Publication date: 5 July 2006 | Covering: April – June 2006
Quarterly Briefing
- Fed final hike: June 29 (FRESH 6 days) 25bp hike brings fed funds rate to 5.25%; Bernanke signals pause; seventeen hikes in cycle from June 2004
- Emerging market selloff: May 2006 sharp correction; Brazil, Turkey, India, South Africa hardest hit; carry trades unwind; commodities correct; risk off
- Iran nuclear: UN Security Council resolutions escalating; Iran refuses enrichment suspension; US considers options; oil risk premium sustained
- US housing: Existing home sales beginning to decline; new home sales down; inventories rising; builders reporting softer conditions; correction becoming evident
- Oil: US$73–75 per barrel through quarter; geopolitical premium; Greenspan “froth” in housing; Bernanke inheriting complicated landscape
- World Cup 2006: Germany hosts; Italy wins (FRESH 5 days); economic boost for Germany; global event
- G8 St. Petersburg: Energy security and Middle East on agenda; Russia asserting energy leverage; commodity nationalism rising
- Jamaica: Active tourism season; NHT loan demand; BOJ interest rates at elevated levels; construction activity
Fed’s Final Hike; EM Selloff; Iran Tensions
The second quarter of 2006 concluded the most aggressive Federal Reserve tightening cycle in two decades. On 29 June, the FOMC raised the federal funds rate by 25 basis points to 5.25% — the seventeenth consecutive hike since June 2004, when rates had stood at 1%. Bernanke, who had inherited the chair from Greenspan in February, signalled that the committee would now assess the cumulative impact of the tightening cycle on economic activity and inflation, effectively indicating a pause was likely at the next meeting. The hiking cycle had been intended to normalise monetary policy from the post-2001 recession accommodation and to restrain what the Fed viewed as excess in housing markets — Greenspan had notably described a “froth” in some local housing markets in 2005. The secondary effects were playing out in global risk markets: May 2006 saw a significant emerging market selloff, as the prospect of higher US rates and a stronger dollar prompted unwinding of carry trades that had funded flows into higher-yielding EM assets. Brazil, Turkey, India, and South Africa saw sharp currency and equity market corrections before stabilising. Commodity markets also corrected in May, with gold and copper falling significantly from their earlier peaks. Iran’s nuclear programme remained a persistent source of geopolitical risk and oil price premium throughout the quarter, as the UN Security Council debated escalating measures and Iran refused enrichment suspension.
US Housing Turns; Subprime Risks Building
By the second quarter of 2006, the US housing market was clearly shifting from boom to correction. Existing home sales were declining, inventories of unsold homes were rising from the record-low levels of 2005, and homebuilders were reporting softening demand and increasing buyer incentive costs. The transition was gradual at first: prices in most markets had not yet fallen significantly, and the broader economy remained healthy. But the structural vulnerabilities in the US mortgage market were becoming more apparent: lending standards had progressively deteriorated through the boom years, with adjustable-rate mortgages with teaser rates, interest-only loans, and no-documentation “ninja” loans all widely available. As the Fed’s rate hikes fed through to higher adjustable mortgage reset rates, the debt service burden for millions of subprime borrowers would begin to rise — the reset shock that would produce the wave of defaults that defined 2007 and 2008.
Jamaica: Active Season; Mortgage Conditions
Jamaica’s economy benefited from a good summer tourism season in 2006, with airlift recovering and hotel investment continuing in the key resort areas of Montego Bay, Negril, and Ocho Rios. NHT loan demand remained active as the Fund continued its programmes at subsidised rates of 0%, 2%, and 4% on loans up to J$6.5 million individually or J$13 million for two-applicant borrowings. The Bank of Jamaica maintained domestic interest rates at levels that kept commercial mortgage costs high, continuing the wide differential between NHT’s subsidised rates and commercial alternatives that had characterised the Jamaican mortgage market for years. Oil at US$73–75 per barrel remained a significant drag on Jamaica’s external accounts, given the island’s near-total dependence on imported petroleum.
Looking Ahead to Q3 2006
The Fed’s pause at 5.25% will now allow assessment of the seventeen hikes’ cumulative impact. US housing is cooling but has not yet produced financial system stress. Oil remains elevated at geopolitical risk premium levels. For Jamaica, the hurricane season — still fresh in memory from the 2004 Ivan disaster — is the primary near-term risk, alongside sustained high oil import costs and the management of the government’s large debt stock.
Mortgage & Housing Finance Disclaimer: This publication is for general information only and does not constitute mortgage, financial, legal or investment advice. Mortgage products, lending criteria, interest rates and borrowing costs vary between lenders and may change without notice. Readers should obtain independent advice from a qualified mortgage adviser, financial adviser or legal professional before making financial or property decisions.
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