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University of Michigan Consumer Confidence hits post-bubble highs

Consumer SentimentEnlarge GraphThe Thomson Reuters/University of Michigan Consumer Confidence Index is a leading indicator for the U.S. economy

The Thomson Reuters/University of Michigan Consumer Confidence Index is an important indicator of the consumer’s perception of the U.S. economy. Similar to other consumer confidence measures, it asks consumers about their views on the current economic conditions, and their expectations for six months out. It is one of the oldest consumer surveys, originally started in 1964.

Consumption is the major driver of the U.S. economy and accounts for 70% of GDP. Consumption has been relatively subdued since the recession began as Americans have boosted their savings rate and spent only on essentials. The real estate bubble drove consumption in the mid ’00′s as people took out cash refinances and spent the extracted home equity. This had the effect of increasing the cost basis for many people’s homes and left them vulnerable when house prices collapsed. As a result, they have focused more on paying down debt than spending.

Highlights from the report

The Consumer Sentiment Index rose to 83.7 in April, up from 76.4 in March. (Consumer confidence in 1964 = 100). The Bloomberg survey consensus was 77.9. The Current Conditions Index rose to 97.5 from 89.9, and the Expectations Index rose to 74.8 from 67.8 last month. Given that an index value of 90 is more or less the average over the past 50 years, consumer confidence is still on the weak side. The index can vary widely – in January of 2000, it was 112 and in November of 2008, it bottomed at 55.3.

One theory that has been thrown out is that consumers are starting to pick up on the improvement in the real estate market and that is driving consumer confidence. As we have seen from the real estate indices, unless you live in San Francisco, Phoenix, Las Vegas, or a few other places, you haven’t really been experiencing a major increase in home prices. At any rate, it doesn’t look like consumer confidence is correlating much with Case-Schiller. If anything, consumer confidence tends to negatively correlate with gasoline prices.

Implications for mortgage REITs

The takeaway for mortgage REITs, like Annaly (NLY), American Capital (AGNC), Capstead Mortgage (CMO), Chimera (CIM), and Two Harbors (TWO), is that interest rates will remain low and the Fed will probably continue asset purchases (quantitative easing). This means that mortgage yields will be low, leverage will be required to generate a return on equity, borrowing costs will remain low and prepayment risk will remain a threat. Prepayment risk stems from the fact that a borrower can refinance their mortgage without penalty. So if interest rates drop, the mortgage investor will find their highest yielding mortgages paid off early and they will be forced to re-invest the money in lower yielding mortgages.

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