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Consumer confidence jumps in May

Consumer ConfidenceEnlarge GraphThe Conference Board Consumer Confidence Index is a leading indicator for the U.S. economy

The Conference Board Consumer Confidence Index (CCI) 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 as a mail-in survey in 1967. The respondents are asked whether the following conditions are positive, negative or neutral: current business conditions, current employment conditions, expected future business conditions, expected future employment conditions, and expectations for family income. The index is then the average of the five questions.

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 ’00s 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 Conference Board Consumer Confidence Index rose to 76.2, up from 69 in April (Consumer confidence in 1985 = 100). While the present situation index rose to 66.7 from 61, the Expectations Index spiked to 82.4 from 74.3 last month. Given that 1985 is more or less par, consumer confidence is still on the weak side. The index can vary widely – in May of 2000, it was 144.7 and in February of 2009, it bottomed at 25.3.

Those saying business conditions are “good” increased to 18.8% from 17.5%, while those that said conditions were “bad” decreased from 27.6% to 26%. The consumer’s assessment of the labor market was predictably mixed; the number of people who thought jobs were “plentiful” increased back over 10%, while those claiming jobs were “hard to get” fell slightly from 36.9% to 36.1%. The final statistic is probably the most important, and confidence isn’t really going to return until the labor market improves.

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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