As the 2010 approaches, a mix of housing market factors are falling into place which could lead to a very nasty start to the New Year for the U.S. economy.
If predictions of soaring fixed mortgage rates come true and damper any nascent housing recovery, the United States could experience the double-dip recession many experts have warned is possible.
Morgan Stanley now predicts 10-year Treasury bond yields will jump more than 40 percent next year, while 30-year fixed mortgages may surge more than 50 percent.
The exploding budget deficit will do the damage, David Greenlaw, Morgan Stanley’s chief fixed income economist, told Bloomberg News.
“When you take these kinds of aggressive policy actions to prevent a depression, you have to clean up after yourself,” he said. “Market signals will ultimately spur some policy action, but I’m not naive enough to think it will be a very pleasant environment.”
The firm forecasts the 30-year fixed mortgage rate will hit 7.5 to 8 percent, the highest level in a decade and up from about 5.3 percent now. It also predicts the 10-year Treasury yield will reach 5.5 percent next year from about 3.85 percent now.
The budget deficit ballooned to $1.42 trillion in fiscal 2009 (ending Sept. 30).
Morgan Stanley sees the gap remaining above $1 trillion as the Obama administration and Congress attempt to revive the economy with spending.
Fearing a slowing housing recovery, the Treasury Department on Christmas Eve removed limits on how much money it will spend to keep mortgage giants Fannie Mae and Freddie Mac operating.
Instead of an existing $400 billion cap, the Treasury Department said it will increase financial support according to how much each company loses in a quarter.
A jump in mortgage rates could derail the nascent recovery in residential real estate, threatening the entire economic rebound as well.
The recovery itself has yielded mixed signals in the last week.
On Dec. 22, the National Association of Realtors said existing home sales rose 7.4 percent, their highest level in about three years. The next day, the Commerce Department said November’s sales of new homes unexpectedly fell 11.3 percent.
Meanwhile, Nobel laureate economist Paul Krugman says the economy may suffer another contraction next year. “It’s a reasonably high chance, (though) it’s less than 50-50 odds,” he recently told ABC News.
The economy grew 2.2 percent in the third quarter.
“What we’ve got right now is a recovery that first of all isn’t showing up very much in jobs yet. It’s being driven by fiscal stimulus, which is going to fade out in the second half of next year,” Krugman said.
“The things we know about are all going to be negative in the second half of next year.”
Financial markets, of course, suggest a different path as stocks have made new highs right into Christmas week.
“The financial markets in the last month have gotten really optimistic,” Krugman notes.
“You look at things like the term spread (yield curve) on bond rates. They suggest that the financial markets really think there is going to be a much more vigorous recovery.”
“I don’t see where it’s supposed to come from.”
Adding to the dire forecasts is Mohamed El-Erian, chief executive of giant bond manager Pimco.
He says the recovery may be gaining steam but is no different than a kid who eats too much candy.
“We're on a sugar high,” El-Erian says. “It feels good for a while but is unsustainable.”
He says the recent burst of economic activity fed by government spending and near-zero interest rates will soon peter out.
El-Erian says stocks will drop 10 percent in the space of three or four weeks, bringing the S&P 500 Index to below 1,000 — though he's not predicting when.
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