Economic Terminology Helps Us Understand Mortgage Rate Movements
Effect Of Economic Indicators On Fixed Income Investments (Bonds)
Investors such as bond and equity market participants look to U.S. Government economic reports as an indication of the economy’s strength and general direction. Overall, economic indicators reflect the rate of economic growth and inflation which, in turn, affects interest rates.
There is an inverse relationship between mortgage interest rates and bond prices. If the economic indicators indicate that the rate of inflation is on the rise, investors sell their bonds. It will likely result in lower bond prices and higher interest rates. Conversely, if these indicators indicate the rate of inflation is falling this will result in higher bond prices and therefore, lower interest rates. The following defines what these indicators are and how they might affect the bond market.
Business Inventories And Sales
These figures measure the inventories and sales of manufacturing, wholesalers and retail establishments. These figures are released monthly by the Bureau of Census. Its purpose is “to provide broad and timely measures of combined changes in domestic retail trade, wholesale trade and manufacturers’ activities.” In most cases, an increase in these numbers indicates an expanding economy which could be inflationary. Bond prices move down in price, rates up.
The capacity utilization rate measures the percent of industrial output currently in use. A change in the rate indicates a change in the direction of economic activity. As the percentage rate moves closer to 90% the industrial output is practically at full capacity and is considered inflationary. A number closer to 70% is recessionary. A higher percentage indicates a stronger manufacturing sector and an expanding economy which can be inflationary. Bond prices move down in price.
Consumer Price Index (CPI)
The consumer price index is an indicator of the general level of prices. Components include energy, food and beverages, housing, apparel, transportation, medical care, and entertainment. When the consumer price index goes up, it is a sign of an inflationary environment. Consumers have to pay more (our devalued dollars buy less) for the same amount of goods and services. Bond prices move down in price.
Durable Goods Orders
This gives a reading on the country’s future manufacturing activity. Durable goods include those manufactured items with a normal life expectancy of three years or longer. An increase in the amount of durable goods orders may indicate an expansion in the economy and, if inflationary, the Federal Reserve may choose to tighten monetary policy by raising interest rates.
Manufacturer’s shipments, inventories, and orders. Factory orders include shipments, inventories, and new and unfilled orders. An increase in the factory order total may indicate an expansion in the economy and could be an inflationary factor. Bond market prices are lower.
FED Is Easing
Exactly the opposite of Fed tightening. The Federal Reserve feels that the economy is not growing at the desired level and eases credit conditions by lowering interest rates to help stimulate the economy. Bond prices move up in price in anticipation of Fed move.
FED Is Tightening
This term refers to efforts by the Federal Reserve to curb excessive growth in the money supply. This can be accomplished by raising the discount rate and/or increasing the federal funds rate. Fed follows bond market move down in price.
Gross National Product (GNP)
The Gross National Product is the broadest measure of the nation’s production. It measures the market value of all the goods and services newly produced in one year by labor and property in the United States. When GNP is down, it shows a slowing down in the economy. To counteract this, the Federal Reserve may loosen money by lowering interest rates. Bond Market Moves Up In Price.
Industrial Production Index
The industrial production index measures the monthly level of the physical output of the manufacturing, mining, and gas and electric utility industries. When industrial production is down, it indicates a slowing of economic growth and, therefore, the Federal Reserve is inclined to allow interest rates to drop to stimulate the economy. Bond Market Moves Up In Price.
Leading Economic Indicators
This index is a composite of 10 (used to be 11) statistics designed to foretell economic activity 6 to 9 months hence, (i.e. building permits, new orders for consumer goods and materials, the average workweek, index of consumer expectations). This is not compiled by the U.S. Government, but rather by the Conference Board, a global, independent business membership and research association.
Merchandise Trade Balance
Released monthly, this figure measures the difference between imports and exports. When exports are higher than imports, there is a surplus in the balance of trade. When imports are higher than exports, there is a deficit. The import-export differential is referred to as the trade gap.
The amount of money in circulation. M1 = cash + regular demand deposits + other check-type deposits. M2 = M1 + savings and small denomination time-deposits. When the money supply figure is up, it is an inflationary factor and, therefore, generates concern that the Federal Reserve, a privately owned central bank will tighten money growth by allowing short-term interest rates to rise.
The non-farm payroll figure is a component of total civilian employment and measures the number of people employed in all activities except agriculture.
Producer Price Index (PPI)
The monthly producer price index measures the level of prices for all goods produced and imported for sale in the primary marketplace. Increase in the PPI tends to lead other measures of inflation.
Key components of retail sales include automobiles, building materials, furniture, department store sales, food stores, gasoline, clothing, restaurants and drugstores. High retail sales are an indication of economic growth and an expanding economy.
This is the percent of the civilian labor force currently unemployed. If unemployment figures are up, it indicates a lack of expansion within the economy and is, therefore, good for the bond market. Conversely, a big gain in employment would be an obvious cue for the Federal Reserve to tighten (raise) either the federal funds rate or the discount rate.