As crude oil crossed $80 a barrel Thursday, the Wall Street Journal ran an interactive poll with its readers.

What sustained price for gasoline would cause you to cut back on other household spending?

The graph above shows the on-going results of the non-scientific study.  You can chime in, too, at http://forums.wsj.com/viewtopic.php?t=805.

As consumers cut back spending, the economy slows down which generally leads to lower mortgage rates and weaker housing markets as a result of job losses.  According to GasBuddy.com, some areas of San Francisco are already topping $3.50/gallon.

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Headlines today read that the value of gold is nearing its all-time high (adjusted for inflation).  The lay people would ignore this story, but those in the know understand that the price of gold is usually reflective of the state of the global economy.

The spot price of gold tells a lot about investor psyche and it is up nearly 10 percent from its 30-day low. 

As a “safe haven” investment, gold’s value tends to increase when an economic recession is expected.  That’s because gold tends to hold its value during a recession; its value is tied to the global economy and not that of any one country.

In the chart above from Kitco, the path of gold’s price appears to mirror the path of market expectations for the Fed’s meeting next week.  As the likelihood of a Fed Funds Rate cut increases, so does gold’s relative value in U.S. dollars.

As gold reaches new highs, it’s predicting somewhat of an economic recession.

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Mortgage rates “come from” one place only: the prices of mortgage bonds as determined by investors. 

The higher the price, the lower the corresponding return, or rate.

Bonds — like stocks — are traded as securities.  An investor may buy Microsoft stock if he thought the company’s future looked bright, and he may buy mortgage bonds if he expected favorable bond market conditions ahead.

In a declining economy, bonds can be an especially attractive investment because they offer a fixed rate of return to an investor.  As more buyers line up to buy, of course, the price of bonds goes up.

Again, higher price = lower rate.

So, because Friday brought us a surprisingly weak job report, investors have increased their exposure to mortgage bonds, pushing prices higher and, therefore, pushing mortgage rates down. 

Now, all of this is happening in advance of the Federal Reserve’s meeting September 18 and that’s important to recognize.

Mortgage rates, in effect, have dropped  because of the market’s expectation of what the Fed will do next week — not because of something that it has done already.  Markets expect that the Fed will lower the Fed Funds Rate, thus signaling that the economy is in decline.

Therefore, if the Fed’s actions meet the market’s expectations Tuesday, mortgage rates shouldn’t move even a hair — that “future scenario” has already been priced in.  If the Fed fails to meet expectations — on the high-side or the low-side — mortgage rates will change.

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Line 901 of a mortgage settlement statement is commonly confused for a closing cost.  It’s actually an “advance payment” on the mortgage.

Often called a per diem by mortgage professionals, line 901 itemizes a borrower’s prepaid mortgage interest charges due at closing.  The total amount due equals the daily rate of interest multiplied by the number of days remaining in the month.

If a mortgage funds on September 28, for example, the per diem would be 3 days.

One reason why per diem is due at closing is because mortgage interest is billed in arrears.  That means that on the first of every month, the mortgage interest that accrued in the month prior is due. 

Now, in the scenario above in which the closing is set for the last Friday of the month, it is highly unlikely that a mortgage lender would receive the loan documents from closing, process them through quality control, and then get a statement to the new borrower in time for the borrower to make his mortgage payment Monday morning.

Even with a 15-day grace period, it’s a challenge.

So, to keep life simple, lenders collect all of the interest that would normally accrue up to the date of first payment at the time of closing.  Then, when the 1st of the month arrives, there is no payment due — it was already paid at the time of closing.

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Weak employment data pushed mortgage rates lower last week.  Against expectations of 110,000 new jobs created in August, last Friday’s Non-Farm Payrolls report showed a loss of 4,000 jobs.

The story made headlines all over the country this weekend but its connection to mortgage rates is not always clear.  Here’s how the jobs report relates to mortgage rates:

1. An employed person earns an income
2. An employed person spends money on goods and services

When more people are employed, more U.S. dollars are circulated inside the U.S. economy.  It’s widely believed that two-thirds of the economy is the result of consumer spending, in fact.

So, because the economy showed job losses, market participants are predicting that the economy will start to slow down as fewer dollars are spent.  Fewer workers, in other words, equals slower growth.

Now, when the economy is growing quickly, the dollar is a risky investment because its purchasing power can weaken dramatically.  This contrasts with when the economy is slowing down, when the risk of devaluation (i.e. inflation) subsides. 

A less-risky dollar renders mortgage bonds more attractive for foreign investors because bonds are denominated in U.S. Dollars.  More demand for bonds leads to lower rates. 

And that’s the connection — fewer workers means slower growth means less risky dollars means more demand for mortgage bonds means lower mortgage rates.

This week, we’ll get to see if consumer spending habits are changing yet.  Friday, the Department of Commerce will release August’s Retail Sales report.  It’s expected to show a 0.3% increase over July.

(Image Courtesy: The Wall Street Journal Online)

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This morning, the government reported that the U.S. economy lost 4,000 jobs in August.  Led by losses in manufacturing and in construction, this is the first time since 2003 that the economy has failed to add jobs in any given month.

Markets had been expecting a job gain of roughly 110,000, but many players on Wall Street had been placing their bets to the weak side of that figure. 

Very few (if any) expected a number this weak, however.

The implication of a weak jobs report is that many now believe that the Fed has an economic reason to lower the Fed Funds Rate at its next meeting.  This is different from a “bail out”-type reduction that economists and market participants have debated ad nauseam in the press.

Remember, a lower Fed Funds Rate doesn’t directly correlate to lower mortgage rates.  However, if the Fed acknowledges that the economy is slowing, that should help keep mortgage rates low.

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The Federal Open Market Committee meets September 18 and traders are aren’t quite sure what to expect with respect to the Fed Funds Rate. 

Will the FFR stay unchanged?  Will it FFR decrease?  If it decreases, by how much?  These are questions that are perplexing market participants. 

Luckily, we can measure how the market is betting on the future by looking at the options trading in Fed Funds Futures.

As of September 5, 2007, an analysis of Fed Funds Futures option pricing leads to the following predictions:

• 5.250%: 12 percent chance
• 5.000%: 28 percent chance
• 4.750%: 42 percent chance
• 4.500%: 10 percent chance
• 4.250%: 8 percent chance

The market is overwhelmingly expecting a drop in the FFR — it just doesn’t know by how much.

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Yesterday was a rather drab day in mortgage circles — not much happened and mortgage rates idled.  The bigger story was how liquidity appears to be slowly returning to some areas of the beaten-down mortgage market.

Specifically, liquidity is returning to prime, fixed-rate, full documentation jumbo loans and pricing appears to be improving (slightly).

The “prime” designation loosely correlates to a salaried employee with a credit score of at least 720.  This class of borrower is a much lower risk than a sub-prime borrower who is generally categorized as having a credit score below 620.

The higher a homeowner’s credit score, the more likely he is to make on-time mortgage payments.

Jumbo loans differ from Fannie Mae/Freddie Mac conforming loans based on the amount borrowed.  Jumbo loans meet the following loan size criteria:

• Home, condo or townhome: Over $417,000
• 2-unit: Over $533,850
• 3-unit: Over $645,300
• 4-unit: Over $801,950

As more investors express a willingness to buy jumbo mortgage bonds, we can expect jumbo mortgage interest rates to improve, and we’ll maybe even see that improvement spill-over into other product types — including sub-prime loans.

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Federal Reserve Chairman Ben Bernanke took the pulpit Friday in Jackson Hole but his remarks made little impact on mortgage bond trading. 

The Fed is aware of economic issues related to housing and mortgage debt, Bernanke said. 

He implied that the Fed wants more evidence that inflation has slowed before taking more drastic measures to help the economy, including reducing the Fed Funds Rate.

Friday morning, the Fed’s preferred inflation gauge — Personal Consumptions and Expenditure — showed modest year-over-year growth of 1.9%, within the Fed’s stated tolerance range.

In this holiday-shortened week, the big data point comes Friday in the form of the Non-Farm Payrolls report. 

August is expected to have added 120,000 jobs to the economy after last month’s 92,000 increase.  The Unemployment Rate bears watching, too, however. 

The Christian Science Monitor estimates that 21,000 housing-related job cuts took place last month and layoffs may have also impacted other industries.  Job losses can impact the economy as much as job gains.

When Americans are working, they earn income.  When they earn income, they spend.  Of course, fewer workers means lower levels of consumer spending — that can trigger an economic slowdown.

A slowly growing economy is generally good for mortgage rates because the dollar retains its value (i.e. no inflation).  Therefore, if jobs created is lower than expected, or if the unemployment rate increases, mortgage rates should fall Friday because growth will be expected to slow.

(Image courtesy: Wall Street Journal Online)

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