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Elliott Waves Say Mortgage Rates Headed Higher

Editor's Note: This article originally appeared in Jason Farkas' February 5 Weekly Insight column of EWI's intensive Currency and Interest Rate Specialty Service

Even though the Federal Reserve purchased 80% of the Treasury securities issued in 2009, it could not manage to lower long-term rates. But the Fed can “claim victory” on its other bond-purchase program,  the mortgage-backed security (MBS) program that buys debt issued by government-sponsored enterprises (NYSE:GSE), such as Fannie Mae, Freddie Mac and Ginnie Mae. Mortgage rates indeed have fallen slightly since the Treasury and Fed announced their artificial support in September and November 2008. However, they had better hurry up and claim victory, because as we will show, mortgage rates now appear to be headed higher.
The Fed and Treasury will have combined to purchase close to 15% of the outstanding MBS by the time they are finished in March 2010. The Fed is 92% complete with its purchases of $1.25T, while the Treasury stopped buying in December 2009 after purchasing $220B. But these government actions don’t control the market, as we have repeatedly pointed out. Mortgage rates simply needed one more low beneath their early 2009 low to complete a larger Elliott wave pattern. Now that the new low is in place, mortgage rates should head higher, regardless of further government meddling.
The chart (courtesy shows the history of the most popular mortgage product, the 30-year fixed rate mortgage. Here are the Elliott details:
1.    A downward zigzag pattern began in 1981 when rates were at 18.63%.
2.    Five waves down completed wave (NYSE:A) in 1993.
3.    Five waves down completed wave (NYSE:C) at 4.71% in December.
4.    Within wave 5 of (C), five waves down are now visible.
5.    Now that the zigzag is complete, a rally up to the 8.64-65 resistance area is the minimum that should develop.
So, an important bottom is in place for the 30-year rate. As rates head higher, there’s little doubt that the Fed or the Treasury will announce another round of MBS purchases in an attempt to force rates back down. But as social mood turns negative once again, we believe that the losses on the GSEs' portfolios will curtail any public enthusiasm for further support.
As losses mount and support for the GSEs decreases, expect the government to announce “new and improved” ways to finance mortgages. The survival of companies such as Fannie Mae will again become front-page news.
Rising mortgage rates, falling home prices, defaults and the depression will squelch the U.S. government’s attempts to solve the real estate crisis. In fact, there are so many government hands in the real estate cookie jar that this industry may be stuck in a downtrend for years after the overall economy bottoms. Remember - the creation of the GSEs was supposed to make housing more affordable, and yet they were a major reason homes became too expensive. As Robert Prechter commented in Conquer the Crash, “It is a principle that meddling in the free market can only disable it.” We couldn’t agree more.

Jason S. Farkas, CMT

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