Fed Watch: Will Bernanke Raise 1/2 Point?
A: My last 2 fed watch posts here on UrbanDigs (#1 & #2) explained why I think Bernanke & Co. should raise the fed funds rate up to 5.5% at next weeks meeting! Nothing has changed my mind since and in fact, now CNBC is starting to have guests on its show explaining why a 1/2 point hike would be warranted.
I've been following the equity markets, commodities markets, and the fed and their reactions to current economic conditions since I was 13 and had $500 to invest in SGI (Silicon Graphics, Inc.), which has since gone bankrupt. Not the best investment now that I look back, but one that triggered an obsession for me in the tradable markets and monetary policy that continues today.
I respected former fed chief Alan Greenspan so highly for his service and his character in handling tough situations and traders expectations. At least he understood the importance of 'certainty' and the critical element of letting traders/investors know what was to be forthcoming. Bernanke is still learning this.
Energy prices are STILL at uncomfortably high levels and right now we are seeing inflation pressures resulting from last years occurences. Remember, economic data released now is lagging and the fact that energy prices have remained this high for this long only leads me to believe that inflation pressures will only increase as we head into 2007. So, the fed is really very limited in combating these pressures to prevent future inflation and only has monetary policy as their biggest weapon in their arsenal.
Every homeowner and prospective buyer out there are beginning to feel the effects of higher interest rates on their monthly mortgage, ARM's, HELOC's, credit card statements, and lending rate quotes that are related to each individual's circumstances. For example, if you are a buyer looking for a new home right now then you probably know that 30 YR fixed rates have increased steadily over the past 3 months or so. Another example would be a homeowner with a HELOC whose monthly payments have risen by 5-10% or so over the past year. The pain is not over as the fed is FORCED to raise rates further to combat inflationary pressures seen today and forecasted to come down the road (energy prices of $70/barrel are yet to effect economic data; in fact, economic data we see now has only been affected by oil prices from late last year).
THE FED SHOULD RAISE 1/2 POINT NEXT WEEK TO PROVE THEY ARE FEARFUL OF INFLATION PRESSURES AND SHOW THE TRADABLE MARKETS THEIR HAWKISH NATURE AND WILLINGNESS TO DO ALL THEY CAN TO KEEP FUTURE INFLATION IN CHECKA recession is all but certain at this point, probably beginning in late 2007 and data proving one in early/mid 2008. I'm not to worried about that as recession's are a normal part of longer term sustainable economic growth (you can't just have an economy booming forever, there has to be bumps along the road). The goal is to limit the severity of the recession and avoid a depression at ALL costs! That is the tricky part right now. The fed may publicly acknowledge that they are trying their best to avoid a recession with their current 2+ year rate hike campaign, but I would think that every fed governor on the committee knows one is coming and is now trying to figure out how to control the inevitable recession the US is about to see! After all, rate hikes are intended to SLOW the economy!
Fact is, inflation is the biggest problem the fed has to deal with and the trickiest one too. The best we can do is understand what is happening right now, and what is probably going to happen down the road to properly invest in it. What I see are 30YR mortgage rates of 7% by years end, 7.5% by mid 2007, and close to 8% by the end of 2007! The logic being that the fed's rate hikes take 8-12 months to funnel through the economic system and we are not even close to the final fed funds # yet. Right now the fed funds rate is at 5% and rising. Will it settle at 5.5%? 5.75%? 6%? No one knows for sure but what most experts will agree on is that it is 1 of these 3 #s!
I would put my money on 5.75% given what I see right now. I'm hoping that the fed raises by 1/2 point next week and provides a clearer statement on future moves. That would be welcome to equity markets but unwelcome for lending rates and those holding alot of debt. Plan accordingly. In meantime, 2008-2009 is looking to be a prime time to buy real estate as sellers in these years are going to be faced with a very slow market as buyers deal with 30YR mortgage rates near 7.5-8% or so. If buyers aren't there, sellers must pull out their only weapon to move a property; price reductions.
Lets see if I'm right or a lame duck! In the meantime, my bet is on cash and I expect the US dollar to see a nice recovery over the next 2-3 years or so as investors/hedge funds overweight cash until the next opportunity presents itself. When real estate in NYC dips, I look at that as a buying opportunity as bust cycles in our city are much shorter than almost every other market across the country and our boom cycles are longer than most markets.
Just look at Jonathan Miller's post on the recently launched CME housing futures which shows NYC still gaining while other markets continue their declines.
