An enormous supply of mortgages is making its way through a system that has little capacity. Demand for mortgage applications is holding at its highest level in five years. Bankers that were desperate for loans a few months ago are now raising rates to slow volume. At more than 1.00%, the spread between mortgage rates to the consumer and the yield on mortgage-backed securities tells us so. The spread will shrink towards its usual level of 0.50% as volume and capacity normalize. Even if mortgage yields rise, rates to the consumer could remain at today’s levels for a long time.

Low rates are driving home sales. Existing home sales jumped 6.5% in December. The jump cut nicely into supply on the market, down nearly 12% from November. Nine months of supply is on the market, down steeply from November’s eleven months. Lower mortgage rates are helping sales as is, unfortunately, falling home prices. The median price fell 2.7% in the month to $175,600, with a year-on-year decline of 15.3% — a decline that is probably the largest since the 1930s.

The homebuilders’ NAHB/Wells Fargo housing market index sank to 8 in January, a new low. Index readings higher than 50 indicate positive sentiment about the market. Homebuilders are pushing Congress for a 10% tax credit of up to $22,000 for new home purchases. They are also asking for a temporary interest-rate reduction on 30-year mortgages.

The good news is that interest rates are not likely to rise materially any time soon. Recessions are almost by definition deflationary. We had two massive bubbles bursting: the very visible housing bubble, and the less visible but even more powerful bursting of the credit bubble. It would be a strange, strange world indeed if inflation could get any real traction in such an environment. So deflation is our immediate problem; inflation will dominate headlines once the excess supply of everything from autos to durables to housing is wrung out of the global economy. And with GDP falling like a rock, excess supply is growing larger.

The 10-Year Treasury had its worst week since June as supply fears weighed on the market. The upcoming Treasury refunding will offer the largest amount of 10-Year notes for sale ever.

The Treasury is borrowing but banks aren’t lending. Low rates “won’t ever get the horse up on his feet, let alone to the water and drinking,” claims John Mauldin. The M2 money supply is 60 times bank reserves, so normally when the Fed gives the banks $1 in reserves, M2 rises by $60. But for every additional $1 of reserves between August and November, M2 only rose by 46 cents!

The New York Times reports that tax issues are the reason Caroline Kennedy took her name out of contention for Hillary Clinton’s Senate seat. Dropped out ‘cause of tax issues. The good news, she’s still eligible to be Treasury Secretary. – Jay Leno

Thanks for your business and have a good week. — Tom Millon