Market Recap - Week Ending August 13, 2010

Tuesday's highly anticipated Fed meeting resulted in a policy change which was slightly positive for mortgage rates. This, along with downgrades to economic growth forecasts and continued low inflation, helped mortgage rates move a little lower again this week.

As expected, the Fed made no change to the fed funds rate and left the "extended period" language in place. The Fed also downgraded its economic outlook, saying that the pace of the recovery is likely to be "more modest in the near term than had been anticipated." In light of this, the Fed has implemented a new policy to purchase additional securities to replace maturing securities from its portfolio, instead of letting its balance sheet shrink. This action will provide a small amount of monetary stimulus to the economy. Even though the Fed will purchase Treasuries rather than mortgage-backed securities (MBS), higher Fed demand for bonds in general supports low mortgage rates.

This month's most closely watched inflation report showed that inflation is not a concern right now. In fact, some Fed officials and investors are worried that inflation will fall too low. The July Consumer Price Index (CPI) rose 0.3% from June, and increased at a 1.2% annual rate. Core CPI, which excludes food and energy, rose at a slim 0.9% annual rate. The Fed is believed to be most comfortable when core inflation is rising at a rate between 1.5% and 2.0% per year. Low inflation is favorable for mortgage rates.

Next week, the Empire State manufacturing index will be released on Monday. Tuesday will be the big day with Housing Starts, Industrial Production, and PPI. Industrial Production is an important indicator of economic growth. The Producer Price Index (PPI) focuses on the increase in prices of "intermediate" goods used by companies to produce finished products. Leading Indicators and the Philly Fed manufacturing index will be released on Thursday.

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