By Ryan Casey Stephens, FPQP®
Special Contributor
Navigating Economic Headwinds: Understanding Today’s Shifting Landscape and Evolving Mortgage Rules
Have you recently observed a noticeable shift in the economic landscape around you? Perhaps you’ve seen a neighbor’s meticulously maintained home lingering on the market for longer than expected, eventually leading to a price reduction. Or perhaps you’ve been in the market for a used car, only to find prices steadily declining week after week. Across the board, credit interest rates have seen a sharp increase, impacting everything from personal loans to mortgages. It’s clear that the gears of our robust economy are encountering resistance, almost as if stuck in the mud. This period presents a complex dynamic, a double-edged sword: the immediate discomfort we experience may, in the long run, contribute to a more stable financial future. However, the full extent of this outcome remains to be seen.
To help make sense of these evolving conditions, let’s dedicate some time to unpack the critical details in this week’s Three Things to Know.
The Persistent Shadow of Inflation: Decoding PCE and Its Market Impact
As the renowned author Mark Twain once quipped, “If you have to eat a frog, do it in the morning and nothing worse will happen to you for the rest of the day.” Addressing the topic of inflation each week isn’t my favorite task, but the ongoing devaluation of our currency stands as a significant threat to our economic stability for the foreseeable future. Understanding its nuances is paramount. This Friday, we eagerly await the release of the latest Personal Consumption Expenditures, or PCE, inflation data. This particular metric holds special significance as it is the Federal Reserve’s preferred measure of inflation, guiding their crucial policy decisions.
The PCE index is favored by the Fed over the more commonly cited Consumer Price Index (CPI) because it offers a broader measure of consumer spending and accounts for changes in consumer behavior, such as substituting cheaper goods or services when prices rise. It also often smooths out some of the volatility present in the CPI by excluding highly fluctuating food and energy prices in its ‘core PCE’ variant, providing a clearer picture of underlying inflationary trends. As the Federal Reserve prepares for its meeting next week to discuss another potential rate hike, this data will be scrutinized intensely. Current projections suggest we might see a slight increase in inflation on a month-over-month basis. However, the more crucial year-over-year number is anticipated to show a decline, signaling a potential moderation of price pressures compared to the previous year. This subtle distinction between short-term fluctuations and longer-term trends is vital for interpreting the report’s true impact.
First Thing to Know:
Unless the Personal Consumption Expenditures (PCE) report delivers an unexpectedly high reading, its immediate impact on financial markets should be minimal. However, a PCE inflation figure significantly higher than anticipated could trigger market panic, potentially leading to an adverse effect on mortgage rates.
Economic Cooling: Unpacking the Slowdown and Its Potential Benefits
With each passing day, it becomes increasingly evident that 2023 is shaping up to be a year characterized by significantly subdued economic growth. The specter of a recession, which many economists have been forecasting since last summer, now appears to be edging closer to reality. A series of key economic reports released this week are expected to further reinforce these expectations, painting a clearer picture of the decelerating economy.
From the Fed manufacturing index released earlier in the week to the highly anticipated GDP report due on Thursday, and culminating with Friday’s comprehensive personal income and personal spending numbers, the overarching consensus among economists and analysts points toward a period of reduced economic activity. This slowdown is manifesting as less production from factories, lower overall output across various industries, and a notable decrease in consumer purchases. While these numbers might initially appear bleak, they represent a necessary phase in the economic cycle, serving as a direct response to the Federal Reserve’s aggressive actions to combat persistent inflation.
Far from being solely a cause for concern, a slowing economy plays a crucial role in the fight against inflation in the U.S. By moderating demand, a cooler economic environment helps to recalibrate the imbalances between supply and demand that have driven prices upward. This period of adjustment allows supply chains to recover and production to align more closely with consumer needs, ultimately reducing inflationary pressures. Historically, such periods of economic cooling have often preceded a stabilization or even a decline in interest rates. Therefore, this strategic deceleration can provide us with a much-needed chance to stabilize the market, which should eventually pave the way for lower mortgage rates, potentially returning as early as this summer. This long-term perspective suggests that short-term pain is a precursor to future market health.
Second Thing to Know:
Despite initial concerns, a slowing economy is a critical tool in combating inflation within the U.S. This period of deceleration provides a vital opportunity to recalibrate supply and demand dynamics, which is expected to lead to the return of lower mortgage rates, potentially as early as the summer months.
Navigating the New Landscape: Consumer Debt, Risk Mitigation, and Evolving Mortgage Standards
As the economic climate continues to shift, real estate agents and lenders alike must proactively prepare for a unique set of challenges when buyers gradually begin to re-enter the market later this year. The financial health of American households has seen significant changes, which are now directly influencing the mortgage landscape. A striking example of this trend is the average American car payment, which has reached a record-high of $800 per month. This substantial financial commitment, combined with other rising costs, is placing immense pressure on household budgets. Reflecting this strain, past-due car loans have surged by an alarming 27 percent so far this year, indicating a growing difficulty for many consumers to meet their financial obligations. Furthermore, credit card debt has climbed by 15 percent, marking the largest jump since the 2008 financial crisis, and underscoring a concerning reliance on credit: one-third of Americans are now utilizing credit cards to cover essential daily expenses, signaling a precarious financial situation for a significant portion of the population.
In response to this dramatic increase in consumer leverage and the heightened risk associated with it, major players in the mortgage market, Fannie Mae and Freddie Mac, are taking decisive action. These government-sponsored enterprises (GSEs), which play a pivotal role in providing liquidity and stability to the U.S. housing market by purchasing mortgages from lenders, have begun announcing new fees and closing costs for certain categories of buyers. These measures are designed to mitigate the increased risk they perceive in the current economic environment. A significant change, taking effect in May, is that a borrower’s debt-to-income ratio (DTI) will directly affect pricing, a factor that was not explicitly considered in this manner before. The DTI ratio, which compares a borrower’s monthly debt payments to their gross monthly income, is a key indicator of their ability to manage additional debt. By linking DTI to pricing, Fannie and Freddie are effectively charging more to borrowers who carry a higher debt load relative to their income, reflecting an increased risk assessment.
Beyond DTI, other notable cost increases are being applied to various mortgage products and strategies. This includes anyone seeking to use a second mortgage, often referred to as a ‘piggyback loan,’ which is frequently used to help cover down payments or to avoid paying Private Mortgage Insurance (PMI). These types of loans, which add a layer of complexity and perceived risk to the overall lending picture, are now subject to additional fees. Similarly, individuals seeking a cash-out refinance – a transaction where homeowners convert a portion of their home equity into cash – will also face increased costs. This reflects the GSEs’ cautious approach to transactions that could potentially over-leverage homeowners in an uncertain economic climate. These adjustments signal a broader tightening of lending standards and a more conservative approach to risk management across the mortgage industry, ultimately impacting the affordability and accessibility of homeownership and refinancing options for many Americans.
Third Thing to Know:
Fannie Mae and Freddie Mac continuously analyze market conditions to mitigate risk effectively. Given the dramatic increase in Americans using various forms of debt to navigate challenging economic times, these entities are proactively implementing measures to curtail individuals seeking mortgages through avenues perceived as unconventional or higher-risk.
Ryan Casey Stephens FPQP® is a mortgage banker with Watermark Capital. You can reach him at [email protected].