Overcast but Clearing in 2011: There Are a Few Good Signs of Better Economic Times Ahead. but Next Year Also Promises to Bring Higher Mortgage Rates. This Review of the Fed's Policy Moves, Budget Deficits and the Housing Forecast Concludes the Sun May Start Peeking out in Late 2011

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As of this writing, we continue to slowly emerge from the deepest recession in years. Most economic indicators point to a slightly better picture than they did last summer. Although the sun is not yet shining, economically speaking, there are patches of lighter gray amidst the overcast sky. And the sun may begin peeking out in late 2011 and early 2012. Gross domestic product (GDP) growth has been revised up for the third quarter and most forecasts, including ours (the Mortgage Bankers Association's research division), will likely reflect stronger growth into next year. The stronger growth has been partially driven by increased consumer spending--as overall conditions and expectations improve, people are gaining confidence and spending again. * Job growth appears to be picking up, with the October and November employment situation reports showing significant payroll increases in the private sector and weekly jobless claims at their lowest levels in more than two years. Moreover, businesses continue to spend on capital goods and information technology (IT), albeit at a slower rate than in recent months. * Despite this job growth, unemployment and labor underutilization remain high. We expect that given the current path of economic growth, the unemployment rate will remain above 9 percent in 2011, and over 8 percent well through 2012. There are still large numbers of workers who are discouraged, marginally attached to the work force, or who have been forced to take a temporary job. As of November, about 42 percent of the unemployed have been looking for a job for more than six months. * The job market is instrumental in the recovery of the housing sector because homeownership and mortgage performance hinge directly on households' incomes. A loss of employment or income is one of the "trigger" events for mortgage delinquency, and in a declining home-price environment homeowners cannot easily sell their homes if they are no longer able to afford their mortgage payments. And those who can afford their mortgage payments may be faced with a loan balance that is still greater than the value of their home.

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The housing sector is still crawling along the bottom, as home prices continue to fall by most measures. A large inventory overhang of unsold homes remains, as well as a significant "shadow inventory"--homes that are either in foreclosure or with mortgages that are delinquent and that could potentially come onto the market as a result of their nonperforming mortgage status.

Purchase application data are just beginning to reattain levels last seen in early May, immediately following the expiration of the homebuyer tax credit. Until we see a sustainable and significant rate of job and income growth, as well as a better consumer outlook for the future, home-price growth will continue to either decline or grow slowly, with variations by market increasing as the recovery develops.

Finally, there are risks also from abroad--specifically the possibility of a currency war as other countries move to devalue their currencies relative to the U.S. dollar and more sovereign debt crises in other European countries, as seen most recently in the case of Ireland.

Given this economic backdrop, prices and wages are unlikely to increase, and inflation will remain contained for now. However, we think that the recovery is for real, and coupled with the end of the Fed's most aggressive actions to jump-start the economy, rates are likely on a slow uphill climb from here.

We anticipate that the 10-year Treasury is likely to be at 3.5 percent by the end of 2011 and 4 percent by the end of 2012. We expect the 30-year mortgage rate will move above 5 percent by the end of 201 r and push closer to 6 percent by the end of 2012 (see Figure 1).

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In the remainder of this article, we review the Fed's recent actions, discuss the outlook for the federal budget and examine the implications of both in the context of our economic forecast. …