couple of problems we have here. One is that the financial service industry (banking) has perversely taken a dislike for manufacturing because it simply does not like the risks and instead has sought profits from things such as high-frequency trading and derivatives. Banks need to reconnect with manufacturing. The government needs to expedite manufacturing by recognizing that if regulations delay the construction of plants here, then they will be built elsewhere and the jobs will be elsewhere.

The Manufacturing Institute says:

- 82% of manufacturers report a moderate or serious shortage in skilled production workers.

- 75% of manufacturers say the skill shortage has negatively impacted their ability to expand.

- 600,000 jobs in manufacturing are unfilled today because employers can't find workers with the right skills.

Apart from manufacturing there has been a decline in middle class jobs in teaching and construction. Teaching jobs are declining because the birth rate slowed and consequently there are fewer kids to teach. Construction jobs plummeted because bad policies encouraged overbuilding of homes before the Great Recession. Home building is still at about two-thirds of its natural level.

Another point is that manufacturing can be growing without creating more manufacturing jobs. It can do this simply by becoming more efficient. In this sense, technical improvements in manufacturing are more likely to result in higher worker productivity (GDP/hour worked) than in the creation of more jobs.

Workers today produce twice as much manufacturing output as their counterparts did in the early 1990s, and three times as much as in the early 1980s, thanks to innovation and advances in technology that have made today's workers the most productive in history.

We need to do three things to help manufacturing jobs: 1) better educate people for these jobs 2) reconnect the banking and investment banking systems with manufacturers and 3) minimize job-preventing government regulation. These three things will not, on their own, restore manufacturing jobs. New manufacturing jobs will be created by entrepreneurs with new ideas and the support of these three things.

 

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Dick Lepre

[email protected]
Web site: www.loanmine.com
Blog: economy.typepad.com
Phone: (415) 244-9383 | Fax: (866) 488-2051
116 Battery, San Francisco, CA 94111
CA DRE # 01143973 | NMLS # 302379
California Department of Real Estate - Real Estate Broker License #01818035, NMLS #9472. Equal Housing Opportunity.

Another Weak Jobs Report

Rate Watch #895 Another Very Weak BLS Jobs Report

September 6, 2013

by Dick Lepre  

[email protected]
www.loanmine.com

 

 Inside the BLS Employment Situation Report

This is my monthly look inside the BLS Employment Situation Report. There are two BLS Surveys: the Establishment and the Household. Establishment surveys about 141,000 businesses and government agencies, representing approximately 486,000 individual worksites. It is taken each month during the week which includes the 12th of the month. Household is a survey of 60,000 households taken each month during the week which includes the 12th of the month.

Each item below is suffixed with (H) if it is from the Household Survey, (E) if it is from the Establishment Survey, and (B) if it is from both.

- Nominal Nonfarm jobs was +169,000. (E). The two previous months' gains were revised to +104,000 (June) and +172,000 (May). Those had been +162,000 (July) and +188,000 (June.) That is a loss (for July and June) of -74,000 from the previous report making the net gain of 95,000 in jobs since the last report.

- the size of the civilian noninstitutional adult population increased by 203,000 in August to 245,959,000 (H). With a labor participation rate of 63.2% 203,000 more jobs were necessary to keep pace with population growth. We had 108,000 fewer jobs added than that including the changes from April and March. (H) The Employment/Population ratio fell to 58.6%.

The Labor Participation Rate fell from 63.4% to 63.2%. It was 63.5% a year ago.

The civilian noninstitutional population is 2,393,000 (H) more than 12 months ago. With a labor participation rate of 63.2% we require 1,512,000 more jobs in the past 12 months to keep pace with population growth. We had 2,006,000 (H) more folks working. The increase in real (population adjusted) jobs in the past year is 387,000.

- Real (population adjusted) job growth in August was -108,000. This accounts for the changes for June and July.

- the Unemployment Rate was 7.278% down from 7.390% in July 2013(B).
- Average hourly earnings was $24.05 up from $24.00 in July 2013 (E)
- Average work week was 34.5 hours up from 34.4 hours July 2013 (E)
- Private jobs were +152,000. Government jobs were +17,000 (E)

-Good producing jobs were +18,000. The two previous months were revised to +6,000 and -14,000 (E)

-The size of the civilian labor force fell from 155,798,000 to 155,486,000 a decrease 312,000. (H) This drop in the Labor Force contributed to the fall in the Unemployment Rate.

-The labor participation rate (percent of adult noninstitutionalized population who are part of the labor force) was 63.2.% down from 63.4%. It was 63.7% a year ago. (H) This, not the unemployment rate, is the number which should get everyone's attention. It is this 63.2% of the adult noninstitutionalized population who get pay checks and contribute to GDP.

 

According to the 4 week moving average of Initial Jobless Claims, 1,314,000 people lost their jobs in the last 4 weeks. That normalizes to 1,423,500 lost jobs in a calendar month (there are about 13 4-week periods in a 12 month year.) This is down from the previous month's 1,423,500 jobs lost/month.

In August 2013 BLS measured 4 sets of people entering or leaving the jobs market:

- Job losers and persons who completed temporary jobs was 5,970,000 up 49,000 from previous month's Job Losers and down 965,000 from August 2012. (H)

- Job leavers was 893,000. This includes anyone who retired or voluntarily left working. This down 86,000 from previous month and down 63,000 from August 2012. (H)

-Reentrants was 3,129,000. Reentrants are previously employed people who were looking for a job and found one. This was -129,000 from the previous month and -187,000 from August 2012.(H)

-New entrants were 1,299,000. These are people who never worked before and who are entering the labor force for the first time. This was +31,000 from previous month and -45,000 from August 2012.

One line in the BLS Report is termed "people employed part-time for economic reasons." These are people who want to work full time but their employer, for whatever reason, decide to employ them only part-time. In this month's report there were 334,000 fewer people working part-time. This may be the most positive part of the report. Transition from part-time to full-time is a positive for the economy

The presentation of the total change in jobs is like looking at the final score of a game. The details tell the story:

- 169,000 more people are working.

- 312,000 fewer people are in the civilian labor force

The unemployment rate decreased 0.112%. We are +387,000 real (population adjusted) jobs for the past 12 months. This is not what a recovery looks like. Cheering that the Unemployment rate dropped to the lowest level in 5 years only because folks have given up looking for jobs and are technically no longer unemployed is just plain dumb.

There has been a significant change in the jobs market. Many jobs including manufacturing jobs require technical skills and a college degree. The very large increases in the cost of college education are making education less affordable as it becomes more necessary. The people graduating from college do not have the right skills for the tech-oriented jobs which are out there. We are producing (to oversimplify) too few engineers. The jobs being added are low paying jobs. Some of the problem is with our education system. It has gotten much more expensive while the value (in terms of ability to get a decent job) has decreased.

 

 

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Dick Lepre

[email protected]
Web site: www.loanmine.com
Blog: economy.typepad.com
Phone: (415) 244-9383 | Fax: (866) 488-2051
1160 Battery Street, San Francisco, CA 94111
CA BRE # 01143973 | NMLS # 302379
California Bureau of Real Estate - Real Estate Broker License #01818035, NMLS #9472. Equal Housing Opportunity.