Rosenberg: Fed Can't Raise Rates Until 2011

A: This may be true unless one area of the tradable markets force the fed's hands to raise rates earlier. Imagine a world with surging equities and oil/commodity prices on a souped up reflation trade - can $100 oil, $1,200 gold, and surging commodity prices impact the fed's thinking? How will that help anyone; especially the latter right as unemployment climbs to its ultimate peak for this cycle? As I mentioned before, in my opinion inflation will first come in the form of higher food, higher energy, higher metals, higher commodities across the board, higher taxes, higher rates, higher health care costs, etc..all the stuff that pinches corporate profit margins and squeezes consumers wallets. I don't see wage inflation being a problem for many years.

From David Rosenberg's Toast With Dave:

FED CAN'T RAISE RATES UNTIL AFTER 2011

The reason — there is a wave of mortgage refinancings coming in the housing market for one, and not only that, but in the commercial space, there are 2.7 trillion of debt coming due through 2011 and another 1.5 trillion of leveraged loans (see page 24 of Thursday’s FT). In other words, the default rate is going to rise even further and the Fed tightening policy would only aggravate that situation. In other words, the Fed is simply immobile for at least the next two years.

I am of the camp that the fed won't raise rates until unemployment is shown to be stabilizing or at the very least, recovering. That may be a ways off but I wasn't thinking 14 months off. Maybe mid 2010 we see the first fed move. Since monetary policy works at a lag and we are coming from a ZIRP, is a 0.5% or 0.75% fed funds rate really considered a tight policy? If it is, then man, what a world we transformed into when only 3 years ago the FFR stood over 5%. In the meantime, I wonder if the markets will force the fed's hand early into raising rates before they really want to.

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The Fed’s Role in All of This – Lender of Last Resort

On Noah’s post last week about the Fed’s $30 billion bailout of Bear Stearns, one reader commented that the Fed was using taxpayer money to bail out the company.

It’s a valid thought; after all, why should the government – at the expense of taxpayers - have to pick up the tab to rescue some bank that got us into this rut as a result of the bad judgment of a bunch of rich guys? And meanwhile people are losing their homes and their jobs.

Much is being said about WHAT the Fed does, but not on HOW it does it. So what I’d like to do here is explain on a high level how the Fed operates and the impact on the US taxpayers. The reality is that it's less than people think.

For starters, when the Fed loans to a bank it requires the bank to back it up with collateral of at least 100% of the value of the loan. The collateral must meet certain liquidity guidelines and the amount depends on the collateral type (i.e. Treasury bills might only require 2% above the loan amount vs. AAA corporate bonds that might require 5%). This way if the bank defaults on the loan, the Fed is covered. Today’s Wall St. Journal includes a good article on how this works; subscription only though.

But if the collateral is gone? Well, then the Fed must run to Congress to fund at the taxpayer’s expense; but the likelihood of this would be remote.

So how does the Fed fund itself; for a primer click here for the structure of the Federal Reserve? Each Federal Reserve District Bank (there are 12 of them, plus the Board of Governors in DC) earns its own income from a spread through issuing Treasury securities and other activities it provides to banks in its respective district, i.e. money transfer services such as Fedwire. Because each Fed Bank is not allowed to operate for a profit, it must return all revenues in excess of operating expense to the US Treasury. So therefore you could argue that this is an indirect cost to the US taxpayers…though on the other hand it wouldn’t be spending anything it’s not earning in the first place.

Although the Fed has government oversight, it runs independently. This is done on purpose in order to ensure its actions are in the best interests of the economy and not politicians in Congress….and one of the reasons why the US is still considered to have the most solid financial system in the world.

So what does the Bear Stearns bailout mean for US taxpayers?

The loan that the Fed is extending to Bear - actually to JPM Chase for Bear - is secured by collateral, as noted above. If the collateral runs out the Fed must obtain funding from either borrowed funds (Treasury bonds) or – yes, you guessed it – US taxpayers. But the latter would be in dire circumstances and unlikely to happen.

Enough of the Fed…the real risk to taxpayers is new regulations permitting Fannie Mae & Freddie Mac to reduce their required capital reserves, allowing them to expand their mortgage portfolios. This actually places US taxpayers at GREATER risk than the Fed’s recent action, but doesn’t get as much notice. But that is another post for another day….

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Fed Set To Cut; Will They Save Their Bullets?

A: We are about an hour and a half from the fed's next rate cut. The question is not whether they will cut, but by how much. This horse agrees 100% with BR over at The Big Picture, which shouldn't be a surprise to anyone here, that they need to exercise restraint and cut only by 1/2 point; limiting the negative effects on the US dollar & commodity prices while acting nonetheless. By saving their bullets now, they will have more ammo to use as the economy weakens, housing continues to be a drag, and credit markets correct themselves.

Unfortunately, I do not think 1/2 point will be the move. I think they will cut 75 or 100 bps this afternoon as a 'shock & awe' offensive to limit the severity of the slowdown and give the markets what they want. I must admit in hindsight, Ben & company handled the Bear bailout wonderfully as they orchestrated an orderly liquidation and averted a complete financial meltdown. Putting my feelings aside of letting the free markets punish those that are weak and the vultures jumping in to grab whats left, the fed's actions avoided chaos that could have played out as a domino effect of Bear Stearns announcing bankruptcy. The move to bail out BSC does NOT fix the housing problem, it does not fix the expectation for rising unemployment & inflation, and it does not fix the expectation of weakening economic data resulting from the credit storm; hence the rate cut move that will come today.

On February 29th I published a post titled, "Credit Check: Running Out Of Bullets", where I stated:

"With future rate cuts likely resulting in further commodity inflation, I'm concerned that we are going to be running out of bullets soon and will have to deal with a period of financial stress without the fed's strongest weapon available to us."

Federal Reserve Chairman Ben S. Bernanke may be running out of room to pump money into the financial markets and cut interest rates to rescue the economy.

The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with yesterday's decision to become a lender of last resort for the biggest Wall Street dealers. The central bank has cut short-term rates by 2.25 percentage points since September and will probably reduce them again tomorrow.

"They're using up their ammunition on the liquidity and overnight interest-rate fronts," said Lou Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions.

"I believe that the FOMC should "man up," show some backbone -- cut rates by "only" 50 bps. They might find out what its like not to be at the Market's beck and call (girl). That should stabilize the greenback, and perhaps send food and energy prices lower (earning Ben the appreciation of consumers through out the country)."

The unknown continues to be:

a) who holds what toxic assets
b) who is experiencing a liquidity crisis similar to Bear
c) when will foreclosures / defaults reverse course
d) when will credit markets normalize; credit spreads continue to narrow
e) effect on global markets
f) pipeline inflation
g) spread to higher quality / other debt classes
h) severity of job losses to come
i) severity of economic weakness
j) effect on local state budgets
k) spread to other markets (ars, muni's, etc)
l) effect on main street

Steps are being taken, but we are not out of the woods. This is not a daily fix, it is a quarterly to yearly fix rooted by housing that will take time to play out! We went from years of credit fueled leveraged bets to a complete STOP in a matter of months; we have been at this STANDSTILL since mid-to-late 2007 and we are yet to see the economic effects of this. The good news is, we must go through this to get out of it, so in my opinion and as I said over 6 months ago, BRING ON THE RECESSION!

PHOTO: Source

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Fed Cuts, Market Loses Gains, Ratings Downgrades Coming

A: I think reality is setting in that there is a reason the fed is acting so aggressively; risks to the economy. The drug injections Ben handed out today obviously wasn't his best stuff and the addicts on wall street feel shafted. In the meantime, reality wakes us up. Fitch cut the rating on FGIC, the 4th largest bond insurer and S & P lowered, or may lower ratings on up to a half a trillion, thats trillion with a 'T', of subprime mortgage securities and CDO's.

It brings me no pleasure to say that reality beat out a drug induced fantasy today on wall street. The fed used more of its precious ammo and cut both the FFR & Discount window by 50 bps, yet markets sold off by the end of the day due to the realization that there are valid reasons why the fed is acting so aggressively. Meanwhile, expect commodities to rise and inflation pressures to rise in the years to come as the fed clearly is pulling out everything in its arsenal to combat the problems bubbling under the surface. Sooner or later, a billion dollar write down starts to mean something.

Since the rate cut is not news anymore, lets get to what spooked the markets. According to Bloomberg (via Calculated Risk):

Standard & Poor's said it cut or may reduce ratings of $534 billion of subprime-mortgage securities and collateralized debt obligations as default rates rise.

The downgrades may extend losses at the world's banks to more than $265 billion, S&P said.

Financial Guaranty Insurance Co., the world's fourth-largest bond insurer, lost its AAA credit rating at Fitch Ratings after missing a deadline to raise capital.

Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody's Investors Service and Standard & Poor's are also reevaluating their ratings.

The loss of the AAA stamp jeopardizes ratings on bonds Financial Guaranty insured and limits the company's ability to generate new business. FGIC, along with MBIA Inc. and Ambac Financial Group Inc., are paying a price for expanding beyond their traditional business of backing municipal bonds to guaranteeing debt linked to riskier subprime mortgages and home- equity loans, as well as collateralized debt obligations.

What does this all mean? A few things come to my mind:

a) The fed is on our side. While we have pain to go through until the ship is righted, when the clouds clear there will be another fed assisted economic boom. The question is when. This will certainly help, but I'm afraid it will take some time.

b) I love gold.

c) The fire is fueled by deflation in housing prices across the country. As home values fall, so does equity withdrawal strapping the homeowner. Those holding homes whose loan balance now exceeds the value of the asset, are considering walking away from their homes. Those who cant afford to pay their mortgages, simply aren't. Its becoming socially acceptable to go into foreclosure these days as that may be the best financial option for the struggling homeowner. And guess who lent out the money, bundled it into a security, and sold off the bond to investors who are now holding the toxic waste?

d) As defaults rise, holders of the securities derived from these debts lose. Hence the billions of losses you are hearing about. So far, we've seen the lowest quality homeowners get hit; naturally. Risks to other debt classes?

e) Leverage. The unsustainable housing boom built from lax lending standards, rising home prices, speculative investing, and low low rates was leveraged up the wazoo! That makes the problem that much more complex and is clear by the struggling financials and those who bought up the risk globally. We will have to fix the financials before we can get through the downturn. Its clear the fed knows this and is taking aggressive action! It will help, but it will take time.

f) Over-estimating Losses? A very valid hope! It is entirely possible that if all this stimulus helps to stabilize housing as time goes on, that losses are overestimate. Way too early to tell now, but certainly a valid hope that I am clinging to and watching out for. I am NOT in this camp right now.

We will get through this. But we are talking about a housing/debt fueled problem, so it will take time. Housing is an illiquid asset, as opposed to stocks, and take time to sell on the open market. With inventory outside Manhattan a concern, it will take time to work through this process. All eyes should be on housing data for signs of:

1) decreasing iventory
2) rising sales volume
3) decreasing absorption rates

...for any clue as to when the clouds may clear.

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Pipeline Inflation: Here Already?

A: When the fed announced its actions on Tuesday, some were wondering why the previous bias towards focusing on growth suddenly seemed to disappear. In its place, was more wording about inflation. I've discussed pipeline inflation plenty here on urbandigs.com over the course of the year, and it's clear that with today's economic data it will begin to take headlines once again. Think to yourself sarcastically, ..."you mean, record high energy prices, higher commodity prices, and higher food prices are inflationary?". Yes, they are.

Forget the whole argument about headline vs core for a moment (read my recent post, "Fake OR Real Inflation?", back in mid November - Search Results for ALL "inflation" articles), today's CPI data came in hotter than expected all around. According to Yahoo Finance:

The Labor Department said the consumer price index rose 0.8 percent in November amid a spike in gasoline prices. The 0.8 percent increase in consumer prices topped the 0.6 percent rise economists had been expecting. The report also showed core inflation, which excludes often-volatile food and energy prices, rose 0.3 percent, the biggest increase in 10 months. The report also found large increases in the cost of clothing, airline tickets and prescription drugs.

The report raises questions about the Fed's plans for priming the economy.

Barry Ritholtz over at The Big Picture provides this chart on the year-over-year changes of the CPI Headline & Core #'s showing the sharp uptick since July:

The 0.8% gain was the largest since Hurricane Katrina's boosted CPI in September 2005. That was obviously a weather induced number, and you need to go all the back to January 1990 to find a comparable CPI price increase. And the so-called Core? 0.3% gain was the most since June 2001.

So, what do these inflation figures really mean?

Well, you can forget about a half point cut anytime soon -- at least until the Fed has gone from nervous to scared $#@tless. That's how you know they are in full blown panic mode.

Pipeline inflation (as I like to call it), the buildup of inflation from the past 6-12 months that is yet to trickle down into higher prices for consumers and be reflected in economic reports, is very real. While we may see short term rate easing as the fed tries to stave off any slowdown from the credit crunch, we are probably in for a medium-longer term period of rate hikes. It's just that this credit crisis needs to show signs of normalization, and the housing market needs to stabilize before the fed can risk raising rates; so we have some time and maybe even another rate cut or two in the near term as recession fears remain.

As for lending rates, I would expect them to tick higher on this report. However, you must keep in mind that these days there is less and less relation of fed action and bond yields on lending rates. The reason is the credit crunch, the risk that comes with mortgage lending, and the risk aversion of the banks to this type of lending. Add that all together and you get:

a) higher cost of debt
b) tighter underwriting
c) fewer loan options

...so yes, the credit crunch is related to real estate on a macro level. The time it takes to hit local markets will lag. My thoughts on our fed? I think they will still act in the near term (lower rates) as the credit crunch lingers, but that longer term we will see the lagging effects of global inflation leading to a more sustained campaign of rate hikes in the years to come.

Related:

Inflation in the Euro Zone Climbs (AP)

Inflation in the 13 nations that use the euro surged to 3.1 percent in November versus a year earlier, its highest level in more than six years, the European Union's statistics agency Eurostat said Friday. It is now well over a guideline of just under 2 percent that the European Central Bank looks to when it decides whether to raise interest rates to boost borrowing costs.

But the ECB is now under pressure to keep rates on hold to encourage reluctant banks to keep lending out money to each other in the wake of a credit crisis where they are worried about taking on extra debt.

A larger than expected pop in the November consumer price index may temper the Fed's willingness to loosen policy any further. As if the Federal Reserve didn't have enough headaches these days, inflation appears to be on the march after a long period of relative quiet. Case in point: The release of the U.S. consumer price index for November on Dec. 14. The headline CPI surged 0.8% on the month, while the core rate, which excludes food and fuel, rose 0.3%. Markets expected tamer rates of 0.6% and 0.2%, respectively, according to S&P MarketScope.

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Fed Time Again: 25 or 50 Bsp?

A: It's the day before the next decision on fed funds rates. Everyone gather round and huddle up. What should be done?

Arguments For 1/4 Point Rate Cut: The more likely option. Since Fed vice chairman Donald Kohn spoke a few weeks ago, the equity markets have translated his words (backed by a Bernanke speech the next day) into a rate cut induced party burning the shorts and resulting in a nice recovery after a very dangerous selloff. Now that wall street has undoubtedly 'priced in' a 1/4 point rate cut, the question is will there be any surprises?

The argument for a 1/4 point rate cut remains the same. The downside risks to the economy are clear, even though at this point in time the economic data continues to show some strength and moderating inflation; giving the fed some room to cut. Flawed or not, this is the data the fed looks at. The credit markets are still in distress, the housing market is getting worse at a faster pace, the future with ARM resets is cloudy at best (even with this gov't sponsored private sector rate freeze plan), and even Stevie Wonder can see the red flags waving that could hurt the consumer and the US economy in the months to come.

As a result, the fed will cut at least by 1/4 point to forestall the adverse effects to the economy. With pipeline inflation still a concern and the US dollar still very weak against other major currencies, the argument for a 1/4 point rate cut gets stronger. Plus, by cutting only by 1/4 point, the fed can save some ammunition for later use should things get real hairy in 2008; something that can prove to be vital to help restore some confidence without over-stimulating the economy or presenting a moral hazard for all those that made bad bets again.

Arguments For 1/2 Point Rate Cut: The main arguments for a 50 basis point rate cut is a combination of the fed being behind the curve already, the street already pricing in 1/4 point cut, and that the macro data shows a seriously slumping housing sector that will inevitably bleed into consumer spending. We know that there is a lack of liquidity in the secondary mortgage markets, but fed rate cuts do little to reverse that. We know that the credit markets are in distress, but that has to be worked out on corporate balance sheets (hey there, UBS with another $10 Billion in write downs; how are you doing?) first before normalizing.

And we also know that the housing market will get worse before it gets better and the side effects of that on the consumer, in my opinion, is the biggest argument for the fed to be aggressive and cut rates by 50 basis points.

For now, lets enjoy the free round of tequila shots that the fed has provided us via speeches by its members, as it almost makes it look like things are getting better. Beware not to confuse rate cut induced rallies for confidence & certainty returning to the marketplace. While subprime has taken all the headline blame for what is going on right now, let us NOT forget that there are plenty more loans out there that are waiting to go bad: option arms, hybrid I/O loans, cosi & cofi loans, alt-a (already starting), second mortgages, HELOC's, credit cards, and prime loans (already starting).

THIS IS NOT A SUBPRIME PROBLEM! This is a complete mortgage/lending mess that has yet to fully reveal itself and explains WHY the fed is taking aggressive proactive measures to soften the blow expected to come.

MY BET

65% ---> 1/4 point rate cut fed funds, 1/4 point rate cut discount window
30% ---> 1/2 point rate cut fed funds, 1/2 point rate cut discount window
5% ---> some combination of above
0% ---> NO CUT; that would be a shock

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Bond Yields & Mortgage Rates No Longer Related

A: I want to touch on this topic as I have been asked recently why mortgage rates are not falling as much as 10YR Bond yields have? In the past there was a much closer relationship between 10YR bond yields and lending rates, but something changed. Risk joined the party. As a result, investors deemed mortgage related security products much riskier than in the past and would only be interested if the yield that came with this riskier bet was increased. For main street, any debt that is related to the current fear of delinquency & default risk, comes with a higher borrowing cost. In this new world where risk has been re-priced, that is the key term here, bond yields are no longer a reliable indicator to the future direction of lending rates. Instead, lending rates will be more closely tied to the evolving credit crunch and will act more on credit history than ever before!

Lets see what I mean. The simplest way to get statistical evidence of what I just said, we must look at how 10YR bond yields & NY 30 YR Jumbo mortgage rates have performed over the past month or so! Lets no forget that things have changed significantly over the past 30 days as the credit crunch worsened, stocks sold off, bond yields plunged, and yet lending rates went higher. Here are my sources:

BANKRATE.COM: showing the trend of NY 30YR Fixed Jumbo mortgage rates; 1 month
MARKETWATCH.COM: showing the trend of 10YR Treasury Yield; 1 month

I merged the two line charts onto one graph that shows:

a) the downward trend of 10YR bond yields
b) the upward trend of 30 YR Fixed Jumbo rates

I don't know how much more clear this point can get! During times of credit distress, your credit rating will be more important than ever in deciding how low of a rate you can get on a loan as lenders try to clean up their books, tighten lending & underwriting standards, and assign a higher rate to riskier borrowers!

My friend and fellow blogger Dan Green will support this theory now, but argued with me a number of times in the past before the credit crunch invaded; where I often showed you charts relating the 10YR bond yields to mortgage rates.

Dan discussed recently, "Where Mortgage Rates Come From", and stated:

Mortgage rates are "made" from the price of mortgage bonds using a mathematical bond formula. This is fact. And by exclusion, this also means that mortgage rates do not come from the price of the 10-year treasury note.

So, let's hammer the point home. As of 2:00 P.M. ET yesterday (Nov. 20th), the U.S. treasury market was rallying. The bond market looked good from 30,000 feet. A check into the mortgage bond market, though, showed that mortgage prices were getting killed, off 25 basis points.
This is about the same time that my inbox starting dinging with new mortgage rate sheets reflecting higher rates from our nation's lenders. I wasn't surprised by the reprice for the worse because I had been watching the market slowly slip away on my MBS ticker all day. I had ample time to contact a few clients and get them locked in at lower rates before the reprice.

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Expect Surprise Fed Rate Cut

A: I'm going with my gut on this one. I think the credit crunch has matured to the point where we could see Ben Bernanke & Co., surprise with an inter-meeting cut. I know, I know, this goes against everything I said only a week ago when I didn't want the fed to cut. Fact is, I don't! We have enough problems with pipeline inflation, weak dollar, and rising commodity and energy prices. But there is a big difference between what I want, and what will happen. I think the credit crunch is getting so bad, that it wouldn't shock me to see the fed use the element of surprise before years end to try and restore some confidence via a stimulative inter-meeting rate cut.

The problem is the rate cut will not be a cure, it will only dampen the effect that the credit crunch has on the overall economy in the months to come.

Here are my concerns:

a) Nov. 15th accounting change; level 3 assets set stage for more widespread write downs
b) Citigroup & Merrill announce pain & management shakeup
c) Mortgage insurers whacked; should insurance availability for CDO's & CMO's shrink or outright disappear, or claims can't get paid out, we'll have major problems for those holding these bad assets
d) Ratings agency downgrades will lead to more credit pain
e) Nationwide housing slump continues; foreclosures & delinquencies rise predicted by ABX Indices

Again, I think the best way to get out of this mess is for our economy to go through a nasty recession that penalizes those that made these bets, without aggressive easing by our fed that may cause a moral hazard, weaken our dollar further, and buildup pipeline inflation. The recession itself will flush out the problems, clean off the balance sheets, and help ease inflation pressures. But, I doubt the fed will stand idle and let this scenario play out like that. They will most likely take action and cut rates to limit the severity of any recession, at the expense of:

a) bail outs; creating a moral hazard
b) weakening our US dollars further
c) rising energy prices
d) rising commodity prices
e) pipeline inflation

Thoughts?

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To Mr. Bernanke: BE STRONG!

A: The fed meets and decides the next move in the fed funds target rate on Wednesday. We also get plenty of economic data this week, which I'm sure the fed will get early access to before making their final decision on rates! The biggest reports will be GDP on Wednesday, ISM Manufacturing Index on Thursday, and the Employment Situation report on Friday. With the fed funds target rate at 4.75%, I wonder, is that really restrictive to economic growth? While the US dollar tanks, oil surges to $93/barrel, stocks just off record highs, and other commodities trek higher, it's hard to imagine that Big Ben will be aggressive with rates on Wednesday. But we all know he will because thats what the market wants! I say, be strong Ben! Show us you own a set of cahones, support our dollars, tell the markets you are not their bitch, and surprise us with your inner strength!!

Free market capitalism, HA! What a joke! It's clear that Ben Bernanke and the fed is a printing press for the tradable markets and will do everything in their power to keep the game going a bit longer and help bail out all those that made bad bets. Only it won't come out like that. It will come out as if the fed is acting to, "...forestall adverse effects to the US economy", or some similar jargon. Meanwhile, expect your dollars to be worth less soon.

With that said, there are problems here. The problems are a direct result of bad bets and bad loans that never should be made in the first place. So, to fix the problem the fed is pumping liquidity into the financial system, at the expense of our US dollars' value and future inflation in the pipeline. Companies are trying to team up and get this super conduit called MLEC up and running so that those holding bad assets can get bailed out and don't have to be forced to sell at distressed levels. Gone are the days where bad bets are penalized by the tradable markets, because if they were it would cause financial distress to our economic system that maintains afloat from interventions from government and private institutions. That is why free market capitalism is NOT AT WORK HERE!

If it was, the markets would have to work themselves out and stocks of banks, lenders, and others who hold these assets would have corrected significantly more; and that is obviously not happening. We have become a society that fears recessions rather than understand them for what they are; healthy and normal disruptions in economic growth necessary to ensure longer term sustainable growth. We need to shake out the bad bets and weak players, let the markets fix themselves, and move on with the lesson learned.

The US economy is slowing and jobs growth is decelerating, no doubt about it, but what happens if the US dollar continues this freefall? What happens to our immediate future if oil prices jump to $120/barrel; which will occur if the fed maintains an easing policy? Won't that hurt us even more down the road? Do we really need to keep cutting rates BEFORE the economic data clearly shows that they are needed at this stage of the game? Is 4.75% fed funds rate really that restrictive?

I think Ben Bernanke needs to stand tall, tell wall street he is NOT THEIR BITCH, and NOT CUT TARGET RATE AT ALL! Instead, I think they should leave the door open for more cuts if need be, and they should cut the discount window so that it comes down to where the fed funds target rate is now at 4.75%! If they do cut, at most cut rates 1/4 point and be clear in their message that future rate cuts are not a certainty!

Here are facts:

- Stocks are 1.5% or so from Record Highs
- Oil is at Record Highs
- Problems lie in credit markets; cutting rates will NOT cure this problem
- Rate cuts will help cushion any slowdown that may come down the road

I would LOVE to see the fed do NO CHANGE with rates on Wednesday, but I doubt that will happen. The credit markets are still in distress, there are more losses yet to be reported, we still do no know who holds what, and if the fed does nothing the markets will selloff and correct. Awww, cry me a river. I wonder if Big Ben can handle a little selloff on wall street?

Am I alone here in this way of thinking? The fed funds futures are actually starting to predict a slight chance of ZERO CUT at the meeting. Bill Pimco says we need a fed funds rate of 3.75%; might as well burn our dollars for heat! Here are some other thoughts around the blogoshpere:

Fed Calls: Quarter-Point Consensus (Real Time Economics - WSJ Blog)

Wall St Wants 50, Fed May Give Zip For Now (Bloomberg)

No Free Lunch: Ongoing Ramifications of an Easy Fed (The Big Picture)

The Fed's Dilemma (Econoday - Simply Economics)

Fed Meeting Wednesday Keeps Pressure on US $ (FXView)

Countdown to the Fed (Think BIG: Bespoke Investment Group)

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Expect Another Preventative Rate Cut

A: Stocks are just off record highs, fed funds target rate is at non-restrictive 4.75%, the US dollar is at record lows and sinking further, oil is bubbling at record highs, inflation is a long term threat, and commodities are at very high levels; hardly an environment that needs rate cuts. But this credit situation is much worse than many people think and I think the fed is cutting rates now so that when they 'kick in' in the future it will be just when we need them to! It's a very confusing time right now, leaving me to focus on the biggest threat to everything: the credit markets.

The fed has two decision meetings left for this year; Oct. 31st & Dec. 11th. As much as I don't want it to happen given inflation concerns down the road, it looks like the fed will cut rates again by 1/4 point at the end of this month.

The earnings for major banks have come out in the past few weeks and they have been nothing short of disgusting!

* Wachovia (WB) - Wachovia Corp. before Friday's opening bell said its third-quarter earnings fell 10% from a year earlier as the bank booked a $1.3 billion write-down as a result of disruption in fixed-income markets.

* Bank of America (BAC) - Nose-diving profits at the company's global corporate and investment-banking group were behind the earnings miss. Profits at the unit fell 93.0%, to $100 million, from $1.43 billion a year ago.

* Citigroup (C) - Citigroup, the global banking giant, said today that third-quarter profit dropped 57 percent after it faced heavy blows to its fixed-income and consumer businesses. "There really is a lot of deterioration happening in mortgages right now," Gary L. Crittenden, Citigroup's chief financial officer, told investors and analysts on a conference call today.

* Washington Mutual (WM) - Washington Mutual Inc. shares fell nearly 8 percent Thursday, a day after reporting fallout from the housing slump drove its third-quarter profit down 72 percent. Chief Executive Kerry Killinger said "increasingly difficult market conditions" are hamstringing the banking industry.

Just to name a few of the big boys. We heard about insolvency cases at Rhinebridge CP and fire sales of assets to meet debt payment deadlines at Tango Finance, Ltd.. But the most compelling case that problems are getting real serious again in the credit markets, comes from the plunge in the ABX Indexes over the past few weeks. Folks, if you want to get an idea of investor sentiment in the subprime mortgage backed securities world, you look at the ABX Indexes! As I have discussed since Tuesday, things are getting very scary! The chart below shows you the selloff in the ABX Index for 'AA' paper. Look at that selloff since October 11th (I inserted red 'y' and 'x' axis so that you can see the low we hit when the credit mess first hit, the recovery, and the recent selloff taking us below the low point hit back in early August)! We are now lower than the bottom hit when the credit crunch first came to the surface back in early August; you know, when the Dow went from 14,100 to about a trading day low of 12,455 or so in a 2 1/2 week period + started the changes for everyone seeking a loan!

The Wall Street Journal Blog, Real-Time Economics, had a post yesterday citing a quote from a hedge fund manager who said:

...Somebody told me this morning, ‘It is starting to feel like early August, and not just because of the weather"...

It was clear that equities were drunk on rate cuts, as I posted last week, and I think the street is yet to adapt fully to a world of credit restrictions, solvency issues, global inflation and higher rates. The first credit blip was an 'awakening' of sorts, and for those that think it's completely over, well, stop hitting the snooze button! Is the latest collapse another indication of distress in the credit markets? I've mentioned before that the credit mess is NOT OVER! We are yet to see the full dragging effects of the credit turmoil in corporate earnings and the side effect to investors and the consumer.

Expect another preventative fed rate cut to help 'forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.'; as the fed stated with their last easing!

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Hot Numbers & The Misleading Core

A: Hot economic data folks. The headline PPI came in high at 1.1%, while excluding food and energy in the so-called core PPI came in at 0.1%. Retail sales were strong. The question in my mind is how much weight should be given to the CORE #'s overall as the fed targets inflation; Barry Ritholtz's take on the misleading core is well known. Fact is, the US economy is a mature, resilient economy and as such I think the day of the CORE # has passed. Inflation is OUT there and the fed's model of focusing only on the core needs to be updated so we don't get hit by the 'cruelest tax of all'. Lets discuss.

First the data. According to Yahoo Finance:

Retail sales posted a stronger-than-expected gain in September as a big jump in auto sales helped offset weak demand for clothing. The Commerce Department reported Friday that retail sales increased 0.6 percent September, compared to August. That was double the gain that economists had been expecting and was also in contrast to reports Thursday of sluggish demand from the nation's leading retail chains.

In other news, the Labor Department reported that wholesale prices jumped by 1.1 percent in September, pushed higher by gains in food and energy costs. Excluding those volatile categories, wholesale prices were up by a moderate 0.1 percent.

I was listening to Rick Santelli this morning and he made a statement that I thought was dead on regarding the Core data that the fed seems to love so much. Let me first explain how this works.

Headline # ---> shows the total data for the specific report type

Core # ---> excludes food & energy because these items are thought to be volatile #'s (sudden & sharp movements) that skew the headline # and don't give an accurate look into how the overall economy is doing on the specific report type
*the fed has been known to follow the core dataset more heavily for policy actions

The argument is WHY THE HELL SHOULD WE REMOVE THE FOOD & ENERGY ELEMENT OF THESE DATASETS? You eat right? You use energy to heat your homes & fill up your gas tank right? They are a part of everyday living right? So, why exclude them when monitoring if inflation is in-line or out of control? Here is what some of the fed governors say about this (via Real Time Economics: WSJ Blog):

Cleveland Fed President Sandra Pianalto ---> "The reality of rising oil and commodity prices is evident, and my Federal Reserve colleagues and I have been clear that we believe the impact of these influences will dissipate over time. But until our beliefs are validated by the data, there is a risk that the public’s trust could erode and inflation expectations could move higher."

Dallas Fed President Richard Fisher ---> "Both food and energy have had a steep upward tilt for the last three years in a row. Under those circumstances, I’m personally reluctant to put complete faith in the core measures because they may be removing more signal than noise."

Berkeley Professor Brad DeLong says:

If the rise in inflation is thought to be (a) transitory and thus (b) self-limiting, the Fed would prefer to let sleeping dogs lie rather than hit the economy on the head with a brick.

However, when increases in inflation are confined to (i) energy and (ii) food prices, odds are that the increase is transitory and will be self-limiting. Hence the concept of "core inflation." If the Federal Reserve concludes that the current rise in inflation is transitory and self-limiting, it can point to the core inflation number as a principled excuse for not hitting the economy on the head with a brick.

Look at what is going on in the mind of Axel Weber, a governing council member of the European Central Bank (via Bloomberg):

European Central Bank governing council member Axel Weber yesterday said policy makers might need to increase borrowing costs to keep inflation under control.

"If risks to price stability are threatening to materialize, monetary policy can't lose sight of its primary mandate -- even if that means no longer supporting the robust economy or becoming restrictive," Weber, who also heads Germany's Bundesbank, said in the text of a speech in Munich. There may be an "additional need" to raise interest rates, given the "expected acceleration in euro-region inflation over the coming months."

Ive said it before; read my post "Moderating Inflation? I Don't Think So" where I discuss this in more detail. I think the days of ultra cheap money and deflation are over. I think we are headed for a longer term period of higher rates and inflation as the global boom continues.

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Wish List: More Rate Cuts OR Strong Data?

A: You can't have them both! Interesting topic to touch on as we head closer to Friday's all-important jobs report! That report will be a leading indicator for the fed funds futures market to re-price expectations of future moves by the fed! While the stock market rally of the past few weeks has been based on one part by more expected rate cuts, what is it that the markets really want? Do we want stronger data showing a resilient US economy holding on and not as bad as first thought OR do we want weak data that will give the fed more leeway to cut rates in the future? With stocks already pricing in a few more rate cuts, should that data come in stronger than expected we may get a selloff as equities take back future rate cuts!

It's strange to have an environment where weaker economic data will be viewed as a buying opportunity in advance of future fed rate cuts! But then again, there is nothing normal about how stocks move. There is an emotional element at play here, with bad news being absorbed quite well and expectations for an accommodating fed. To understand what I mean, look at how the markets reacted to the news on Citigroup, Netbank, and UBS in the past week:

CITIGROUP ---> Admits a $5.9B loss and write-down due to subprime related mortgage market investments gone bad; stock gained 2% on news

UBS ---> Admits a $3.4B hit to earnings; stock gained 3.2% on news

From USA Today:

Two of the world's biggest banks, Citigroup (C) and UBS (UBS), announced multibillion-dollar third-quarter write-offs Monday. But instead of dampening spirits, the red ink stoked enthusiasm among investors who appear to believe that the meltdown in the subprime mortgage market is over.

The stock of Citigroup, which announced a $5.9 billion write-down, closed at $47.72, up more than 2%. The stock of Zurich-based UBS, which announced a $3.4 billion hit to earnings, gained 3.2% for the day.

NETBANK ---> Internet banker files for bankruptcy as regulators take over accounts. The bank's failure this year was the result of margin compression from an inverted yield curve, fewer mortgage originations, and demands to repurchase delinquent loans, according to a bankruptcy court filing.

Lets go back. When this credit squeeze first hit the media and became a big headline risk to stocks, I wrote a post titled "Should The Fed Step In & Save The Credit Markets?", and dug deep to my past experience trading and following the markets to state very clearly:

LET THE COMPANIES WHO MADE BAD BETS STEP UP TO THE PLATE, PUBLICIZE THEIR LOSSES, TAKE BOOK VALUE & LIQUIDATE BAD HOLDINGS IN ORDER TO WRITE OFF THE LOSSES! ANNOUNCE A RE-STRUCTURING EFFORT AND PUBLICIZE EXACTLY WHAT IS BEING DONE TO FIX THE PROBLEM & BRIEF INVESTORS ON THE FUTURE DIRECTION OF THE COMPANY

By coming out in this manner and letting the current value of their holdings to actually trade and liquidate would allow the financial markets to weed out the bad bets made and the losses to be written off. While it will be painful for the companies and their investors to do this, it will be better for the overall credit mess and it will allow the markets to function more effectively in re-pricing the risk so that we can move past the mysterious problems that we now face. It’s the uncertainty right now that is killing equities.

What would you rather have? STRONG ECONOMY or MORE RATE CUTS?

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Moderating Inflation? I Don't Think So...

A: Barry Ritholtz often argues about the flaws in the datasets that the fed uses to monitor inflation. These statistics, issued by the BLS/BEA/COMMERCE DEPT, has shown inflation as moderating here at home which allowed the fed to act aggressively in preventing the US economy from falling into a recession with their 1/2 point rate cut a few weeks ago. But I and many others out there have argued for some time that inflation IS out there, there is now a buildup of inflation in the pipeline, and to ignore food/energy in the so called CORE datasets is to turn your head away from reality! You want to see inflation? Look at what Dean Foods CEO said today about the current environment to get an idea about what it really is like out there!

First, why do I talk about this if this is a Manhattan real estate site? Here's why:

INFLATION RISKS ---> COMPANIES RAISE PRICES OF GOODS AS COSTS RISE ---> COST OF LIVING INCREASES ---> SPENDING POWER DIMINISHES ---> FED MUST RAISE RATES TO COMBAT INFLATION ---> AS RATES RISE, THE COST OF DEBT RISES ---> BOND YIELDS RISE TO REFLECT THIS MACRO ADJUSTMENT ---> LENDING RATES & CREDIT RATES RISE ---> AFFORDABILITY GOES DOWN

If you don't understand the macro effects of a high inflationary environment, then you probably will have a hard time connecting the dots to how it can ultimately trickle down to investment classes like stocks or housing. It's all connected.

THE FED WAS ABLE TO CUT RATES TO 'FORESTALL ADVERSE ECONOMIC EFFECTS' BECAUSE:

a) inflation data showed moderation (while some argue about the makeup of these models)
b) jobs data showed weakness indicating an adverse effect on US economy
c) housing woes continued to pose threat to overall economy

But I ask? HAS INFLATION REALLY MODERATED? Look at energy costs, look at overall housing prices in the past 5-6 years, look at food prices, look at health care costs, look at commodity prices showing whats in the pipeline! To say inflation is NOT a problem is utterly ridiculous! It's this train of thought that leads me to believe the fed is VERY CLOSE to being done with rate cuts, and that we are in a longer term trend of rising rates. I mean, since when is a fed funds target rate of 4.75% restrictive to economic growth?

Here is real world evidence of inflation via the CEO of Dean Foods:

"The third quarter has been particularly challenging as dairy commodity costs have risen sharply, hitting all time highs," said Chairman and CEO Gregg Engles. "This is by far the most difficult operating environment in the history of the company, reinforcing the importance of the long-term strategic initiatives we have underway."

The company, which makes products such as Silk soy milk and International Delight coffee creamer, said that increasing commodity costs have materially reduced profits. They also have hurt sales as customers react to higher prices

Recall the inflation problem of the late 1980's, as indicated by Core PCE # above 4, and how the fed raised the fed funds rate (the same one they just cut to 4.75% two weeks ago) to just below 10% to combat runaway inflation. While I am not predicting such an extreme, I do think inflation in the pipeline is a problem. Its not on the surface yet and the fed is clearly taking a 'wait and see' attitude about this problem. If the problem doesn't go away, rates will HAVE to go up.

Is inflation out there? Do you think your cost of living has increased in the past 5 years OR no? Here are some others take on this incredibly confusing situation.

There's No Inflation: If You Ignore The Facts - (Newsweek via The Big Picture Link) -

Imagine that a cardiologist told you that aside from the irregular heartbeat, the stratospheric cholesterol count and a little blockage in your aorta, your core heart functions are just fine. That's precisely what the government's cardiologist - Ben Bernanke, chairman of the Federal Reserve - has just done. The central bank is supposed to make sure the economy grows fast enough to create jobs and make everybody richer, but not so fast that it produces inflation, which makes everybody poorer.

Catch that bit about "core inflation"? That's Fedspeak for: inflation is under control, unless you look at the costs of things that are going up.

I wonder what people will be saying when the September CPI comes out. It will be substantially higher due to soaring energy and food prices this month. Oh, wait, that's not in the core. (Nevermind). Gee, I wonder why the Fed prefers Core PCE as an inflation measure -- instead of what is occurring in the real world?

The Fed has said, quite consistently, that the measure of inflation it cares about most is core inflation, as measured in nominal dollars, ex food and energy. You can argue with that decision, but once they've made that decision, I'm not a fan of suddenly deciding when food and energy prices rise that, oh deary me, they do matter for monetary-policy purposes after all.

The U.S. consumer price index continues to be a testament to the art of economic spin. Since wages, Social Security cost-of-living increases and some agency budgets are tied to it, the government has a vested interest in keeping it as low as possible.

Yet your real cost of living -- what you keep after taxes, medical bills, college expenses and other household costs -- is probably much higher than the 2 percent annual rate the government reported in July, showing a slight decline.

First of all, as far as I can tell food and energy are the only two items you should NEVER exclude from an inflation index. Tell your wife and kids they can have everything in the consumer basket except food and energy and you will quickly see that they are actually the two MOST important and indispensable factors in the CPI.

This will come back to bite you but not nearly as much as it bites us. The cheaper the dollar gets the more expensive all our imports get, inflation will rise faster than you can statistically manipulate it and when that happens expected inflation goes through the roof (which as you yourself have pointed out many times is by far the most serious threat to economic existence). Then the only way out will be interest rate increases as swift and severe as all the cuts have been.

I wouldn't consider the housing correction as deflationary because the cost of living has not declined in lock step with pricing. Where I do see deflation is in consumer electronics, apparel and autos; hardly anything that I would consider as essential to daily living!

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Fed Totally Dissing Inflation / Dollar

A: There is a very heated debate in the macro economic blogosphere about whether Ben Bernanke & Co. are doing the right thing by aggressively lowering the fed target rate as a preventative measure to fend off any recession, or doing the wrong thing by giving wall street what they want at the expense of future inflation and the weak US dollar. Stocks like inflation. Inflation is a side effect of a hot economy, or hot global economies, and when you see record prices in energy and other commodities its hard to ignore why stocks continue to do well; especially with fed rate cuts on their side. But is all this good for us in the end? Is housing even going to be helped by the rate cuts? Is the weak dollar good for the US?

For anyone whose been reading my blog for past years, you know that I lean heavily on macro economic discussions in the hopes of understanding what may be going on to drive stocks, housing, commodities, etc.. There is never a dull moment in this arena, especially in the past few months.

The US dollar is whitering away and inflation is no where near gone as the fed decided to put two of their stated mandates on hold (keep inflation in check and price stability) and focus instead on economic sustainability. What does that mean? It means the fed made it absolutely clear that the threat of a US recession was the #1 reason for their latest move in an attempt to "...forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

It was preventative and the unwanted side effects of making this bold move are:

1. Moral Hazard Issue - Did the fed give wall street what they want? Did they give the lenders too much liquidity and bail them out? Were the free markets unable to correct themselves that they needed this action? In my opinion is what August's awful Jobs data that gave the fed the opportunity to pull a move like this. Without that direct evidence of a slowdown hitting the labor market, the moral hazard argument becomes way stronger and the fed probably only cuts by 1/4.

2. Wasting Away of US Dollar - Anyone who has visited Canada or Europe recently knows how weak our currency is. It's as if the greenback has cancer and we are all watching as the currency whithers away. Good for stocks, bad for consumers and purchasing power. A weakening dollar will help corporate profits (especially those with businesses abroad) but will add to inflation concerns here at home down the road (and that means possible future rate hikes!). How low can this US dollar go before action is taken, or at lease inaction (no more fed cuts) is taken?

3. Steepening Yield Curve / Future Inflation - When the fed made its move, the bond market saw yields RISE, not fall! This is because with such a stimulative move by the fed, future inflation concerns become a very real problem and the bond market prices that in. Energy prices and other commodities soar helping to bring yields higher at the longer end of the curve. Here is a chart of what 10YR & 30YR Bond yields did right before and after the fed move:

For anyone that doesn't believe in inflation or the government's measure of it, just tell me whether the cost of living, eating, heating your home, filling up your gas tank, etc has risen over the past few years? If you say NO to those questions, please tell me where you live?

4. Longer Term Lending Rates DIDN'T FALL That Much - This is why you do NOT listen to the heads of mortgage companies, brokers, or anyone with a vested interest in you making a decision that puts money in their pockets. Everyone was on the bandwagon that if the fed cuts, all will be fine and dandy and lending rates will fall big time for a very popular loan product; the 30YR Fixed! This didn't happen and here is why.

For past 3 months, lending rates didn't follow the bond market as there was a re-pricing of risk in the mortgage markets; see my post that discussed this disconnect. During the height of this liquidity & credit squeeze, bond yields fell big time and lending rates rose significantly; thus, the disconnect between bond yields and mortgage rates due to perceived added risk of lending. However, with the latest fed move in target rate and discount window, it's clear that our central bank is doing what it is needed to stimulative and add liquidity to those in most distress; the lenders/banks/holders of mortgage backed securities. With this comes an increase in confidence, at least to some level, and the beginning of a return to a more normal relationship between bond yields and lending rates.

As you see from the charts above showing you longer term bond yields AFTER the fed move, they moved higher! That means little to no relief in longer term lending rates even with the fed rate cut. Those looking into short term ARM's, holders of HELOC's, and holders of credit card debt did see some relief due to the fed rate cut as both the Prime rate and LIBOR rate eased. All of this may have been an intended side effect from our fed, as 2008 poses a very big threat to nationwide housing and secondary mortgage markets when a record number of short term adjustable mortgages will reset to significantly higher rates. Those with resetting ARM's next year won't enjoy that much relief, even with LIBOR rate easing, because as Dan Green noted a ways back, there are CAP's set to how much your rate can jump and chances are even with this fed rate cut and relief in LIBOR rates, you are still near the top end of how much your mortgage can reset at.

For now, its BYE BYE to our US dollars and HELLO to future inflation risks in the years to come. I wonder, at what point does:

* $80+ oil start to HURT the economy?
* The weak US Dollar become a priority?
* The fed take a bigger picture stance towards future inflation risks?
* Housing inventory build reverses course giving fed ammo to raise rates?
* ECB takes stance against strong Euro for fear of it slowing Eurozone economies?
* Higher commodity prices fully trickle down to consumers?

Here are some interesting reads about these topics for those wishing to learn more sides to the story:

Inflation is Dead? Part II (The Big Picture)

Eurozone Slows (Calculated Risk)

50bps Cut May Be Too Little Too Late (RGE Monitor - Professor Nouriel Roubini)

Forward Rates & Inflation Expectations (Econbrowser)

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Fed Acts! Cuts By 1/2 Point!

A: The fed decided to GO VERY AGGRESSIVE and cut the target rate by 1/2 point PLUS the discount window by 1/2 point! Holy cow! Quite a surprise and stocks are obviously rallying big time on this news! With such a move, I question how bad this credit mess really is on effecting the US economy and continuing the housing downturn!

Wow! This was my least likely of options as we all learned a bit about Ben Bernanke today! Here are side effects:

1. YIELD CURVE STEEPENS - Short term bond yields fall & long term yields rise!
2. STOCKS RALLY - Stocks get what they wanted!
3. US DOLLAR FALLS - Dollar index under pressure
4. OIL HITS NEW INTRADAY HIGH - Not a surprise with such a stimulative move
5. LOWER HELOC RATES - Expect Prime rate (tied to HELOC's) to fall for first time since last July. Expect lending rates to fall as well with this move.

The accompanying statement mentions the "return of inflation concerns" and it appears that this VERY AGGRESSIVE MOVE IS A TWO AND THROUGH MOVE! I'll have to fully read the statement to discuss that likelihood more.

Some excerpts from the fed (read the full FOMC statement here):

Big Fed Day: Rate Cut Likely But...

A: Ben Bernanke and Co. will decide at 2:15 EDT today what their course of action will be, if any, for monetary policy that affects the overnight lending rate banks charge each other and which sets the tone for either restrictive or stimulative policy towards the US economy. In my opinion, the stock market has already priced in a 1/4 point rate cut and future cuts into equity prices and will ultimately selloff when they don't get as aggressive a move or statement when the fed releases their decision later today. Here's why.

Here are the main reasons why the fed will only cut by a 1/4 point, if at all, and not release as aggressive a statement in regards to future rate cuts:

Inflation Risks - Oil is at record highs, Gold is over $700/ounce, and other commodities are at highly elevated levels keeping longer term inflation risks from dissolving. Alan Greenspan even went on record recently as stating that long term inflation remains a very real concern and that he worries about double digit fed funds rates at some point down the road. The fed is still stuck between a rock and a hard place and can't risk aggressively lowering the fed funds rate and pumping too much liquidity/stimulus into US economic systems and ultimately making long term inflation risks even worse.

Weak US Dollar - The US dollar will gain some strength against European currencies if the credit mess hits over there and the ECB sees a need to stop raising rates, reverse course and actually lower rates. But that is yet to be seen. The credit crunch hitting Northern Rock in the UK has told us that Europe is not immune to current risks and that they may be next. As far as strength in any currency, there will be little if the overall economy gets hit; a strong economy yields a strong currency. We know that the US dollar has been super weak and I just don't see how our fed could start to embark on a aggressive rate easing campaign, further weakening our currency. Our currency could see gains on other currencies though IF this credit contagion ends up hitting global economies which will cause central banks to lower rates and global currencies to give up some gains against the US dollar. It seems we were first in this mess and could be first out of it too.

Stocks Still Near Record Highs - Major stock indexes are only 5-6% off record highs. Does this sound like an environment ripe for major rate cuts to you? If there were no chance of a fed rate cut, stock indexes would probably be 2-3% lower! There is already a premium priced into stocks for today's expected rate cut.

Avoid Recent History - One major reason we are in this credit mess (which is the main reason for US recession fears right now) is because of ultra cheap money and Greenspan's aggressive action on monetary policy bringing the fed funds rate down to 1%, keeping them there for too long, and not raising them back up aggressively enough (2 years of 1/4 point rate hikes is as slow a course of action as you can get). How could Bernanke and Co. ignore the risks of recent history repeating itself by aggressively lowering fed funds rate again; they can't and won't!

There are also real reasons for the fed to take action knowing that any fed move today will not effect the overall economy for a good 8-12 months. A few of these reasons include the very weak jobs report that came out a few Friday's ago, the nation wide housing problem, illiquidity in credit markets (which a cut in discount window can help a bit), and expected side effects to US economy and consumer spending. Some argue the fed is already behind the curve and about 2-3 rate cuts too late, while others argue that inflation fears are far too real to warrant any move in the fed funds rate. Very tough position for Ben Bernanke and his colleagues.

Here is my call. The fed will:

1. Cut Fed Funds Target Rate 1/4 Point (25 basis points)
2. Cut Discount Window 1/2 Point (50 basis points)
3. Issue a more conservative statement than most expect and mention they will be 'ready to act' as needed and determined by incoming data. Mention that inflation risks still remain in some way, shape or form.

I think the stock markets will ultimately selloff on the move after pricing in this action already. I do NOT think the fed is about to embark on a long term rate easing campaign! I think they will cut rates by a total of 50-75 basis points at most, bringing the fed funds target rate down to 4.5% or so, as a preventative measure to cushion any economic slowdown that does result from the credit/liquidity crunch. Not only that, but it is very likely that we won't stay at those levels for long, as inflation risks will force the fed to raise rates more aggressively down the road (a longer term view of fed funds target rate).

If I'm wrong, and the fed doesn't cut the target rate today by 1/4 point, I think the move will be NO CUT AT ALL! I think those expecting a 1/2 point rate cut are way off, and I will be very surprised and worried if that happens. Here is what to expect for all scenarios and my percentage bet for each:

65%: Fed Cuts Target Rate 1/4 Point + Discount Window Cut ---> Initial jump in stocks and then selloff
30%: Fed Doesn't Cut Target Rate + Discount Window Cut ---> Stocks selloff
5%: Fed Cuts Target Rate 1/2 Point + Discount Window Cut ---> Stocks rally

All in all, a very important day to see where our monetary setting body stands right now and for future moves that may be in the works.

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Expect A Preventative Fed Rate Cut

A: Tough tough call here but something I must discuss as there is now statistical evidence that the US economy is slowing (read "Jobs Weaken Big Time...") amidst the turmoil in the credit markets. However, and its a BIG HOWEVER, there are still reasons NOT to cut rates that I will get into here. What will the fed do on September 18th, which will prove to be one of the biggest and most important fed meetings of 2007? I'm putting my bets on a 1/4 point rate cut, (25 basis points) PLUS another cut in the discount window, as preventative medicine to cushion the severity of any slowdown that is to come. Your thoughts?

First, let me explain why a fed rate cut will NOT necessarily mean a drastic reduction in lending rates! Right now, we are living in a new world. A world that is in the process of re-pricing risk as investors determine what type of risk demands higher premiums and what type of risk doesn't. In this new world, LENDING RISK is demanding higher premiums because quite simply it is filled with uncertainty and backed by a secondary market that is now illiquid and void of buyers. This is the simplest way for me to explain what is otherwise a very complex situation. For more in depth on this topic, read:

* How Mortgage Backed Securities Work
* Wells Fargo Rates Jump To 8% Overnight
* RMBS Markets Explained
* It's A Risky New World / Credit Spreads

Now, while lending risk is running under it's own set of guidelines, there has been a disconnect between the relationship it has with bond yields; specifically the 10YR bond yield. Recall in my AUGUST 4th post about the risky new world where I clearly stated:

Relating this to the mortgage markets, while short and medium term US gov't treasury yields are falling fast due to a flight to quality as stock prices fall, the rates on mortgage products are NOT falling at the same pace! This is because mortgage debt is now MORE RISKY than treasury bond notes and therefore demands a HIGHER RISK PREMIUM to gather investors; i.e. higher yields.

Again, this is the simplest way for me to explain what is going on! So, in this new world what does the fed do? Well, there are two ways to think about it.

REASONS TO CUT RATES

* Inflation Moderating - Yea, but US metrics have been argued to be flawed. Commodity & Energy prices still very high. Inflation threats still persist. Arguments on both sides here.

* Prevent Recession - Cushioning move in monetary policy to help soften the hit when/if it comes

* Housing - Housing is still awful across much of the nation but we are yet to see a trickle effect in consumer spending. We are seeing effects in jobs now. Will fed be pro-active and cut ahead of the curve in anticipation of a slowdown in consumer spending as a result of housing downturn?

* Jobs Slowdown Three Months Now - Statistical evidence and the most compelling to warrant a rate cut. August jobs data was outright awful and the prior two months were revised down. This means the slowdown is in place already and fed is behind the curve.

REASONS NOT TO CUT RATES

* Moral Hazard - Fed bailout may prompt risky bets in future

* Weak US Dollar - Cutting rates will further weaken our currency? There are some arguments for the flip side though.

* Stocks Expect It & Priced In - Stock Indexes are only slightly off record highs as they priced in a rate cut. The fed should NOT give the markets what they want for fear they will selloff if they don't get what they want. In other words, the fed should NOT do what wall street expects. If we get no rate cut, we get a selloff!

* More Stimulus = More Inflation Risks - Cutting rates and pumping umph into the economic system could cause inflation to re-ignite down the road and energy prices to rise even further.

* Globalization Cushions Recession - Strong global economies could help cushion the downturn by itself. It may help corporate America, but the consumer is a whole new issue!

* Inflation Still A Risk - Sure, it is moderating at home, but how long will it last with oil at record highs and commodity prices still high! At some point will this re-ignite?

Cutting the fed funds target rate will NOT immediately turn around housing woes. It will NOT solve the illiquidity in credit markets and secondary mortgage markets. It will NOT solve problems with buyouts that fail to close. It will NOT solve the debt problems we have. It will NOT cause lending rates or the all-important LIBOR rate (to which adjustable mortgages/credit cards are tied to) to reverse course significantly!

You can see how tough a call this is for our fed and why this meeting is so important! The accompanying statement is just as important as the fed action is because it will tell us more what the fed is thinking in terms of future actions and their thoughts on the economy in general.

MY CALL - The fed will cut 1/4 point and bring fed funds target rate to 5%. Stocks will rally slightly as they really want a 1/2 point rate cut. I think the fed will also cut discount window again by 1/2 point to help liquidity in banking system a bit. If it's not 1/4 point, I'm betting on NO cut at all. The 1/2 point rate cut option is my least expected option. I would break it down like this:

60% CHANCE ---> 1/4 point cut
30% CHANCE ---> NO CUT
10% CHANCE ---> 1/2 point cut

Questions I have are how this will effect lending rates and the LIBOR rate, if at all. Since lending rates are operating under a different set of rules now, it's naive of us to think that past relationships between fed rate cuts and lending rates will prove true this time around!

YOUR THOUGHTS? WILL THE FED --->

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Jumbo Rates Still Surging / ARM's Too

A: Weekly Mortgage Report from Wells Fargo (hat tip Michael McGivney) shows falling 30YR fixed rates but rising ARM rates across the board. Any buyers out there care to report what they are seeing after talking to their mortgage lenders? Lets see how consistent this report is with other brokers doing lending business in Manhattan!

First, some charts via the Wells Fargo report. Here are weekly rates check, unfortunately it doesn't show jumbo rates, I'll get to that shortly.

Here is a chart showing Home Sales data as released by NAR.

Now, onto the Jumbo rates that are more in tune with reality here in the world of Manhattan real estate. Michael McGivney is reporting to me another surge in Jumbo Loan rates for 30YR fixed loan products reflecting the increasing risk seen by lenders towards the mortgage markets.

The exact quote from Michael is...

"Jumbo rates are awful; 30 yr at 7.375% - 7.5% depending on LTV and credit. It is 0.125% higher than last week"

In addition, short term ARM product rates are rising because quite simply the risk is increasing for this type of loan product and fewer investors are willing to buy these riskier loan products on the secondary mortgage markets. That means lenders may be stuck holding the bag and that is something some don't want to do. According to the report:

Treasury yields dropped on AUG 30th as investors fled asset backed commercial paper in favor of the safety of government debt. The credit market situation is becoming quite unpredictable, with reports coming out almost every day detailing further ills for companies and the market as a whole. The housing market remains in a deep slump while consumer confidence is waning. We expect these factors to keep downward pressure on long-term mortgage rates in the near term. However, shortert-term ARM rates rose sharply this week and will carry upside risk as liquidity has dried up for these riskier mortgage instruments.

Great stuff from the inside trenches of the lending world here in Manhattan. WHAT ARE YOU BUYERS SEEING OUT THERE WITH RATE QUOTES? IS THIS REPORT ACCURATE OR OFF?

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That Pesky Libor Rate Hits 8-YR High

A: It's a misperception out there that borrower's lending rates and adjusted mortgage rates are based on fed funds target of 5.25%; not so as I have pointed out before here on urbandigs.com. Instead, lending rates are based more on the bond market while all those adjustable ARM loans are based on the LIBOR rate, which is now at 8 1/2 year highs. That means if you have an adjustable rate mortgage and the fed cuts the target rate, you MAY NOT feel any relief! If LIBOR continues to stay at these heightened levels, resetting ARM's will face significantly higher monthly payments when the lock in expires. Lets discuss.

This is important because many resetting adjustable rate mortgages are based on the LIBOR rate. I discussed LIBOR previously in my post titled, "Global Feds, LIBOR Rate, & Fear Continues" back on AUG 10th where I stated:

It's an index that is used to set the cost of various variable-rate loans, including credit cards and adjustable-rate mortgages.

Recently, this LIBOR rate has been moving higher; a bad sign for all those with adjustable rate mortgages that are resetting to current LIBOR rates. If you are a resetting ARM holder, you may see your monthly payments jump even higher.

According to an article today in Forbes.com:

The costs for banks of borrowing money over a three-month period hit another eight-and-a-half year high today as the credit crisis sparked by losses from US sub-prime mortgage investments made banks increasingly unwilling to lend money.

The London interbank offered rate (Libor) fixing for three-month sterling deposits -- the rate at which banks lend to each other -- jumped to 6.79750 pct, the highest level since late 1998 following the collapse of the hedge fund Long Term Capital Management.

Something to keep an eye on as more distressed homeowners who can't afford their payments means more defaults, more foreclosures, more risk in mortgages, less interest in secondary mortgage markets, even tighter lending standards, etc..The trickle effect is a long one and I think it is safe to now say that 2008 poses the most important test for housing in the past 15 years or so.

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Markets Forcing The Fed Into Rate Cut?

A: I have to stick to more heavily weighting macro discussions on urbandigs while so many changes are taking place. Its just very important to explain to you why things happen. Right now, the short term US Treasury markets are rallying bringing yields WAY WAY down! Normally, the spread between the 3 Month T-Bill and the fed funds rate is about 50 - 75 basis points (0.50% - 0.75% spread in yields). We know that the fed funds rate stands at 5.25% right now, but 3-Month T-Bill is now yielding below 3%, over 200 basis points spread! This is the markets way of forcing the feds hand into a rate cut, and it may just work!

First off, there is much debate about whether this is the markets way of forcing the feds hand, a repricing of assets to quality and out of anything associated with risk OR the markets overshooting as they normally do which will ultimately correct itself. In either of these cases, its worth discussing.

Check out what the 3-Month T-Bill yield has done over the past 4 weeks; just an amazing rally in bond price and subsequent steep selloff in yield (a drop of over 240 basis points or 2.4%!). I circled the yield change from last month to yesterday for ease of interpretation.

This discussion focuses on the 3-Month T-Bill, whose yield movement over the past 30 days I just circled above, and the spread that this short term yield now has when compared to the fed funds target rate of 5.25%; I discussed credit spreads widening about two weeks ago. Historically, the spread between these two instruments are about 50-75 basis points OR 0.50%-0.75%. However, in the past 30 days due to the repricing of risk, the spread between these two has gapped to about 240 basis points. Reasons why could include:

1. T-Bill Markets Are trying To Force The Fed To Cut Rates To Normalize The Spread
2. Short Term Treasury Yields Are Experiencing A Flight To Quality As ALL Risk Is Avoided
3. Short Term Treasury Yields Are Pricing In Severe Deterioration In Economic Conditions
4. Short Term Treasury Markets Are Overshooting & Will Correct As Risk Repricing Continues

Yesterday alone, the 3-Month T-Bill experienced the steepest decline in yield since the crash of 1987; the T-Bill yield was down by a full percentage point before recovering!

MoneyAndMarkets has a great peice on what is going on in the short term T-Bill markets yesterday:

Some of the world's largest and most "professional" investors, so cozy in their complacency just days ago, are dumping short-term loans (commercial paper) like hot potatoes, especially those backed by mortgages.

* The 1-month T-bill rate has plunged from 4.52% last Tuesday to as low as 1.25% today. That's not a typo! It was actually down by more than THREE full percentage points in just four trading days!

* Today alone, the 3-month T-bill rate was down by over one full percentage point before recovering a bit.

* The all-critical spread, or difference, between the 1-month T- bill and 30-day commercial paper rates is now as much as THREE times bigger than it was just a few days ago - another confirmation of panic in these markets.

First - even investors in the shortest-term debt market are shunning any kind of loans with risk attached to them. They don't want sub-prime paper. They don't even want prime paper. They just want ultimate safety - short-term Treasury bills backed by the full faith and credit of the U.S. government.

Second - if you've got a chunk of your nest egg in one of our favorite short-term Treasury-only money funds, good. It means you already own what nearly everyone else now wants.

But if your fund has an average maturity of just a few days, don't be surprised if your yields start dropping sharply very soon.

Third - don't be surprised if the panic in the U.S. money markets soon becomes a panic in the U.S. stock market. Heck, if investors think normally-safe commercial paper is so risky, why should they believe stocks are any less risky?

Fourth - with the yield on U.S. Treasuries plunging, watch out for another, even more severe plunge in the U.S. dollar, especially against the Japanese yen.

Fifth - brace yourself for more. Today's panic in the money markets is just a sampling of what's possible in the days ahead.

Personally, I think the markets will successfully get what they want: A FED MOVE! I expect a fed rate cut in September UNLESS tradable markets show a bounce and close near 13,400 or so by the next meeting. However, I dont expect that. I expect uncertainty to continue and volatility to be high as markets re-price risk. I think there are many hedge funds, lenders, and banks still yet to come out with their holdings. The fed may have to move sooner rather than later and an intra-meeting rate cut is certainly possible. It's going to be a wild few months!

**Investors.com: 3-Month T-Bill Yield Sees largest Drop Since 1987 Crash Amid Flight To Safety

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Mortgage Report: August 20th - 24th

The Federal Reserve moved in last Friday to calm the financial markets and cut the discount rate by 50 basis points to 5.75%. This is the rate at which the Fed lens money directly to commercial banks, credit unions, and large savings and loans institutions. The Fed's move to cut the discount rate has no impact on mortgage rates or consumer rates like home equities.

As the press continues to sensationalize the mortgage meltdown nationwide, we need to
remember that our NY Metro Marketplace is in much better shape than most of the rest of
the country. Yes there are clearly many changes being made by banks on a daily basis and
more banks will fold - and some types of loans are harder to get today than they were even
just a week ago - but the mortgage market is not broken - it is correcting and we cannot lose
sight of the many lenders, especially our portfolio lenders, that continue to offer COMPETITIVE
rates and mortgages to all sectors of the marketplace.

You CAN still get a No-Income Verification loan
You CAN still borrow 90% on a mortgage – in fact there are still lenders allowing 100%
You CAN get a fixed rate at 6.75% with 0 points up to $1 million
Banks ARE still lending on super jumbo loans – no loan size too large
You CAN still get a home equity loan
You CAN still get financing for an investment property
YOU CAN STILL GET A GOOD MORTGAGE.

Yes, the playing field has changed and many of the banks that we have done business with
over the years are going through a period of correction and they will be back but, in the meantime, we have a large number of portfolio lenders that are ready to lend money and they have not increased their rates. We are simply going back to doing business the old fashioned way – and this is a good thing for the future of the Real Estate Market.

Best,
Steven

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Bernanke Cuts Discount Window

A: The Federal reserve cut the discount window rate, the rate that banks can borrow at, by 50 basis points in an effort to normalize liquidity concerns amid growing downside risk to the US economy. This is an amazing move by the fed WITHOUT cutting the fed funds target rate which continues to stand at 5.25%. Bernanke is quickly gaining an enormous amount of credibility by the timing of his actions in dealing with this credit mess, and not cutting the target rate to maintain longer term policy goals. Amazing job Mr. Bernanke! First the liquidity injections and now the cur in the discount window rate. Lets discuss.

Obviously, and I agree completely, cutting the target fed funds rate is an emergency option for the fed. Instead, the fed cuts the discount window today and offers a so called 'time-out' for markets. Let me first define the discount window and the fed funds target rate so you know the difference and exactly what Ben Bernanke did today.

Discount Window Rate - Discount window represents an instrument of monetary policy (usually used by central bank) that allows eligible institutions to borrow money, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. The interest rate charged on such loans by central bank is called discount rate, and constitutes important factor in the control of money supply -- which is a significant tool of monetary policy. When a bank in the United States is in need of money, it can turn to the Federal Reserve for a loan, the interest that the Fed charges the bank is called the discount rate.

Fed Funds Target Rate - The federal funds rate is the interest rate at which private depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight.

According to Yahoo Finance:

The Federal Reserve, declaring that increased economic uncertainty poses risks for U.S. business growth, announced Friday that it has approved a half-percentage point cut in its discount rate on loans to banks.

The action was the most dramatic effort yet by the central bank to restore calm to global financial markets which have been roiled in the past week by a widening credit crisis.

The decision means that the discount rate, the interest rate that the Fed charges to make direct loans to banks will be lowered to 5.75 percent, down from 6.25 percent.

The Fed did not change its target for the more important federal funds rate, which has remained at 5.25 percent for more than a year.

Another way banks can borrow funds to keep up their required reserves is by getting a loan from the Federal Reserve itself at the discount rate. These loans are very short term and rare, as they are subject to audit by the Fed and the discount rate is usually higher than the federal funds rate.

What does this move do?

1. It Adds Credibility - tells the markets that Bernanke & Co. are on top of the liquidity crisis in the banking system and willing to provide the liquidity needed to normalize the markets.

2. Provides Lift To Equities - stock futures first down big, reverse course and surge. Gives a great opportunity for those long equities to unwind some positions and puts shorts in a very bad situation of having to cover, further bullying the stock market.

3. Adds Liquidity To Banking System - alternative move gives more liquidity to the banking system and allows banks to borrow money on a short term basis, to meet temporary shortages of liquidity

4. Yield Curve Steepens - Banks like a steep yield curve so they can profit more. Todays fed move is steepening the yield curve, a good thing for banks

5. Brings Arbitrage Players Back - which helps the markets become more efficient. How long it lasts is another question.

It's important to note that this is NOT A PERMANENT FIX! This is going to have a temporary effect and in my opinion, gives investors a chance to unwind positions and banks a chance to fix their books a bit. It does not solve our credit problems longer term! I'll have to do follow up reports on this once the market opens and I need a chance to unload some long positions I have been building up over the past 4-5 days as the market sold off.

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Wells Fargo Rate Jumps To 8% Overnight?

A: Not news, as this was announced late last week and is a result of the re-pricing of risk I discussed previously. On Friday, Wells Fargo announced that the rate for jumbo fixed rate loans will jump from 6.78% to 8% overnight due to the increased risk in the credit markets and specifically loans made to residential home buyers. While their website still shows lower rates for Jumbo loans, I'm sure that 8% quote is for those that are at the bottom of the credit quality food chain. In essence, this is Wells Fargo's way of tightening lending standards and controlling their exposure to mortgage risk without outright shutting down the loan products altogether. Whether or not other major lenders will follow suit remains to be seen.

Lets jump right to the news. Wells Fargo Raises Rates: Are Homeowners Out In The Cold:

"They're pulling themselves out of the market to regroup," is what one of my mortgage broker buddies told me on the phone this morning when I asked how in the heck Wells Fargo could raise rates on a 30-year jumbo fixed rate mortgage from 6 7/8% to 8% overnight. A jumbo is anything over $417,000, and given today's home prices, that's going to hit an awful lot of borrowers.

Then he tells me he got an email this morning from Vertice, which is part of Wachovia, saying:

Based on current market conditions, investor appetite and liquidity for Alt-A features, including higher LTV/CLTV products and reduced documentation types, have all but disappeared. In response, Vertice is announcing the temporary suspension of a number of programs effective immediately.

This means they're pretty much not doing Alt-A loans anymore (these are the loans somewhere between prime and subprime--the "low-doc" or "no-doc" loans with no income verification). There's just no liquidity for Alt-A. The CDO's are not being packaged and sold anymore because there's no market for them, so forget it.

IndyMac Bancorp (IMB) - CEO Michael Perry states that the market for mortgage backed securities is "very panicked".

Countrywide Financial (CFC) - Nation's largest home lender states they are seeing a spread from subprime defaults into alt-a and prime borrowers. Also states they have plenty of funds to weather the storm.

National City Corp. (NCC) - Said yesterday that it is suspending originations of stated-income loans, which don't require the borrower to verify income

Wachovia (WB) - Said it had stopped making Alt-A loans through brokers, joining a trend among big lenders to rely less on outsiders to arrange mortgages

Wells Fargo (WFC) - Raises rates on jumbo loans. Tells brokers this week that it was making "day-to-day" decisions on the pricing and availability of Alt-A loans amid reduced investor demand.

Accredited Home Lenders Holdings (LEND) - Stock dives after auditors said its "financial and operational viability" is uncertain if a pending merger isn't completed

American Home Mortgage (AHM) - Stopped making loans earlier this week, said late yesterday it would cease most operations, slashing its work force to about 750 from more than 7,000

Novastar Financial (NFI) - Will temporarily suspend funding for wholesale loans that have not been locked in. Suspension will last until Aug 7th when a re-evaluation will take place.

MGIC Investment (MTG) - Says $515M partnership stake in C-Bass, may be worthless. C-Bass hires Blackstone Group to advise and help raise cash to "help solve the liquidity challenge it currently faces."

Sound contained to you? I didn't even include the big bond players that are no longer buying these repackaged MBS. This is a perfect example of the widening of credit spreads that is happening at a very fast pace as the correlation between treasury yields and lending rates widen.

As long as the credit crunch continues to play out and more lenders publicly announce how deep their troubles really are, I would expect more of the same in the lending industry in the near term. Here is a chart of Jumbo Rates as published on Wells Fargo site right now:

Unfortunately I couldn't get any inside information to you as my favorite Wells Fargo contact Michael McGivney is in quarantine and not allowed to comment on the fast changing environment that surrounds their institution. I don't blame them for advising their lenders to keep quiet until credit concerns die down a bit. However, he did say that his rates are approximately 0.125% lower than what is quoted on the above chart, and that obviously depends on credit risk, risk adjusters, loan amount, relationship with wells fargo, and the other normal items that effect the ultimate rate you will be quoted.

Prospective home buyers are not only facing less options as tighter lending standards limit the number of loan products at their disposal and the conditions get stricter for qualifying for these loans, but now they need to deal with a jump in rates as well as risks rise.

Just so all of you are clear on one very simple and fundamental issue regarding credit: AS RISK RISES SO DOES THE RATE ASSOCIATED WITH THAT LOAN. IN OTHER WORDS, LITTLE RISK OFFERS LOW RATES & HIGH RISK DEMANDS HIGHER RATES

All of the lenders, brokerages, homebuilders and other industries directly exposed to the re-pricing of risk will continue to face pressure until the markets fully correct themselves and that will only happen when companies come clean, write down the losses, and remove the uncertainty.

I worry that this rational behavior might be difficult to gather, as companies try to ride out the bad times and do everything possible to avoid financial distress and investor/shareholder losses.

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Should Fed Step In To Save Credit Markets?

A: There is talk on the street about whether or not Bernanke & Company at the fed should jump in and become the savior, or ‘lender of last resort’ to help the credit markets in their time of turmoil. Barry Ritholtz recently criticized Jim Cramer on his blog, The Big Picture, for practically begging the fed to step up and cut the fed funds rate! In my opinion, this would be a drastic mistake and I am not betting on any rate cut by our fed at this time; agreeing with Barry's ultimate conclusion that its not the fed's job to bail out speculators and 'guarantee a one way market', as he says. The fed meets on Tuesday and I'm betting on no change, with hopefully an adjustment in the issued statement removing the 'tightening bias' phrase so that a neutral bias is put in place for future meetings/actions; slow and steady.

First Off - Check out the Jim Cramer Madness on CNBC late last week. The blowup happens halfway through the video:

The fed’s job is not to bail out bad bets. It is the markets job to correct itself and the environment we are in right now, the re-pricing of risk is the markets way of fixing the current credit mess. These funds that are in trouble made tons of loot during the past years with their high risk high reward bets. Sometimes it doesn't work out. You can't just expect the fed to come to the rescue every time this happens. One could easily argue that one of the reasons we are in this mess in the first place is because Alan Greenspan cut rates so drastically from June 2000 to October 2002 (from 6.5% all the way to 1%), pumping the system with liquidity to stimulate the economy after the dot com bust and 9/11. The result was excess liquidity which led to a housing boom, that of course was unsustainable. This time around, let the markets adjust and hopefully get help from our corporate leaders! A 5.25% fed funds rate is not restrictive given the global boom and worldwide inflation concerns that are still in place.

During Friday’s 2PM Bear Stearn’s conference call to investors, the CFO of the company described the current credit environment as the “…worst in 22 years”! While this may be true, the problems are not big enough to warrant any fed action in monetary policy at this time!

Let the markets re-price risk on their own and let the companies who made bad bets take their losses and write-offs! This is extremely important if we are to get though this mysterious crisis! I’ll repeat:

LET THE COMPANIES WHO MADE BAD BETS STEP UP TO THE PLATE, PUBLICIZE THEIR LOSSES, TAKE BOOK VALUE & LIQUIDATE BAD HOLDINGS IN ORDER TO WRITE OFF THE LOSSES! ANNOUNCE A RE-STRUCTURING EFFORT AND PUBLICIZE EXACTLY WHAT IS BEING DONE TO FIX THE PROBLEM & BRIEF INVESTORS ON THE FUTURE DIRECTION OF THE COMPANY

By coming out in this manner and letting the current value of their holdings to actually trade and liquidate would allow the financial markets to weed out the bad bets made and the losses to be written off. While it will be painful for the companies and their investors to do this, it will be better for the overall credit mess and it will allow the markets to function more effectively in re-pricing the risk so that we can move past the mysterious problems that we now face. It’s the uncertainty right now that is killing equities.

If the fed comes out and cuts interest rates to help the current credit problems, it will come off the wrong way and will be interpreted as an acknowledgment by our monetary policy makers that there are major issues that are seriously bothering them right now. While stocks will likely rally due to the surprise of action, in the longer term it will spook investors and not have the desired liquidity effect of the fed coming to the rescue. Lets not forget, a rate cut now is only good for psychological reasons and will not 'kick-in' until 8-12 months down the road. Lets see things get way worse before any fed action is put into place so that a more planned and systematic course of action could be put into effect.

Instead of cutting rates at Tuesday's meeting, in my opinion the fed should:

1. Remove the tightening bias in the statement. Excessive growth should no longer be a concern and inflation, while still a global threat, seems to be moderating here in the US.

2. Take a balanced stance between growth & inflation. Perhaps mention that credit concerns are being monitored.

The fed meets Tuesday and I’m betting on NO CHANGE in rates with hopefully an updated statement as I noted right above.

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Its A Risky New World: Credit Spreads

A: Back to blogging in a very different world. While the news that has come out in the past few weeks at Bear Sterns, American Home Mortgage, Countrywide Financial, etc. is by no means a surprise, they have been the most direct contributors to the current instability in the mortgage markets leading to a re-pricing of risk in the corporate and residential debt markets. As a result of this uncertainty, stock prices have corrected from record highs, especially the financials and homebuilder stocks, and there has been a flight to quality into the bond markets driving down yields as investors seek the safety of treasury returns. However, you may have noticed that lending rates have not dropped that much considering the 10YR yield fell by over 50 basis points in the past 4-5 weeks. The reason why lies in RISK!

Lets get right into this mess! For the past few years I have been explaining the relationship between stock markets and bond prices/yields, inflation, fed moves, currency trends and global growth and how they all relate to the Manhattan real estate marketplace and your investment! I try my best to simplify these macro issues so that you can understand what is going on in the world and why rates go up or down leaving you with either a lower or higher monthly payment on mortgages, credit cards, and other forms of debt. But now, the world is really changing and rather than stick to the old model, we MUST adapt quickly with the markets to understand where we are RIGHT NOW in the hopes of best understanding how any changes might relate to our investment decisions.

In the Old World (2002-2006) - Money was very inexpensive to borrow, especially in the beginning of this range. After Sept. 11th and the dot com stock market crash, the fed did everything possible to pump liquidity into the financial systems via cutting the fed funds rate all the way down to 1%. The effect took a year or so to kick in with stock prices bottoming out in 2003 (in hindsight), and lending rates fell to ultra low historical levels providing homeowners with amazingly low rate offers for home purchases. This pumped up affordability and led to a housing boom involving real buyers, developers, and speculators. Lenders of all types jumped on the bandwagon and offered very creative loan products to prospective buyers as home prices boomed and buyers found asking prices out of their budgets. The exotic loans made the home payments more affordable, albeit for a little while. The fed started raising rates at very small increments (mainly at 0.25% clips, or 25 basis points) all the way up to today’s level of 5.25%. The effect of this rate tightening took some time to kick in again, leading to the new world of higher rates and more expensive debt.

In the New World (mid 2006 - Present) - Subprime woes, bad loans, resetting ARM’s, rising rates, falling home prices, rising defaults, tighter lending standards all started to come to a head. Higher rates started to wake up homeowners to the new reality that monthly payments are significantly higher than they first thought; especially for those with resetting short term ARM products and interest only loan products. Defaults started to rise. The lenders found themselves in a bit of trouble as the repackaging and reselling of mortgage backed securities became more and more difficult as risk started to rise in the mortgage markets. In lay terms, with defaults rising and home prices falling, fewer and fewer investors wanted to buy these mortgage backed securities. Those funds that had to sell were forced to liquidate their holdings at levels far below what they thought they were worth; Bear Stearns funds are a great example of this. Other funds and lenders tried to ride out the wave until they had margin calls due and couldn’t pay up; American Home Mortgage is a great example of this. All in all, there is a re-pricing of risk going on in the tradable markets right now and risk is getting very expensive driving up rates for risky debt. As a result of this, those holding mortgage backed securities and CDO’s are having trouble finding buyers and are forced to liquidate at big time losses. Liquidity is drying up and that is bad for everyone. This is the world we live in. This is the beginning of a credit crunch. Every company with exposure to this is feeling pain.

Credit spreads are widening as a result of all this. In other words, the difference between corporate bond yields and US government treasury yields are increasing as the risk associated with corporate paper rises! Relating this to the mortgage markets, while short and medium term US gov't treasury yields are falling fast due to a flight to quality as stock prices fall, the rates on mortgage products are NOT falling at the same pace! This is because mortgage debt is now MORE RISKY than treasury bond notes and therefore demands a HIGHER RISK PREMIUM to gather investorsl i.e. higher yields. This is causing the spread between the two to widen.

Confused? I'll put a pure definition of credit spreads up here to hopefully clear things up.

Credit Spreads - In finance, a credit spread, or net credit spread, is the difference in yield between different securities due to different credit quality. The difference between the yield on a corporate bond and a government bond is called the credit spread. As such, the credit spread reflects the extra compensation investors receive for bearing credit risk (these last 2 sentences & hypothetical chart example below via Investopedia.com).

I have said for a long time that the 10YR bond is our most reliable short term indicator as to where lending rates are headed in the very near term. Due to the current credit crunch and re-pricing of risk, this NO LONGER APPLIES as a reliable indicator!

Due to the re-pricing of risk, mortgage rates are NOT falling as much as one would think with such a dive in 10YR bond yields over the past 4-5 weeks. As more and more lenders go under and less options become available to homeowners and perspective buyers (stated income loans are starting to go away now), rates are going to be in a generally upwards trend (Wells Fargo recently announced that 30YR rates for jumbo loans are going to be around 8% - I'll write on this topic shortly)! In short, the risk is too high to allow mortgage rates to fall in conjunction with falling bond yields; again, causing the widening of credit spreads.

Starting to get it? If I were a soon to be homeowner, I would keep my eyes glued to what is going on in the credit markets. Its hard to miss! Just watch CNBC for 15-20 minutes at any given time and you should catch at least one economic discussion on the topic. For those interested in more in depth conversations on the topic, tune in to Kudlow & Company on CNBC from 5-6PM daily and I guarantee you will start to learn more about what is going on in regards to the re-pricing of risk currently underway.

It’s a changing world. Either you realize it and adapt with it, or you lose; plain and simple. I believe bond yields will continue to be pressured as long as this credit mess is around with more and more lenders and home builders getting into trouble in the near future. Every time a major lender goes under, tighter lending standards get more real, risk gets more attention, and home loans should demand higher rates and stricter underwriting requirements.

In the end, its healthy for all markets that this is a known problem and that its OUT for the markets to adjust to. It would have been worse if there were cover ups on this delaying the inevitable to a later time; this is yet to be seen. Instead, lets get it all out now or in the very near future and let the tradable markets do what they have to do to absorb the problems so that a longer term sustainable growth pace can reveal itself. In the meantime, we are still trying to find out how deep this rabbit hole is!

Lets See Why This May Ultimately Hit Manhattanites - Stock/Job losses are the most direct threats to the continued sustainability of the New York City real estate marketplace. If stocks flounder, it could start a chain reaction of events that includes job losses, contraction in bonuses, lower salaries, weaker buyer demand, and forced resales of already purchased properties that were bought by unsuspecting high earners hurt by job loss or salary/bonus cutback. It could also put some fear into non wall street homeowners who will choose to sell and pocket profits made over the past years. The current inventory tightness could reverse as a result providing more competition amongst sellers during a time with weaker buyer demand and higher interest rates on loans. All of this has not yet occurred and is only a potential outcome should stock losses really hit the market. I will not comment on the likelihood of this happening due to the uncertainty in the credit markets and what may be done about it.

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Mortgage Report: July 30th - August 6th

U.S. treasuries did extremely well last week and gained ground they had lost five months earlier. The yield dropped 16 basis points and ended at 4.80%. The stock market lost 586 points for the week overall. When traders and investors unload stocks they usually place their monies in bonds and that's why home loan rates stabilized. This week the Personal Consumption Expenditure Index and monthly jobs report are expected to be released and will have an impact on the yield. If inflation numbers are lower than expectations while the data for the economy is worse than expected home loan rates should improve. As a general rule, weaker than expected economic data is good for rates and positive data causes rates to rise.

Please call or email me if you have any questions.

Best,
Steven

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Watch That 10YR For Rate Lock-ins..!

A: While I'm away, be sure to watch the 10YR for a rise in yields! They closed at 4.8% and I don't expect them to stay at these low levels for that long! If your close to a rate lock in, I would consider doing it soon especially if these yields start rising, which is what I would bet on after the huge drop off in past week. The lending markets already corrected at a lag from these rate drops, and who knows how quickly they could rise if bond yields start going up again! Keep your eyes open.

Just a heads up as postings will be light for next few days while Im in SF for Inman Conference! Read my post a few days ago on Rate Check Follow Up for more about this.

Good Luck.

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Rate Check Follow Up: Watch For Lock-In

A: Exactly 1 week ago I wrote a post titled, "Bond Yields Fall / Lending Rates Next" in anticipation of relief in the lending markets for all you prospective purchasers out there. Here is the follow up. In the post I predicted relief in lending rates as the lagging effect of the mortgage markets react to the fall in the 10YR bond yield. Since, we have had some fear installed in the tradable markets with the accompanying uncertainty causing a flight to quality in the bond markets. That drove down equity prices and drove up bond prices resulting in lower bond yields; bond prices and yields move in opposite directions. Due to this change in market psychology and resulting lower bond yields, those buyers looking to lock in their rates have something to be excited about. Lets analyze.

First off, here is the drop in the 10YR bond yield over the past 30 days. As you can see, yields are down about 40 basis points (0.40% - WOW) since July 6th!

When I wrote that post a week ago, lending rates were at...

JUMBO Loan Rates Quoted At...

30YR Fixed - 6.875%
7YR ARM (principal + interest) - 6.375%
5YR ARM (principal + interest) - 6.125%

*Disclaimer - Rates are subject to change based on loan amount, credit, risk adjusters, and a minor banking relationship with Wells Fargo. All may affect the final rate quote.

...as quoted by Michael McGivney of Wells Fargo.

Today I went with Steven Maasbach of Manhattan Mortgage Company to provide me with rate quotes. Here they are showing you the drop in the past 7 days or so. Please note their disclaimer.

JUMBO Loan Rates (no points) Quoted At...

30YR Fixed - 6.625% (drop of 0.25%)
7YR ARM (principal + interest) - 6.25% (drop of 0.125%)
5YR ARM (principal + interest) - 6.125% (no change)

*Disclaimer - Interest rates and products are subject to change at any time without
notice. Manhattan Mortgage is not responsible for any rates that may
change prior to lock confirmation.

So, what do you do if you are in the midst of signing that contract or just recently signed the contract and are attempting to time your interest rate lock in? WATCH 10YR YIELDS!

Now that 10YR yields had a huge drop in a relatively short period of time, I would expect the lagging effect into the mortgage markets to continue for a few more days on top of what already happened; hopefully! Here is what to do and how to follow it yourself.

BE PATIENT & DON'T LOCK IN YET - -> The recent move will probably still take a few more days to trickle through to lending rates. As long as 10YR bond yields continue to stay around 4.78% OR continue to trickle lower there should be some more slight relief in lending rates to come early next week. Any move BUT UP means you can be a bit patient for that lock in.

LOCK IN RATE WHEN 10YR YIELD BOUNCES HIGHER ---> Only lock in the rate if you see a surge in 10YR bond yields in the coming trading days; as a bounce in bond yields is very possible and if it does happen it could be sharp! Thats what you are waiting for to pull the trigger on your lock in! If 10YR bond yields surge to 4.95% on Monday, then you lock in your rate immediately! You are on '10YR bond yield SURGE WATCH' as the indicator to pull the trigger on locking in! I can't be more clear on this. If the surge doesn't happen, then be patient. If it does, lock the rate in that day as the next few days should see a rise in lending rates as the lagging reaction.

I don't see any action from the fed even in the face of what happened this week in the credit and equity markets. I think they are still on hold so in the meantime, you must understand how to ride the short term volatility in the bond markets if you are trying to time your rate lock in. Its the best near term indicator we have.

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Bond Yields Fall / Lending Rates Next?

A: With disappointing earnings from GOOG, CAT, INTC, and continued uncertainty in the subprime markets, stocks are getting a bit jolted today. Honestly, its completely healthy as the tradable markets have been on a tear for the past few years. You must understand that traders are emotional and react as such! With slumping stocks, there is a flight to quality in the bond market pushing bond prices higher and yields lower (bond prices and yields move in opposite directions). The 10YR bond yield dropped convincingly below that 5% mark today and if it holds, should provide some nice relief to prospective buyers with easing lending rates as we get into next week.

Here is a chart showing you the past 6 months (and the original surge) of the 10YR bond yield but does NOT include todays 8.5 basis point drop (0.85%) so far:

Here is today's drop with 10YR yields currently at 4.94%:

Now, yields are still at a higher trading range from where we were earlier in the year when 10YR yields were around 4.5% or so. This is what comes with volatility and so much uncertainty, however, it doesn't change the fundamental challenge to contain very fast global growth and inflation. Even the fed recently declared that inflation is their #1 concern, reducing expectations of any fed cut.

I still think yields are in a general upwards trend, especially as global central banks raise their rates, so all of these short term moves are really only helpful to discuss for those who:

a) recently signed a contract of sale and are deciding WHEN to lock their rate in

AND

b) very serious prospective buyers with a time pressure to purchase who need to understand where lending rates are headed so that affordability can be analyzed

*************************
UPDATE: 2:09PM EDT - Let's see what happens. According to Michael McGivney of Wells Fargo, a direct lender, here are today's rate quotes for three popular loan products:

JUMBO Loan Rates Quoted At...

30YR Fixed - 6.875%
7YR ARM (principal + interest) - 6.375%
5YR ARM (principal + interest) - 6.125%

*Disclaimer - Rates are subject to change based on loan amount, credit, risk adjusters, and a minor banking relationship with Wells Fargo. All may affect the final rate quote.
**************************

UrbanDigs Says: As 10YR yields drop, a lagging effect will hit the mortgage markets giving you lower offered rates in the days to come. The question you need to look into now if you fit into criteria 'a' as I noted above is, will this dropoff in yields HOLD? If it does, expect better rate quotes early to mid next week for lock-ins. If it doesn't, any relief will be short lived. If yields keep dropping and reach 4.85% or so, wait a bit longer as the lag to hit the mortgage markets will take a few extra days. Stay on top of this & lock in your rate accordingly!

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Don't Get Too Excited About Rates

A: Just saw this news reports released via AP on Yahoo Finance, "Rates on 30-YR Mortgages Sink". This is the lagging effect of the 10YR bond yield dropping from 5.1's to 5.0% over the past week or so. However, in the past 2 trading sessions the 10-YR bond yield is UP 12 basis points and now trading around 5.12%! You know what that means. Don't expect lending rates to stay at these relief levels after the huge runup in early June! I would anticipate lending rates to rise over the next few days especially if bond yields continue their volatile upwards trend.

According to Yahoo Finance article released at 11:32EDT today:

Rates on 30-year mortgages sank this week to a one-month low, while rates on most other mortgages also fell, good news to prospective home buyers.

Freddie Mac, the mortgage company, reported Thursday that 30-year, fixed-rate mortgages averaged 6.63 percent. That was down from last week's 6.67 percent rate and was the lowest since early June, when rates stood at 6.53 percent.

The moderation is welcome for people in the market to buy a home. In mid-June, rates on 30-year mortgages climbed to 6.74 percent, an 11-month high.

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US Dollar, Global Rates, & Our Fed

A: US Dollar is getting pounded today as the Bank of England does what it needs to do to stave off inflation concerns and keep economic growth at bay; it raised its overnight lending rate 1/4 point to 5.75% strengthening their currency over the US dollar. With our fed on hold for the foreseeable future, we don't have the catalyst to support our own dollars. Meanwhile, the European Central Bank left rates unchanged at 4% but will most likely hike rates before October. At home, energy & commodity prices are still high, inflation seems to be moderating (for how long I wonder) and the economy seems resilient to the still worsening national housing correction. In short, there is NO WAY the fed can afford to cut rates anytime soon and bond yields are clearly in a generally upwards trend.

Three reasons why the fed can NOT cut interest rates and rather could be argued in favor of a rate hike include:

1. Globally Rising Rates / Strong Global Economies - Rates are in an upwards trend across the globe as central banks attempt to balance growth & inflation at the same time. A very hard job to do. With very strong economies in Europe, Asia, and some other emerging markets (much stronger growth than we are seeing here in US), rates have risen to slow things down and help prevent inflation from getting worse. The job is still not done yet because the story is still being written. Right now, you are STILL seeing the after-effects of years of ultra cheap money and mega liquidity! While the engine to this freight train has been slowed, the speed of the train is yet to come down with it! No way the fed cuts rates while global central banks continue to hike theirs!

Keep close tabs on how this plays out because in the years to come we will eventually see the ultimate effects of rising rates and trimmed liquidity. For now, enjoy the good times and try to learn how long it takes for globally rising rates to have a slowdown effect on economies; which is the ultimate goal by the way. Why slow things down? Central banks know that by letting economies grow like wild fire and inflation to get out of control will have much more severe long term effects than if slowed down in a calculated manner.

2. Weak US Dollar Must Be Supported - Due to the Bank of England's rate hike to 5.75% we are seeing strength in the british pound versus the US dollar. It now takes over $2 US dollars to buy 1 British pound, a record high I believe. Here is a 1 year chart showing the downward trend of the US dollar's worth versus the pound:

The drag on the US dollar doesn't stop here as the Euro is also enjoying highs against the dollar making American assets very cheap for Europeans. An argument can be made that Manhattan real estate is being supported by foreign buyers taking advantage of currency trends; among other fundamentals.

As long as our fed stands on the sidelines with monetary policy, which they obviously are doing, the US dollar will gain little support from our policy makers and will continue a trend of erosion.

3. High Energy & Commodity Prices Could Be Inflationary - At a lag that is. With the price of oil hovering over $70/barrel and the US dollar weakening causing other commodities to rise (gold, silver, etc.) future inflation concerns are warranted. Rises in the price for corn, oats, wheat, milk, cocoa, orange juice, etc. just can't be ignored. No matter how you cut it, with commodity prices at such high levels one can only hope that this doesn't trickle down the economic system in the future leading to a general rise in prices paid for goods. For some, this has already happened.

Looking at the big picture, we have enjoyed ultra cheap money and tons of liquidity for many years leading up to today's global environment. Now that rates rose a bit, its narrow minded to think its over. In general I see a cyclical upwards trends in global rates the end of which is not in sight. It is very possible that rates continue their slow, upwards trend for years to come. Fact is, these are very confusing times and todays economy is vastly different than from past history. Questions I wish I could have answered include:

1. How will credit be effected by CDO mess?
2. What the longer term effects of high commodity/energy prices will be?
3. How high will rates have to go?
4. How low will US dollar fall before stimulative measures need to be taken?
5. What is the next unforeseen event?
6. What can possibly stop globalization?
7. Which global economy will be the first to unravel?
8. How will hedge funds react to changes in tax code?
9. Will capital gains tax be changed?
10. Will the fed's next move be a hike or cut?

Thoughts?

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Rate Check: Relief in ARM's Only

A: A week ago I wrote a post titled, "So Rates Rose & You Didn't Lock In", where I discussed some options for those who missed the boat in mid to late May to lock in their rate. I was hoping for some relief after the huge runup in lending rates over the past 4-5 weeks as the 10YR yield corrected from a trading high of 5.316% on June 13th. Currently, 10YR yields are in a trading range of between 5.08% - 5.19% or so and hovering around the 5.1% mark. So far there has only been rate relief in the adjustable rate loan products.

According to Michael McGivney of Wells Fargo, a direct lender, here are today's rate quotes for three popular loan products:

JUMBO Loan Rates Quoted At...

30YR Fixed - 6.875% (same as last week)
7YR ARM (principal + interest) - 6.25% (down from 6.375% last week)
5YR ARM (principal + interest) - 6.125% (down from 6.25% last week)

*Disclaimer - Rates are subject to change, size of loan, risk adjusters, and a minor banking relationship with Wells Fargo may all affect the final rate quote.

Keep an eye on 10YR yields for where lending rates might be headed next. Use this as a general guide:

MORTGAGE RATES WILL TREND LOWER IF ---> 10YR Yields Drop Below 5% & Holds
MORTGAGE RATES WILL REMAIN UNCHANGED IF ---> 10YR Yields Stay Between 5.05% - 5.15%
MORTGAGE RATES WILL TREND HIGHER IF ---> 10YR Yield Surges Over 5.2% & Holds

The goal here is to educate you on the relationship between the bond market (10YR bond yield) and the mortgage markets. Once you grasp an understanding of this relationship, you should be able to use the bond market as a very short term guide for where lending rates might be headed. Obviously you should focus on this if you are very close to signing a contract or if you are a seller trying to figure out what affects buyer demand. As rates rise affordability goes down and purchasing power is restricted. This is the current environment we are in AFTER rates and the 10YR bond yield made their respective moves higher. We are still waiting to see the full effects of higher borrowing costs on Manhattan property pricing.

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Any Rate Relief Will Be Temporary

A: Well, 2 days ago I told you to expect some relief in the mortgage markets, "...as long as there is no reversal to the downward trend..."! Of course, I picked the exact bottom to the 10YR's volatile trading of late as yields since jumped back up 14 basis points in 2 days time (0.14%) to near 5.21%. However, the lag did provide some relief to the mortgage markets as of yesterday and today, although not as much as I was hoping for. With 10YR yields popping back up again, expect any relief in mortgage rates to be temporary!

Here is the move in yields since I wrote the post "So Rates Rose & You Didn't Lock In?", 2 days ago.

According to CNN Money article yesterday titled, "Mortgage Rates Back Off":

Mortgage rates eased slightly after taking their biggest jump in four years a week ago, Freddie Mac said Thursday. Last year at this time, 30-year mortgage rates averaged 6.71 percent.

The rate on a 15-year loan averaged 6.37 percent, down from 6.43 percent a week ago. Five-year Treasury-indexed adjustable-rate mortgages (ARMs) averaged 6.31 percent this week, down from 6.37 percent last week.

Again, with rates already making their big move higher it is up to the buyer to keep tabs on the 10YR yield for clues as to whether they should LOCK IN now or wait a bit. It all depends on your unique situation and when you expect to close or refinance. If 10YR yields push back to 5.3%, LOCK IN NOW! If they drop back down to 5.1% or under, WAIT for the lag to provide relief to lending rates; a few days or so.

Post a comment if you have a specific situation you want my opinion on as far as when to lock in!

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So Rates Rose & You Didn't Lock In?

A: So many readers have emailed me about what to do now that rates just made a big run over the past few weeks and whether they should rush in now to lock in. My answer to them is NO! Here is why.

I write about interest rate trends as a very short term trend. I have NO IDEA where rates are going to be in 6 months! So, don't even ask. However, I do have a very good idea where rates are most likely headed in the next 1-2 weeks; making this component of urbandigs.com great for serious buyers and sellers.

If you read the site, then the run up in rates was not a surprise. So lets move on to what to do now. The 10YR woke up to reality and surged to an entirely new trading range which is currently trying to discover its boundaries. The 10YR yield reached a recent trading high of 5.316% back on June 13th. Six days later you can ask your mortgage broker how bad it was for their buyer clients who got the unfortunate news before locking in their rate.

But since then, we have fallen nicely a total of about 24 basis points, or 0.24%, over a 6-day period and are still drifting lower. This WILL provide relief to the mortgage markets toward the end of this week and beginning of next! According to Michael McGivney of Wells Fargo, a direct lender, here are current rate quotes for three popular loan products:

LOAN AMOUNT - $750,000

30YR Fixed - 6.875%
7YR ARM (principal + interest) - 6.375%
5YR ARM (principal + interest) - 6.25%

Lets see where these loan product rates are next Tuesday, and whether they reacted to the correction in 10YR yields at a lag! Here is a 5-Day chart of the 10YR yield showing the fall from the 5.31% tradable high reached on June 13th:

For Buyers Who Recently Signed & Didn't Lock In - Try to wait until this time next week! I think you MISSED the boat to lock in your rate 4 weeks ago in anticipation of your new home purchase, and there is more risk than reward in rushing to lock in after the move already occurred. The better play is to wait a week and watch 10YR yields for any sharp reversal in the downward trend. As long as there is no reversal to the downward trend, mortgage rates should see relief in the days to come!

The Bigger Picture Thought - With the overnight fed funds rate at 5.25%, there is talk on the street that the 10YR might be in a generally upwards trend, as long as the fed is clearly on hold. There very well could be a run up in 10YR yields so that it trades above the overnight rate. However, this is a longer term trend to watch out for and NOT something that should be taken into account if you have to make the rate lock in decision soon! When it comes down to days, look at the trend in the 10YR over the past week or two for a quick guide.

I also wonder how low yields really can go given that oil & food prices are STILL trending higher! With oil nearing $70/barrel, it should help provide a floor to dropping yields.

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Stocks Surge on Calm Core CPI - But Why?

A: This is the disconnect between the stock markets and the real world that makes equity trading so mysterious. When I saw the inflation numbers come out this morning at 8:30, I saw a surge in consumer inflation. But when you strip out the volatile food and energy components, the Core CPI rose only 0.1% as reported on CNBC. Stock futures surged as this was below expectations of a rise of 0.2%; giving a bullish knee-jerk reaction to the equity markets and a fall in yields. But when you look a bit deeper, it's not all rosy. Here's why.

First, the news. According to Yahoo Finance's article titled, "Consumer Prices Shoot Higher in May":

Consumer Prices Shoot Up at Fastest Pace in 20 Months in May, Fueled by Surge in Gas Prices. So far this year, consumer prices have been rising at an annual rate of 5.5 percent, double the 2.5 percent increase for all of 2006. The acceleration has occurred because of the surge in energy costs and increases in food costs that have been caused in part by higher demand for ethanol fuel, which is produced with corn.

Outside of the volatile energy and food categories, inflation rose by a much more modest 0.1 percent. That was slightly lower than the 0.2 percent which had been expected and provided reassurance that this year's surge in energy costs has not spread to other parts of the economy.

Furthermore, add in this interpretation of one aspect of the Core CPI reading that housing costs remained at the same level and you see that rental price decreases outside Manhattan helped keep inflation lower than what it might normally be.

30YR Fixed Hits 6.74% - Up 0.21% in Week

A: This is the lagging effect of the mortgage markets following the trend of the bond markets; and more specifically the 10YR T-note yield. Unless you have been living under a rock the past week or so, rates have been surging due to renewed inflation concerns and globally rising interest rates. Global economies are very strong and rates are rising to slow things down and ease inflation pressures. Although we are off the highs in the 10YR yield, the short lagging effect to the mortgage markets is only now beginning to be felt. Buyers will realize at a lag that home loans are getting more expensive to take out and will affect affordability and purchasing power.

According to CNN Money:

30-year fixed-rate mortgages spiked to 6.74% this week, up from 6.53% last week, according to Freddie Mac

My response is, "YES, rates are still historically low which tells me there is plenty of upside to this current trend! And I don't need to tell you guys that rates are signficantly higher than what many of us have gotten used to over the past few years. So, to say there will be NO effect on purchasing power due to the surge in lending rates is putting a blindfold on your eyes to block out what is really going on".

So what is going on? In a nutshell:

For now, if you weren't prepared for this rise in rates then let it be a good lesson to be learned that some of the stuff I talk about on this site, is discussed for reason! Being a savvy real estate investor goes way beyond knowing what location to buy in, or what property features to look for. A general understanding of macro-economic trends will take you to the next level of becoming a savvier real estate investor; unless you believe nothing affects real estate cycles in which case all of this is irrelevant. Personally, I don't think that way and have an urge to understand what effects these cycles and what risks or rewards may loom on the horizon.

Like I have mentioned in previous posts, you MUST adapt to this changing world of higher borrowing costs especially if the trend holds or continues higher. Reasses your personal financial situation with the new rate quotes for todays world and see how that increases your monthly payments. Knowledge is power and understanding every aspect of your real estate investment is a MUST in today's marketplace!

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Follow Through...Will Yields Hold?

A: The past week was a very exciting one for traders. With lots of volatility comes good profits; as long as you are on the right side of the trade. When I was an equities trader I used to hate the slow, non volatile markets that made it hard to predict short term movements. Last week, markets reacted to what could be a new world of higher rates and the movements were volatile. Which leads us to this coming week and the economic reports that are set to be released. Be sure to watch if higher yields hold onto last weeks moves, correct back down a bit, or make another strong surge higher. The world may not be done changing yet!

Over the last week, yields on the 2YR, 5YR, 10YR & 30YR all surged to near peak levels seen last June; when analyzed over the past year. To show you just how dramatic the moves have been, take a look at the last 4 weeks (in the below chart) in the US Treasury bond markets that should explain to those who don't understand, exactly why their debt payments are getting 'more expensive'! (doesn't include Friday's big moves for some reason, so please take into account that yields are higher than noted here)

Leverage was used waayyy to much in the 'old' low interest rate world; you know, that world we are just leaving! But there is still tons of liquidity out there and plenty who are not heeding the wake-up call. Fact is, rates are only higher than where they have been and could very well be headed to much higher levels.

According to Yahoo Finance and via FT.com:

Investors have got used to taking ever more risky bets, assuming a stable economic backdrop, low inflation and low interest rates. They have been right for a long time. In recent years maximum leverage has been the right call....

...The recent sharp rally in global government bond yields is a wake-up call that things might have gone too far. The massive 30 basis point move in 10-year Treasury yields in the space of as many hours last week was the most dramatic.

And the recent sharp adjustment shows that even predictable US Treasuries can still spring surprises. The real risk is that long-rates will continue to move higher as still flattish yield-curves start to steepen to more normal levels. Or, more alarming, that a real inflation scare will give rise to greater market volatility.

In this new world, you could start to notice some re-allocation of assets, especially amongst large institutions and private equity groups. For stocks, in a rising rate world consumer staples and healthcare get more attractive while utilities and REIT's get less attractive. What you need to look out for is whether it will happen or not. So, carefully watch what happens to these boring bond yields this week and their reactions to the inflation data expected to be released. On tap for this week includes:

BEIGE BOOK - Wednesday
RETAIL SALES - Wednesday

PPI - Thursday (expected to rise by 0.5%)
CORE PPI - Thursday (expected to rise 0.2%)

CPI - Friday (expected to rise 0.6%)
CORE CPI - Friday (expected to rise 0.2%)

Given the volatility, and that a sharp move was already made it makes it very difficult to predict what will happen next. While rates are STILL at low levels and there is plenty of upside potential, I think traders will wait out the economic data before making bigger bets. But definitely keep an eye on whether or not yields will hold at these levels, correct back down a bit, or start a new run towards higher levels.

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Global Inflation Fears - A Changing World

A: Get used to it! Either you adapt because you are keeping tabs on what is going on in the world or you don't. I hope it's becoming more clear why I talk about this inflation stuff here on UrbanDigs instead of writing about the next good deal in town. The world is changing. As global economies continue to have strong growth, inflation becomes more of a problem and that ultimately makes money more expensive to borrow. Already, I see the number of mortgage applications falling due to higher interest rates. If this continues, you can argue the ultimate negative effects on purchasing power and consumer spending.

First, onto the latest news. According to Yahoo Finance's article, "Productivity Slows in 1st Quarter / Wage Pressures Ease":

The productivity of American workers slowed sharply in the first three months of this year but wage pressures eased as well, providing evidence that inflation is being restrained.

Labor costs rose at an annual rate of 1.8 percent. That was up from an initial estimate of 0.6 percent growth in unit labor costs but was still lower than the 8.9 percent surge reported in the final three months of last year.

While higher wages are good for workers, increases that outstrip the growth of productivity can trigger unwanted inflation as employers are forced to boost the cost of their products to meet their higher payroll costs

Rising productivity means that employers can boost salaries because of workers' increased efficiency. It is the single most important factor supporting rising living standards.

According to CNN Money's article, "Wall Street Slumps at the Open":

Investors' rate jitters intensify after a government report shows productivity slowing amid a growing economy, an inflationary signal that could mean rate hikes are coming.

Worker productivity in the first quarter was much lower than original estimates, according to a government report Wednesday that was in line with the latest Wall Street expectations. The slower productivity raised inflation concerns, and could keep the Federal Reserve from moving to cut rates to spur the economy.

I don't need to explain this effect on purchasing power and affordability again do I? Ok, I will, one last time:

AS INFLATION LOOMS AND RATES HEAD HIGHER TO COUNTER IT, MONEY GETS MORE EXPENSIVE TO BORROW. AS MONEY GETS MORE EXPENSIVE TO BORROW, THE CONSUMER GETS HIT WITH RISING MIN PAYMENTS AND HIGHER BORROWING COSTS ON LOANS. PURCHASING POWER RESTRICTS AS AFFORDABILITY GOES DOWN. THE CONSUMER CAN'T AFFORD WHAT THEY USED TO AND THAT MEANS PRICES HAVE TO COME DOWN TO STIMULATE SALES, WHICH IS THE ULTIMATE GOAL OF HIKING RATES IN THE FIRST PLACE ---> TO COUNTER INFLATION AND BRING PRICES LOWER.

As the world finally 'gets it' and realizes that inflation is not going away, those in the dark will be hit hard by what is to come. If you see the 10YR bond yield pass 5% and head closer to 5.2% or so, expect lending rates to really pop and move closer to 7% on 30YR fixed! For anyone that says "7%, yea right, that guy doesn't know"...is living in a fantasy world. Fact is, this is a very good possibility and so far there has been very little data and news released to reverse the current trend of rising rates, strong economies, and still bothersome inflation! Either you adapt to it, or you get hit!

If this does follow through, you will start to hear that inflation is the direct cause for the next leg of the housing downturn as borrowing costs rise driving down demand and affordability. House prices will have to fall further to stimulate sales.

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US Economy Rocks On - 10YR Nears 5%

A: U.S. Service sector expands at a faster than expected pace in May, removing any last hope of a fed rate cut; aww, all those fed rate cut people..I feel so bad! NOT! Folks, I've been saying for over a year now that rates need to go higher to curb inflation pressures and right now the markets are functioning properly to correct itself! As the latest report on US economic growth comes in better than expected, 10YR bond yields continue their upward trend and flirts with 5%! Expect lending rates to stay at already risen levels and even trickle higher as long as this trend in the bond market continues!

According to Yahoo Finance:

Surprising strength in the nation's service economy, coupled with recent data showing the manufacturing sector is humming along, suggest the broader economy may be shaking off slumps in the housing and automotive industries.

The Institute for Supply Management, based in Tempe, Ariz., said Tuesday its index of business activity in the non-manufacturing sector registered a faster-than-expected pace of 59.7 in May. The reading was higher than April's reading of 56 and Wall Street's expectation of 56.

While a rebounding economy is welcome news, investors worry that unchecked growth could prompt the Fed to hike interest rates, a move that could dampen spending.

Here in Manhattan, the effect of purchasing power as a result of more expensive money is still yet to seen. I still see a generally strong market here with healthy buyer demand and VERY little inventory to choose from! I don't expect the inventory trends to change much as we enter the hot summer months but do expect many overpriced listings to come down to earth as they realize savvy buyers aren't biting!

For all those serious buyers out there with a time pressure to move, be sure to re-assess your financial situation now that lending rates have risen to see how your buying power is effected.

Read my post, "Rates Going Higher - How To Adjust" and download the spreadsheet for help with this. As for your apartment searching, continue to be disciplined and be sure to ask your buyer broker for all data on what the building of interest is trading for so that you can evaluate the specific property in question to see if it's asking close to market value! Some fundamentals against buyers right now include:

While it is not a frenzy market like it was back in February & March, the scale is still biased towards a sellers market here in New York City, and you should definitely give yourself some time to find a good product if you already made the decision to buy and have a time pressure to close.

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Rates Going Higher - How To Adjust

A: With the US economy strong like bull and inflation seeming to moderate, interest rates have been rising. The trend is clearly UP and we are reaching the highest levels of 2007 which means those who hold lots of debt should expect to see their minimum payments rise. It's all part of the equilibrium process of capitalism. If the economy is hot, money gets more expensive to borrow to try to slow things down a bit. So now that we know rates are higher, how do you adjust? Here's how buyers and sellers should adjust along with a spreadsheet that I think I got working properly so that you can update your decision making after researching how higher rates affect you.

Use this EXCEL Spreadsheet to re-analyze your financial situation now that rates have gone up. First, re-analyze all your minimum payments for all debt now that rates are higher. Then plug in the property details you are considering buying and see what the #'s tell you. Use ONLY AS A GUIDE and take into account more assets and higher salary needed for co-op purchases!!

DOWNLOAD HERE - Fill In Yellow Boxes; The Rest Will Automatically Compute

Debt Consolidation Tip: If you have multiple high interest credit cards that you can only afford the minimum payment for, strongly consider into consolidating those debts into a special offer from a new credit provider! If you can get 12 months of 0% interest, than do it and be disciplined to take advantage of that offer to lower your outstanding debt! Via Google , I see various offers from CreditCards.com here.

HOW BUYERS SHOULD ADJUST TO MORE EXPENSIVE DEBT

First off, re-assess all your minimum debt payments and consider paying off high interest debt first with liquid assets. The goal here is to get acquainted with the recent rise in interest rates and how that affects your personal monthly payments. Most people don't do this and realize later on how much higher their minimum payments went and the spending they have been doing during this time should have been cut down. In regards to real estate investing, you know mortgage rates have risen over the past 2-3 weeks. But so has all your other debts. So first things first, re-analyze all your debt payments and educate yourself on what your total costs are to maintain your debts. Chances are they are higher than you think.

Now that you know this, you must re-assess your purchasing power for real estate! You know your monthly income and your total liquid assets, and now you should know how much higher your current debt's are costing you per month. Next step is to re-analyze your credit score and rate quote that are offered to you. Chances are this is higher than you thought. It's never a good idea to do a financial analysis to see how much you can afford and expect that # to remain constant when other variables are changing; i.e. the cost of money to borrow.

Call a few lenders and get a more updated rate quote and see how that affects the monthly payment with your previous MAX PRICE budget! Chances are it is higher than you thought! Educating yourself on this is extremely important because in the end there is no sense going to a property that you can't even afford to buy and opening up the possibility of making a real estate decision based on emotion, not discipline.

Now that you know some rate quotes, be sure to use the mortgage calculator on properties you have been eyeing to see how the new rate affects your total monthly payment; I added a section on the above spreadsheet so you can do this there and get an idea of the #s. Add in the new monthly payments of your debts from above and see how that fits into your financial picture. In the end:

ALL YOUR DEBTS COMBINED REALLY SHOULDN'T EXCEED 33% OF YOUR GROSS MONTHLY INCOME. MOST BANKS WILL SAY TO KEEP DEBT/INCOME RATIO UNDER 28% OF YOUR GROSS MONTHLY INCOME, BUT I THINK IF YOU ARE STRONG IN ASSETS YOU CAN RAISE THAT UP A BIT AND STILL BE OK, ESPECIALLY IF YOUR TIMELINE TO OWN IS 5+ YEARS

HOW SELLERS SHOULD ADJUST TO MORE EXPENSIVE DEBT

Higher interest rates = Less affordability

No doubt about that. If you are pricing high and testing the market and at the same time keeping a blind eye towards what is going on macro economically, you may be wondering why you haven't sold your home yet! Now is NOT the time to keep your price at the level where YOU think it should be. Rather, talk to your broker about what price adjustment might need to be made to stimulate buyer demand now that the 'price high' strategy didn't work!

If you MUST sell your home and are not just seeing if you can get your price, a price reduction right now is more than warranted. Ask yourself, "...are you doing what you need to do to move the property?". Now that we are entering the brutally hot summer months you are also faced with buyers dealing with higher lending rates pushing down affordability.

Question is, are you on top of this and ahead of the curve? If so, then you have had a discussion with your hired broker about what to do to stimulate activity and if you are willing to get more realistic on pricing than your broker should be willing to up the ante and buy a larger than normal ad to stimulate marketing's ultimate effects. With me, I usually double the NY Times Print ad out of my own pocket and e-blast the entire Manhattan brokerage community if my seller client heeds my advice and lowers the price on the property to a level more in line with market value.

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Side Note - Interest Rate's & China

A: For all you who signed a contract of sale in the past week or so, or are about to, keep a close eye on US equities in their response to the China selloff. Should US stocks fall but then rally as buyers step in for discounts, then rates will hover around where they are now. But if US equities get hit hard (with a selloff, then small rally, then another selloff towards the close) today and in the next day or two, the 10YR bond yield will fall and provide some relief in Mortgage rates; telling you to hold off for a week or so to lock in your rate. Here's the skinny.

10YR Bond yield fell 3 basis points to 4.851% from a previous close of 4.882% yesterday. The relationship is that of a see-saw. As stocks fall bond prices rise (yields fall). As stocks rise bond prices fall (yields rise). Mortgage rates tend to follow the action on the 10YR bond yield which is why I'm trying to ingrain this train of thought into your heads.

Use this model as a guide if you recently signed a contract of sale and are considering when to lock in your interest rate.

STOCKS FALL / CHINA SELLOFF STICKS --> Hold off locking in your rate as the 10YR bond yield will drop more the harder US equities fall

STOCKS REBOUND / RALLY HOLDS --> Still no rush. If you didn't lock in a rate on May 17th when I said to, then the damage is already done and short term trend might be in your favor right now. Worst case, rates should hover where they are now or drop very slightly in response to China selloff. I'll report to you if this changes.

The bond market is still not predicting a hard landing (if it was rates would be heading lower; but the trend has been higher). In fact, I'm surprised of the muted reaction thus far in US equities and bond yields. Lets see if it holds.

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New Home Sales Soar: Bye Bye Fed Cut!

A: Stocks surge on the just released New Homes Sales which showed the biggest increase in 14 years! Sales volume of single family homes increased 16.2% last month. Adios el cutto in interest rato! On a side note, prices recorded plunged providing insight into the rapid growth in sales volume. It's clear that as prices fall, interest is rising!

10YR Bond Yield Surges from 4.85% to 4.89% on the news pushing lending rates higher!

Personally, I don't buy this New Homes Sales report; it's surprised too much to the upside. I think its an anomaly that will later be revised down. But, whatever. It is what it is.

According to CNN Money:

A big drop in the typical price of new homes spurred much better than expected sales, according to the latest government reading on the battered real estate and home building market.

New homes sold at an annual pace of 981,000 in April, up 16.2 percent from the revised 844,000 pace in March. Economists surveyed by Briefing.com had forecast an 860,000 rate in April.

But the median price of a new home sold in April plunged 10.9 percent from a year earlier to $229,100. The new price reading was also down 11 percent from the March reading.

KEEP AN EYE ON - The US dollar that everyone dissed! As 10YR bond yields rise so will the US dollar! One reason why corporate profits have been so strong recently is because of globalization and profits oversees taking advantage of currency trends. If US dollar surprises and starts a comeback, those currency gains that helped bulk profits in the past will restrict. Interesting topic for another day.

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Does Fed Funds Rate Affect Mortgage Rates?

A: The short answer: NO. For a more accurate near term predictor of mortgage rates look to the 10YR treasury note. I discuss this often here for those that need to make a decision in the very near term; i.e. days or weeks. Based on the trend of the 10YR bond yield (that's the percentage yield NOT the bond price), chances are mortgage rates will follow shortly thereafter. Here's a great chart I just came by showing you this relationship.

Thanks to HSH Associates Library of Mortgage Information: This graph contrasts the movements of the weekly average Federal Funds rate against the movements of the weekly 10-year Treasury Constant Maturity and those of the average 30-year fixed rate mortgage and 5/1 Hybrid ARM. It covers the period from April 2004 through April 2007.

Does the Federal Funds Rate Affect Mortgage Rates?

Conclusion - Look very carefully how the Red & Green lines closely follow the Blue line at a very slight lag. This lag is days but tells you that if you get acquainted with following the bond market and why bonds move one way or another, you'll soon grasp the concept of the relationship between 10YR yields and mortgage rates. Come time for you to buy a home, you'll have a general understanding of whether you should lock in a rate NOW, or wait a few weeks.

Fine tune your observation and knowledge of what affects the bond market; economic growth, jobs, inflation, expectations and risk, etc. The key is to understand on what occasions a slight move in the 10YR yield will turn into a sustainable trend. That way, you have a good idea of whether its a blip or a sustainable trend to make a decision on. On may 17th, the jobs data came in much better than expectations signaling a strong labor market; a good sign the US economy is holding its own. This is a situation where yields will trend higher until a situation arises to disprove the last jobs report.

As I discussed on May 17th in my post titled "10YR Surges: Mortgage Rates Next" -

The 10YR bond yield has been making higher lows and now higher highs for the past 10 weeks or so, which should hit the mortgage market next week. In fact, I would expect lending rates to already have popped a bit on the latest jobs report.

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10YR Surges: Mortgage Rates Next?

A: The 10YR bond yield has been making higher lows and now higher highs for the past 10 days or so, which should hit the mortgage market next week. In fact, I would expect lending rates to already have popped a bit on the latest jobs report. Here is some info you need to know if you are active right now in Manhattan real estate as well as some worthwhile takes from the blogosphere.

For Buyers IN CONTRACT - Did you lock in your rate yet? If not, call your mortgage broker RIGHT NOW and lock that baby in. Chances are if you were waiting for next week or the week after, rates will be higher.

For Serious Buyers on the Hunt - Adjust your affordability range taking into account likely higher mortgage rates! As lending rates rise affordability goes down especially if you already are stretching your budget looking at property's above your max.

For Sellers Who Must Sell - Higher rates as we get past Memorial day is just not a good combo for those sellers who MUST sell soon! If you are financially struggling and must sell because you can't afford your home, lower your price NOW and have your broker up marketing efforts to encourage buyers before it slows down. If rates rise 1/4 point or more, buyers will certainly have less incentive to chase purchase prices.

Here is the 5-Day chart via Yahoo Finance showing the jump in yield from 4.62% to 4.756% today:

Get educated on what is going on that affects affordability in the housing market! Lending rates, jobs, stock market wealth effect, and high salary's all affect affordability for buyers. So, when rates look like they are going to rise, your buying or selling strategy might need to be adjusted or else you will be left without a chair when the music stops!

Here are some statements worth reading from the blogosphere on macro economic issues.

Via The Big Picture -

Its time to admit that "the notion of price stability requires a broader definition. Various indices, house price inflation and the cost of rents and mortgages should all form part of a judgment about price stability." Failing to do that risk the ire of the public. They increasingly lack belief in the government statistics in general, and there may develop a decreasing faith in Central Bank's credibility in particular.

To paraphrase Munchau, if we are to judge inflation on a broader scale, we would undoubtedly come to the conclusion that like the rest of the world, the US has an inflation problem.

Today's figures on housing starts and building permits show that the housing recession is worsening.

Other data from the housing market are no better; they all point to a worsening housing recession. Moreover, there is strong evidence that the massive credit crunch in the subprime mortgage market is now spilling over to other near prime and prime mortgages and also more broadly to some non-housing components of consumer credit.

My favorite indicator of the medium-term inflation trend, owner equivalent rent (OER), continued to moderate, rising a mere 2.1 percent (a.r.) for the month -- well below it's recent readings that have been in excess of 4 percent. Regular readers of this update may recall last year when I was warning that rises in OER would eventually push core inflation over 3 percent. Well, that hasn't happened and I have a theory about where I went wrong. At the time, my logic went like this: Over the past 5 years, resale prices of houses have risen far faster than rents, opening up a significant gap between the two. My sense was that house prices were likely to languish, perhaps even fall modestly, so that the lion's share of the gap would be closed by a step-up in the rise of rents. What I failed to see was that the combination of a high inventory of unsold new homes, combined with increased mortgage defaults could flood the rental market. It is the glut of rental houses that is holding OER down now and is likely to continue to do so in the foreseeable future. The result will be falling CPI inflation.

"Time will tell but the conversion of unsold condos to rentals seems inevitable and should help ease inflation down the road, reverse the trend of rising rental costs, and contribute to easing the high levels of unsold inventory."

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Inflation & Condo Conversions: Good Combo

A: An interesting topic as there is a new trend nationwide that could eventually help drive DOWN inflation, and specifically the CPI #! The trend of existing unsold condos converting to rentals nationwide is helping to add to the supply of rentals on the market (mostly outside Manhattan), which is expected to help ease inflationary pressures in the CPI number. The reason, is that apartment rental costs are a key component to the CPI # and as rental costs fall so does the inflationary pressure on the overall number. Today's CPI # came in at expectations as the very important Core CPI yr-over-yr dropped to 2.3%; a sign that the fed's hold policy is working and inflationary pressures seem to be moderating.

First, lets pass on to you what today's very important economic data told us and then Ill discuss in more detail how condo conversions will help ease inflation down the road.

According to CNN Money:

Prices rose a bit less than forecast in April, according to the government's key inflation report Tuesday, but a closely watched reading showed a pick-up in prices outside of food and energy.

The Consumer Price Index showed prices at the retail level rose 0.4 percent in the month, compared with the 0.5 percent rise in March. Economists surveyed by Briefing.com had forecast a 0.6 percent increase in the CPI.

The more closely watched core CPI, which strips out the volatile prices of food and energy, rose 0.2 percent, after edging up only 0.1 percent in March. The reading was in line with economists' forecasts.

According to Yahoo Finance:

Through the first four months of this year, consumer inflation is rising at an annual rate of 4.8 percent, almost double the 2.5 percent increase for all of 2006. The acceleration has occurred in large part because of higher costs for food and energy.

However, excluding energy and food, core inflation is up at an annual rate of just 2.2 percent through April, an improvement from the 2.6 percent rise in core prices for all of 2006.

That improvement is certain to be welcomed at the Federal Reserve, where policymakers are hoping that their campaign to restrain inflationary pressures is beginning to show results.

It's very important to note that this trend is mostly true for markets outside of Manhattan real estate, where inventory is not so much of a problem and therefore won't be included in this theory.

To understand this theory we must first understand what makes up the Consumer Price Index (CPI) and why it is such a closely watched dataset by the Fed for inflation monitoring.

According to Wikipedia:

SOURCES OF CPI DATA

Prices for the goods and services used to calculate the CPI are collected in 87 urban areas throughout the country and from approximately 23,000 retail and service establishments. Data on rents are collected from about 50,000 landlords and tenants.

a) avoid taking a loss on the property via selling
b) help ease overall inventory
c) take advantage of high rental prices

As this trend continues, I would expect rental inventory to grow as we head into the end of 2007 and into 2008 causing the supply/demand imbalance to shift in favor of renters, finally! Again this is mostly true for outside of Manhattan. In Manhattan, there are a lot of new development units set to come to market but thus far there are no major inventory issues to speak of. As long as this doesn't change, the # of unsold new condos that convert to rentals should stay at normal levels.

As rental inventory increases across the rest of the nation prices should ease, helping to further moderate the CPI data that eventually comes out! The chain of events that ends with moderating inflation is already underway. We already have high inventory of unsold condos with reports like...

Housing is Going to Get Worse (Miami Herald, FL)

Making It Appealing (Myrtle Beach, SC)

Downtown Condo Sales Down 46% in First Quarter (Crain's Chicago Business, IL)

Washington, DC: Big Condo Supply Brings Prices Down (USA Today)

Time will tell but the conversion of unsold condos to rentals seems inevitable and should help ease inflation down the road, reverse the trend of rising rental costs, and contribute to easing the high levels of unsold inventory. Something to keep an eye on especially for those looking to time their re-entry into a correcting housing market for most of the nation outside of Manhattan. Fundamentally speaking, all of this should be on your radar so that you can learn the after effects of the biggest bull run in housing recent history ever produced.

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Inflation Moderating Yet Bond Yields Up?

A: What gives? In a perfect world, the inflation data that came out this morning via a mild PPI # told the street that the fed would have an easier time cutting interest rates since inflation seems to be moderating? Right? Not exactly. If this were true, the yields on most bonds would be falling to anticipate future lower interest rates. But that is NOT what is happening? So what is really going on?

The pipeline is what is going on! While the PPI report came in ahead of expectations in terms of inflation worries, its what is yet to come that is still worrisome; there are still signs of trouble in regards to inflation and a few moderate reports does not a trend make. Let the street applaud the temporary relief in inflation with higher stock prices, but I'm not convinced yet and neither should those expecting lending rates to dip on this news!

According to CNN Money:

The Producer Price Index, which measures the price of goods at the wholesale level, rose 0.7 percent last month, down from a 1.0 percent gain in March, the Labor Department reported. Economists surveyed by Briefing.com had forecast a 0.6 percent rise.

But the more closely watched core PPI, which strips out volatile food and energy prices, showed no rise after also coming in unchanged in March. Economists had forecast a 0.2 percent increase.

The report showed that energy prices jumped 3.4 percent in the month, while food prices rose 0.4 percent. Both were down from the increases posted in both February and March.

The overall PPI is now up 3.4 percent over the last 12 months, while the core PPI is up only 1.6 percent over the same period. The Federal Reserve is generally believed to want to see core inflation readings in the range of a 1 to 2 percent increase on an annual basis.

Mark Vitner, a senior economist with Wachovia, said the PPI report has some readings that justify the Fed's concern. The overall and core PPI is for finished goods such as bread but prices for crude goods such as wheat and intermediate goods like flour are also measured. Prices for intermediate goods jumped 0.9 percent, while prices for crude goods excluding food and energy climbed 0.4 percent, pointing to inflation pressures in the pipeline.

"The Fed is not going to say 'We have to cut rates because consumer spending was weak in April,'" Vitner said. "They're right that inflation is still higher than they'd like. The best way the Fed can keep higher energy prices from spilling over is to hold the line on rate cuts."

While short term bond yields dipped on this latest inflation news, the 2YR / 3YR / 5YR / 10YR / 30YR all rose a bit signaling that the bond market is not buying into an easing inflationary world. If it was, all yields will be falling as expectations that the fed can lower rates take hold. You see, the main reason why the fed CAN'T lower rates right now is because of inflation. High energy prices, high food prices, high commodity prices are all contributing to this dynamic. As long as these fundamentals stay at these levels, all the fed can do is HOPE that an economic slowdown resulting from these higher costs in itself eases inflationary pressures. If it works out this way, you will see energy, food prices, and commodity prices all fall. This has not yet happened.

Stocks still seem to be the market of choice for investments although short term CD's and even some online savings accounts are offering no risk 5% returns. With a continuing weak US dollar, the fed is stuck with leaving rates unchanged. The only thing that will change this is if the housing market gets so bad that consumers stop spending and the economy completely derails; which will force the fed to cut rates to settle things down. If this should happen, I don't see how stock prices will hold onto their recent gains given all the uncertainty that is to come with this scenario playing out.

Time will tell. For now, you need to know that inflation STILL EXISTS and the fed will keep rates unchanged. Don't bet on lower rates yet to bail out out housing market. Perhaps towards years end.

Expect lending rates to see-saw around current levels heading into Tuesday's CPI report, which will tell us more detailed information on the inflation front. Looking back, I cannot recall a more confusing time in terms of future monetary policy direction than what we are in right now. I have been following this stuff obsessively since 1992 or so and right now we seem to be in a war between those that think the US economy is in the midst of a serious slowdown mostly from housing woes, and those that think the US economy is still strong but inflation is hiding and waiting to attack. Where interest rates go depend on how the ivy leaguers at the fed interpret the data, so that is our best chance of making the right bets and investments in the near term. Don't fight the fed.

Keep in mind one very important factor, that monetary action lags by a good 12 months or so! We are still waiting for the FULL EFFECTS of monetary action to funnel through the economic system. In my opinion, the fed is waiting to see the full effects of what they have done so far. In the coming months either the US economy will slow enough to ease inflation OR it won't. It will be the answer to this question that I think will dictate the next move. The jury is still out on whether Bernanke & Co. are true inflation hawks, and the next 3-5 months should reveal the hand they have been playing since pausing with their 2+ year interest rate hike campaign. You would be wise to keep tabs on this!

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Mortgage Report: Week of April 16th - 22nd

Last weeks market was active as the Fed's minutes from the past meeting were released. The minutes give all the commentary between voting and non-voting members before the official statement is released to the public as their "Policy Statement". The Fed delays the release intentionally so the market has time to digest the policy statement before it trys to interpret the banter among members.

The decision to leave Fed Funds Rate unchanged in the latest policy statement was a result of the members being concerned with inflation. Bonds didn't like the inflationary comments and reacted negatively with home loans increasing by .125%.

This week the Consumer Price Index is being released and its numbers will tell the Fed if there is inflation on the consumer level. If the CPI number comes out under 2.7% this will show inflation is under control and home loan rates may improve. If the number is above that 2.7% watermark home loan rates will most likely move higher.

Call or email for updated daily rates.

Best,
Steven

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Labor Market Strong: Yields Rise

A: Three weeks ago I wrote a post titled, "Interest Rate Talk Likely To Begin Again", based on rising inflation fears that I saw not going away. In the monetary world, interest rates adjust based on the state of the economy, price stability, and most importantly inflation pressures. In the real estate world, interest rates are directly tied to the affordability of property; the higher the rate, the more expensive money is to borrow, and the less a potential homeowner could afford. This is why I talk about this stuff here on UrbanDigs with the hopes of getting more exposure to the fundamentals that may ultimately affect real estate cycles. Understanding these concepts could help you make savvier investment decisions that leads to more money in your pocket!

In my post three weeks ago, I publicly stated that I thought the yield on the 10YR would start a run up towards 4.75%, from 4.54% at the time, based on inflation fears that are continuing to persist. The fed's primary job is to control inflation and price stability regardless of what the stock market and housing market are currently doing. Their secondary job is to NOT rattle the markets and to provide economic stimulus or constraint as they see fit; then they have some regulatory functions as well.

Here is what I said three weeks ago:

If I'm right, then in 4 weeks the 10YR Treasury yield will be at least 25 basis points (0.25%) higher.

Here are some reasons why I thought the yield on the 10YR Treasury would rise in the near term:

1. Fuel, Food Prices Push Higher
2. Wholesale Prices Shoot Higher

Unfortunately, I don't trade anymore because this would have been one nice little play. Here is what the 10YR Treasury Note has done since I wrote that post three weeks ago without taking into account todays reaction to the jobs report which made the yield surge to 4.74%:

The reason is because the economy, while showing signs of weakness, is still relatively strong. In particular, todays labor report presented very bullish data on the jobs market. A strong jobs market means a healthy US Economy, which means bye-bye to rate cut hopes and hello to more inflation pressures and possible rate hikes. Which is why yields on the 10 YR Treasure note are rising! Get it?

According to Yahoo Finance's article titled "Bonds Slide, Dollar Up After Jobs Report":

The yield on the benchmark 10-year Treasury note surged to 4.75 percent from 4.68 percent late Thursday. U.S. Treasury bond prices tumbled and yields rose in a holiday-shortened session Friday after the unemployment rate fell to a five-month low, signaling the economy could be stronger than expected.

The Labor Department report that employers increased their payrolls by 180,000 in March, the largest increase since December. Wall Street had been expecting an addition of about 135,000 jobs. In another positive sign for consumers, workers' pay also increased.

UrbanDigs Says: Inflation is capable of doing way more damage than a recession. The best known medicine to control rising inflation is to RAISE interest rates and try to SLOW the economy. The hardest part of applying this medicine is getting it just right so as NOT to slow the economy too much forcing us into a recession. Right now, there are many inflation pressures (high commodity prices, strong labor market, rising wages, higher food prices, and a Core PCE # at 2.4% and ABOVE the fed's comfort zone of between 1-2%) that may not ease if the economy proves stronger than expected; and todays jobs report hints at that! The thing is, the fed is clearly counting on a soft landing where a slowing US economy will help ease inflation pressures without the need for more interest rate hikes. Well, if the economy doesn't slow as much as expected and inflation pressures continue to hover or rise in the near future, then rates MUST go higher to contain longer term damage! I'm very curious to see how high the yield on the 10YR will go to on this run and will continue to report on the macro factors that ultimately lead to policy change.

I am still on record for saying that one of the two fears I see towards keeping housing down for a while longer is weaker jobs later this year. I'm still standing behind this statement and worry that jobs reports in the months of Oct-Dec could come in weaker than expected showing a slowdown in the US economy.

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Mortgage Report: Week of April 2nd - 6th

The Fed closely watches the rate of inflation and uses different indeces to gauge what is happening. The Core Personal Consumption Expenditure(PCE) is one of their favorites. Last week it increased more than expected through February. The Fed usually doesn't want inflation more than 2%, and the report form the PCE was at 2.4%.

Mortgage bonds worsened during the week and home loan rates increased modestly(.125%). Next week we expect the Employment Report due on Friday and hope the number is higher than the 90,000 reported in February. A weak report(less than 90,000 jobs) could help bonds rally and inprove home loan rates. A good report may cause home loan rates to worsen even more then they have this week. Stay tuned.

Best,
Steven

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Loan Choice: 15YR vs 30YR

A: Extending the mortgage posts a bit longer here, I want to discuss the possible advantage towards choosing a 15YR Jumbo mortgage over a 30YR one. If feasible based on your income and liquid assets after closing, a 15YR Jumbo loan might be a wise investment option.

No one knows where rates are going in the near future let alone 7-15 years from now. If anything, the environment right now is filled with so much uncertainty that the fed really could go either way based on incoming data. But people want security. They want little risk. So, to keep your investment decisions clear and to avoid making things more complicated, lets forget the adjustable rate mortgages (ARM) for now and take a look into whether or not a 15YR Jumbo loan might be a better choice than a 30YR one!

According to Bankrate.com, the rates on both the 15YR & 30YR Jumbo loan & their 1-Year charts are:

15 YR JUMBO LOAN - 5.69%

30 YR JUMBO LOAN - 6.03%

Now lets do some math. Lets assume that you are buying a $650,000 condo with 10% down and are doing an analysis on what the advantages of a 585,000 loan would be for a 15YR loan over the 30YR option in terms of monthly payments and interest saved.

While statistics show that most homeowners wind up selling or refinancing in less than 7 years, take a look at the incentive in interest savings if you live in or rent your home 15 years! Of course, this is entirely dependent on whether or not it is economically feasible for you to pay that extra $1,300 a month.

But if you can pull it off through the decision of buying a property that is well in your budget rather than at the top end, you will end up saving a bit less than $400,000 in total interest paid to the lender over the life of the loan.

What about the higher expense that you pay monthly to get that advantage? Lets do some more math:

180 months (15 years) X $1,300 in extra monthly payments = $234,000 over the life of the loan

So, thats $234,000 more money that you are paying out of pocket over the life of the 15 year loan in order to save about $395,000 in total interest paid to the lender. In reality, that $234,000 more money is a bit less because in this example I didn't take into account tax benefits offered to homeowners!

UrbanDigs Says: For all those who have high salaries and are buying a property well within your budget, I say to consider the 15YR loan option with your lender and see if it is both economically feasible and consistent with your timeline to own! If you plan to grow into this new home, than it becomes a very attractive loan option. To determine if its economically feasible, check your debt/income ratio and see whether or not the higher loan payment will keep this ratio below 33% or so; and if the board will allow that. You might want to make up that expense by cutting down your costs somehow if you are closer to 33% to rationalize the decision. In the end, you could save some big bucks in total interest paid to your lender even after calculating in the total extra money you need out of pocket to carry the loan! You can quickly build wealth by using a combination of live in / rent out investment strategy over a 15YR term and at the end of the day have a great debt-free asset in your portfolio!

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The New Fed: Who Are They...?

A: I feel the need to defend myself. Exactly six days ago I went on record as saying, "If I'm right, than in 4 weeks the 10YR Treasury yield will be at least 25 basis points (0.25%) higher...". Then, four days later the fed announced no change with monetary policy but a change in statement. The fact is, after digesting the statement over the past day or so many economists, anaylsts, and traders are getting to know the new fed chairman is different than what we first expected. This is a new fed, and we MUST learn to live with the idea that we may not know what all the statement changes mean for a while. That is exactly what happened in the past few days; here is why.

Here is what I said back on March 17th:

The 10YR yield ended the week at 4.54%. If inflation fears start to come out again as I expect them to, the yield on the 10YR will be closer to 4.75% by mid April to account for the possibility of more fed rate hikes down the road.

But this fed is not the old fed. Its an entirely new fed that is yet to distinguish its true character to the tradable markets. We don't know Bernanke yet! And with their most recent NO CHANGE IN INTEREST RATES but change in statement issued, we are beginning to wake up to this fact; we don't know what the capabilities of this new fed are yet.

Here is the statement that was removed in this weeks fed statement that caused such a stir on the street:

"The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

"Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

As for me, those of you who actually read my stuff know that I am an inflation hawk and believe very strongly that the fed's # 1 job is to fight against inflation. But what is the real job of the fed?

Here is what I found on their site at the federalreserve.gov mission page:

So what did the fed really do? Upon further digestion of this first ever radical change in statement issued with the most recent fed decision, it's hard to ignore the newly inserted line "...the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected...". Although it originally seemed that the removal of the 'any additional firming that may be needed..." phrase was thought to meant imminent rate cuts, look at what the 10YR did over this 5-day chart taking note of the move AFTER March 21st and a day of digesting the change in statement:

The initial FALLOFF in yields and SURGE in stock prices was the immediate reaction, prompting me to write this "Ben Bernanke's Mistake - Dissing Inflation" post. My first prediction of higher yields due to the fundamentals happen to be more accurate than I thought after this fed statement was issued. I felt like, 'this is the fed, they know their sh*t, I must learn as quickly as possible what they do and how they do it for future references and investment decisions'. But looking at what the 10YR did and how the yield responded back to what is really going on in the world makes me wonder what this fed is really up to! Honestly, I have no clue.

They can either:

CUT RATES - Because they feel that protecting economic growth is more important than current inflation indicators and that a cooling economy would in effect lower inflation pressures.

HOLD RATES - Because they don't know their true identity yet and what might unfold in the near future. Likely course.

RAISE RATES - Because they still admitted that their #1 fear is that inflation will not moderate as expected. What I think will happen.

Hence my prediction BEFORE the fed meeting of 10YR yields at 4.75% by mid April. Since the fed meeting and AFTER the initial reaction, 10YR yields went from a low of 4.52% to a close of 4.613 2 days later. Quite a move.

This tells me my initial feelings are reasonable and that many people may be mis-interpreting this move by the fed to mean rate cuts are in the works. I just don't see it. As before, inflation didnt ease in the past few days, it remains exactly the same. The only thing that changed is that we realized that this fed is a mysterious one and that we are still learning what their actions mean.

UrbanDigs Says To Those Fed Watchers: This is the first major change worth noting what the ultimate reaction is! Take note, is all I can say so you will be wiser when a similar situation comes up down the road and this same fed does a duplicate maneuver.

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Ben Bernanke's Mistake - Dissing Inflation

A: Ben Bernanke & Co. DISSED Inflation pressures today in favor of US economic growth concerns as the fed left rates UNCHANGED. A mistake showing that today's fed is not about fighting inflation, the stated #1 job of the federal reserve, rather is about bringing stability to capital markets and providing a psychological floor should a slowing US economy take place.

FED STATEMENT SHOWING CHANGE IN BIAS:

Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

I don't like it. I think the fed folded to the markets and put themselves in a tougher position should inflation pressures not go away in the near term. Maybe the fed knows something the markets don't? Maybe they didn't want to mess around with a tightening bias in the face of subprime woes? Maybe they know that the US economy is slowing faster than everyone else thinks? I doubt that. Corporate earnings are still strong and the unemployment data soon to come will be a very interesting data point to analyze to see if the labor market is worsening. If so, that would validate today's move as a slowing economy should help ease inflation pressures and a rate cut will be the likely medicine to pump ummph back into the US financial system.

Hats off to Nouriel Roubini, long time bear and blogger of RGEMonitor, who called it exactly right and predicted in this video (17 min long) that the fed must acknowledge the slowdown in housing, the slowing US economy, and change the bias towards a neutral or rate cutting one. Exactly what they did! VIDEO REPORT

Learn as we go with this new fed chairman. One thing I do know is that inflation hawks HATED today's statement by the fed, including me, who fears that inflation can cause way more damage than a recession could!

The stock marked SURGED today as the fed abandoned the tightening bias and interpreted the move as the clear step towards a future rate cut; something equities like to see to stimulate future economic growth. Recall my last post on why lower rates might not be good though as if the fed does cut rates it is because the economy is slowing and jobs are being lost!

For Buyers - Don't expect lending rates to go up anytime soon! Expect them to stay put or trickle down a bit in the near future. No rush to lock in a rate.

For Sellers - It's a bit worrisome that the fed stated, "...the adjustment in the housing sector is ongoing", a clear acknowledgment that housing still has major hurdles against it down the road. While NYC remains strong and is isolated from the nation-wide slowdown, it's narrow minded to think there will not be any correction at all to Manhattan real estate. If you are thinking of selling, take advantage of the current strength in our marketplace and sell sooner rather than wait for the generally slow summer months.

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Interest Rate Talk Likely To Begin Again

A: I hate to say it, but get ready for a whole new round of fed talk to start brewing in the blogosphere and media as inflation begins to rear its ugly head again. Even with the slowing housing market, sub prime worries, and recent stock declines that have been pricing in future risks, the fed's #1 job is to fight against inflation; and that may mean HIGHER RATES!

If I'm right, then in 4 weeks the 10YR Treasury yield will be at least 25 basis points (0.25%) higher. So, lets play a game and take a look at the 10YR Treasury Yield over the last month with the week ending yesterday:

The 10YR yield ended the week at 4.54%. If inflation fears start to come out again as I expect them to, the yield on the 10YR will be closer to 4.75% by mid April to account for the possibility of more fed rate hikes down the road.

If anything, there is NO WAY the fed will cut rates anytime soon! Not with inflation risks out there. I don't care if the economy looks like it is slowing, housing is worse than expected, or if sub-prime woes continue to get worse. If the fed ignores inflation concerns and starts targeting growth or housing woes, than we will be in for even deeper trouble down the road! There is a reason that the controllers of monetary policy has a #1 job to control inflation and pricing stability. Here is the data that I saw come in a few days ago:

Fuel, Food Prices Push Higher -

Higher gasoline and food prices pushed the cost of consumer goods up in February, according to a government report that showed inflation pressures roughly in line with Wall Street forecasts.

The Consumer Price Index, the government's main inflation gauge, climbed 0.4 percent in February, after a 0.2 percent rise in January. Economists surveyed by Briefing.com had forecast a rise of 0.3 percent.

Wholesale prices shot higher in February, according to a government report Thursday that showed much greater inflation pressures than had been forecast.

The Producer Price Index rose 1.3 percent after a 0.6 percent decline in January. Economists surveyed by Briefing.com had forecast a 0.5 percent rise in the overall measure of prices paid by businesses.

Wall Street slumped Friday after another reading on inflation deflated hopes the Federal Reserve will start moving toward an interest rate cut when it meets next week.

Inflation concerns remained entrenched on Wall Street Friday. The Labor Department's report that its Consumer Price Index rose by 0.4 percent in February renewed some of the concerns that dogged stocks on Thursday. Wall Street had expected an increase of 0.3 percent. The rise was double that of January and the largest rise since a similar increase in December. Rising costs for gasoline, food and citrus crops helped boost prices.

So what does this all mean? Well a few things!

1. Stocks are falling due to risks to the future of US economic growth, the fact that inflation is still an issue and the fed will not be cutting rates, and housing woes.

2. Bond Yields didn't rise as much as expected given the inflation data because stocks have fallen in the past week.

3. Rates are definitely NOT going down, and in fact might be going up first.

4. If inflation remains or gets worse, rates will definitely go up and housing woes and lending issues will deepen.

Thanks to CR I noticed that Macroblog also has a take on this in their latest post titled, "The Inflation Report: Just Not Getting Better".

Lets not forget what I said back on Aug, 8 2006 when the Fed finally Paused with their slow and steady 2+ year interest rate campaign. I remember everyone already planning on early 2007 interest rate cuts and the media was all over this consensus. That lead me to say...:

A pause does NOT mean the fed is done completely! Yes, if the economy continues to slow, inflation will seem to dissipate, and the fed may have to cut rates to stimulate the economy again. But the timing of such rate cuts are probably further down the road than people think! For the short term, another future rate hike is much more certain as future inflation #'s will reflect the lagging effects of very high energy and commodities prices!

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Mortgage Report: Week of March 12th - 17th

A meltdown of the sub-prime market captured headlines all last week. Several companies refused to accept any new loans and some closed shop. For the most part, I do not deal with the sub-prime market(The sub-prime market is for borrowers that have credit scores below 600), so their recent contraction and blow up will not affect Manhattan Mortgage. The majority of my clients are A-paper and have good to great credit scores. U.S. stocks were firmly lower today after weaker-than-expected February retail sales fueled concerns about growth. As I've stated many times before, when there is weak or negative economic news, treasury bonds tend to rally, which sends yields lower, and hopefully will improve rates by .125%.

Please email or call me if you have any mortgage related questions.

Best,
Steven

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Mortgage Report: Week of March 5th - 10th

The bond market rallied last week and sent interest rates south. When there is a meltdown in the stock market, mortgage backed securites are usually purchased at least temporarily. With the dow down over 500 points last week, rates certainly improved to new levels not seen since last year. The 10 year yield fell from 4.68 down to 4.52 and that really affected the market positively. Market experts predicted that the recent seven month climb seen in stocks was unusual and bound to be volitile months ahead. The current 1000 day streak without a 10% decline was the second longest in history. Experts knew that stocks needed to regroup before heading north again. It's a good time to lock in your rate before the stock market begins to rebound.

Best,
Steven

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Why Lower Rates Might Not Be Good

A: There is a false perception out there that if the fed starts to cut interest rates that housing will be set up for another boom. I strongly disagree with this train of thought and here is why I think lower interest rates might not be good for housing, at least right away!

First off, with the economy still relatively strong (only starting to show some signs of peaking) and with oil/commodity prices still at very high levels, there is no way the fed will get involved in a long standing rate easing campaign. With that said, lets analyze what the fed might do.

If the fed cuts interest rates one or two times towards the end of the year, which is by no means a certainty, it is because they are starting to see signs that the economy is weakening and want to add some stimulation to prevent a recession.

So lets break that down. If the economy is starting to weaken, then stock prices will reflect that early on with a selloff. Since the stock market is a leading indicator of the economy, it will be the first to show signs that trouble might be ahead. Assuming this happens, paper profits and consumer portfolio values will restrict making people feel less confident and less wealthy. As this occurs, there will start to be talk of a fed rate cut as Ben Bernanke and company attempt to put a floor on how bad things might get.

In fact, the fed might even wait until there are real data points signaling a weakening economy before actually cutting; which is why many argue that the fed is lagging in its policy. In short, they want to know that something is actually happening and not any type of anomaly before changing monetary policy.

As the fed cuts rates, it is because the economy is getting worse. The more they cut, the worse off things really are and the more in need of stimulation to prevent things from getting real bad. While interest rates and lending rates might dip a bit, it will come at the expense of restricting wealth effect due to falling stock prices and job losses.

The first thing that happens in the beginning of a weakening economy is that corporations start cutting capital expenditures and other costs. The ripple effect begins. As corporations prepare for the worst, their spending cuts fuel the upcoming weakness that results in lower profits and profit margins reported. As this happens, job cuts are considered as another option.

THIS IS NOT GOOD FOR HOUSING!

Here is a chart of the unemployment rate dating back to 1997, charted monthly, derived from the Bureau of Labor Statistics website:

Now here is a chart of the fed funds rate and monetary policy changes during this same time:

Now, lets combine the two charts and see if any relationship exists between when the fed starts cutting rates and unemployment reports soonafter:

Hmmm..Very interesting! At least we know that when the fed is cutting interest rates, it is because the economy is weakening, and in a weaker economy unemployment usually rises.

We have seen a very strong economy for some time now which has been reflected in higher stock prices since 2003 or so. Now one can argue that todays economy is a global economy with tons of liquidity and historically low real interest rates, and I'm fine with that, but what worries me is the warning signs. I see commodity prices still at very high levels, a stock run up that is due for a correction, possible policy changes in Washington, a weak dollar, and signs of peaking profits and profit margins.

But put all that aside and trying to keep focused on real estate, I just don't see how one can argue that as the fed cuts rates the housing market will boom again! There is a reason the fed is cutting rates to stimulate the weakening economy, and it is those reasons that might not bode so well for housing in the near term.

As I mentioned before, the biggest threats I see to housing in the near term is a change in policy of lending standards (which is already happening as lenders get tougher in the loans they hand out restricting purchasing power) and job losses. If the fed starts cutting rates, then its because corporations might be in for some tough times that could very well lead to job losses. How could that be good for housing? Even if rates on the 30YR fall from 6.2% to 5.75%, if you don't have a job or take a pay cut, then you can afford much less of a home if at all.

UrbanDigs Says - I'm not a pessimist and hope you don't look at me as such a negative broker. Its just the way I see things and like to play devils advocate and talk about the stuff that few like to publicly talk about; especially in this business. If the fed cuts rates it is because they sense weakness which will ultimately be priced into equities and which will force corporations to take action. That is my fear. Don't get caught up in the idea that 1-2 fed cuts will make the housing market boom because deep down those rate cuts are in reaction to more serious underlying issues that will overpower lower lending rates! Rather, it is the nearing of the end of a rate easing cycle and when the fed starts raising rates again (because the economy is strengthening) that I feel is a more optimal environment for the next round of housing price appreciation.

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No Need To Rush Into A Rate Lock

A: With the stock market selloff yesterday, Greenspan mentioning the 'R' word in a speech, Cheney being targeted by the Taliban, Asian stocks selling off, and corporate profits and margins showing signs of peaking, bond prices rose bringing yields down. As you know from reading UrbanDigs, a great indicator as to the short term movements of lending rates is the yield on the 10YR Treasury note. Lets see what has happened the past 5 days that leads me to think mortgage rates might come down a bit more in the very near term.

In my past post titled, "Why Rates Are Going Higher", I discussed the relationship of short term rate swings to the movements in yield of the 10YR Treasury Note. Specifically, I stated:

With the 10YR moving significantly higher over the past few months, it tells me that the bond market is a bit more worried about inflation and future monetary policy than the stock markets. Whatever the reason, it should cause lending rates and your credit card rates to RISE over the next month or so.

Bankrate has a graphing tool that lets you compare mortgage trends to economic indicators, but seems very aggressive in their reporting. I don't recall rates being as low as this tool suggests, so just use it to show the relationship between rate trends and the 10YR:

Now, take a look at what the yield on the 10YR Treasury note has done in the past 5 days alone; showing a drop in yield to about 4.5%:

With the sharp drop in yields expect lending rates to continue to follow suit over the next week or so and drop a bit further.

Conclusion: If you have recently signed a contract of sale and deciding what day to lock in that rate, you probably have time on your side. While anything can happen on a day-to-day basis, for those who like to eek out as much savings as possible before they lock in a rate, keep an eye on the 10YR (watch CNBC or read Yahoo Finance) in the coming days to see if this trend continues, holds, or reverses course. If it continues to fall or holds steady, a slight drop in lending rates will likely be in our very near future.

Otherwise, no need to focus too much on this. It shouldn't have any impact on what is going on right now from a macro standpoint and shouldn't cloud your investment decision to buy or rent.

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Mortgage Report: February 20th - 23rd

Mortgage rates dipped a little bit last week and showed some signs of improving. Here are the rates for today:

30 Year Fix (Under $417k): 6.125%

30 Year Fix (Over $417k): 6.25%

7/1 Adjustable Rate Mortgage: 6%

5/1 Adjustable Rate Mortgage: 5.875%

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Lenders Starting To Tighten..!

A: Wow! It's starting earlier than I thought. Check out this corporate email from an insider at Fremont Investment & Loan, a division of Fremont General Corporation (NYSE: FMT), published on Calculated Risk today.

Here is the corporate email published on Calculated Risks post titled, "Fremont lending Changes":

Sent: Monday, February 12, 2007 1:54 PM
Subject: PLEASE READ - IMPORTANT PROGRAM CHANGES at FREMONT
Importance: High

Due to general negative Industry sentiment, due to recent articles in the media, and the ripple effect to the secondary market, Fremont has made the difficult decision to speed up some changes that were set to take place later in the year. PLS READ BELOW.

2nd MORTGAGES ELIMINATED effective TODAY!!!!!

Any Prequals out there that are 80/20 or combo loans, pls contact me by email asap for new pricing, with an outside second if available from IBC or other lender, or as a 100% or straight one loan

AA CUT BACKS AND HUGE CHANGES – any files that have been priced on the AA program need to be looked at ASAP, pls email me and attach a copy of the prequal with 1003 and Credit

Note: Fremont is typically at the forefront when making changes to programs, I would urge you to expect our competitors to be making similar changes in the next few weeks. Fremont ’s goal is to be here for the long term, thankfully we are self funded with tons of capital and reserves….We will be here to close your loans.

Thank you for your patience and understanding in these tough times in the industry.

More Details will be communicated later today ... I apologize for the barrage of emails, but I wanted to make sure that everyone is aware of what is going on ...

Thank you.

Fremont Investment & Loan

UrbanDigs Says: If this email turns out to be the real deal, it takes blogging to a new level of providing true insights to readers about the changing funamentals of real estate investing. I love blogging and I love reading Calculated Risk. It adds so much transparency to real estate and gives readers an inside look at what is happening NOW in real estate across the country! These lending changes are inevitable and will ripple through to the bigger banks in time. For now, expect the smaller banks and sub prime lenders to start out with these tighter standards which ultimately restrict purchasing power. And if you forgot, read my post I wrote, "Credit Crunch: Tighter Loan Standards?", that was publised 2 weeks ago containing my thoughts on this very issue.

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Mortgage Rates Surge

A: When did I warn you about this? 7 days ago on January 25th, I wrote a post titled, "Why Rates Are Going Higher". Todays report on CNN Money released at 12:12PM today reports a 0.09% rise in mortgage rates to the highest level since October 2006.

According to the CNN Money article:

Moderate inflation along with a strong economic growth pushed up mortgage rates, according to a survey. The 30-year fixed rate mortgage rate averaged 6.34 percent for the week ended Feb. 1, up from 6.25 percent the previous week, according to Freddie Mac's (up $0.23 to $65.16, Charts) Primary Mortgage Market Survey released Thursday. Last year, the 30-year fixed mortgage rate stood at 6.23 percent.

If you recall, in my post 6 days ago I stated:

With the 10YR moving significantly higher over the past few months, it tells me that the bond market is a bit more worried about inflation and future monetary policy than the stock markets. Whatever the reason, it should cause lending rates and your credit card rates to RISE over the next month or so.

Buyers Should - Keep a close eye on interest rates; money may be more expensive in the near future restricting your budget. If you recently signed a contract and haven't locked in your rate yet, consider doing so as long as the time on the rate lock coincides with when you expect the deal to close. If your not sure, as your mortgage broker if they would give you a 5-10 day extension on the house should the deal close after the lock period expires.

Sellers Should - Understand that if borrowing rates do rise, that this means buyers will be able to afford less. Purchasing power will decrease. If you have a time pressure to sell, consider a price reduction sooner rather than later to stimulate activity in buyer demand. Ideally, you want to get a deal now rather than to wait a month or so when lending rates could very well be higher. We still have the fed meeting coming up so one thing I assure you, this rate environment will be volatile.

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Fed Update: Goldilocks Economy So Far

A: Yesterday's Fed meeting ended as expected with interest rates staying put at 5.25%. The all important statement issued with this rate decision suggests that the goldilocks economy, which means strong growth and moderating inflation pressures, seems to be in place thus far. However, the fed is still keeping an eye on future inflation risks and re-iterated that '...the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information".

Goldilocks Economy - A term used to describe the U.S. economy of the mid- and late-1990s as "not too hot, not too cold, but just right." An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. Some economists consider this optimal, and in such situations the government usually decides not to undertake any policy measures to improve macroeconomic performance.

The economy seems very strong these days which was confirmed by recent data and predicted by the runup in equity prices 3-6 months ago. Remember that equities are a leading indicator of the economy and corporate profits; so when stocks ran-up as they did from AUG-DEC of 2006 it should be expected that good economic data was soon to come. And it is coming right now. Question is, what happens next?

FED ON HOUSING & ECONOMIC GROWTH

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.

FED ON INFLATION RISKS

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Quick Tip: The fed's primary role is to combat inflation pressures and maintain pricing stability through monetary policy. Any change in monetary policy affects how expensive money is to borrow and in a rising interest rate environment (which is what we experienced over past few years) consumers will realize higher minimum payments on their credit card bills, higher mortgage rates, and higher payments on other debts.

Here is a chart of what the fed has done with monetary policy since 2004 & what the Dow Jones Stock Index performed along the way:

What You Need To Know: The fed has done a terrific job of battling inflation pressures and averting a recession due to the lack of a highly restrictive policy and statement on interest rates & future policy. Props to Ben Bernanke on a great first year as fed chief. However, we are NOT out of the woods yet. Expect rates to stay at this level and possibly be raised a bit more by years end if inflation pressures remain. Right now, I notice:

1. Energy Prices Are Rising Again - Oil Prices Rise Above $58/Barrel
2. Core PCE is Still Above Fed's Comfort Zone of 1-2% - US Core PCE Grows 2.2% on Year
3. Housing Showing Signs of Stabilization - Treasury prices Down on Housing Report

...all of which lead me to believe that there is no way the fed will lower rates anytime soon. As long as the economy is strong, housing news isn't horrible, and inflation pressures remain homeowners might have to deal with short term ARM's resetting into a higher rate and future homeowners finding money a bit more expensive to borrow than the past 3-4 months. Something to keep an eye on as I will continue to report on this very crucial fundamental that ultimately affects housing's affordability on the open market.

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Why Rates Are Going Higher

A: One of the more reliable indicators as to where 30YR fixed mortgage rates are headed in the very short term, is the bond market and more specifically the 10YR Treasury Note. Based on the most recent trend and current economic evironment, it's making me believe that mortgage rates are heading higher. Here's why and how to be prepared!

Most buyers look to the 30YR fixed mortgage rate for identifying trends, especially if you are gearing up to buy a new home. But most people don't understand what drives these rates higher and lower; which brings us to the purpose of this blog!

As HSH Associates points out:

As a 30-year fixed rate mortgage rarely lasts longer than about 10 years before being paid off or refinanced, the closest instrument which has similar (though lesser) risks is the ten-year Treasury Constant Maturity. Because of this, the ten-year Treasury makes an excellent tool to track mortgage rates.

10YR Treasury Chart (Last 2 1/2 Months)

Take a look at what the yield on the 10YR note did in the past 75 days! But don't take my word for it. Dan Green over at The Mortgage Reports is thinking the same thing, and he's in the business. Dan states:

I am predicting that rates will increase over the next 30 days, but that doesn't mean you should necessarily follow my advice when choosing whether to lock a rate, or float it. My advice may not be appropriate for your individual situation.

Now I know some of you hate this stuff and want me to keep posting new apartments and price cuts, but if thats the case than you are missing the whole purpose of this blog. Understanding how these fundamentals work and how they relate to one another will help you make the most educated investment decision possible.

UrbanDigs Says: Lending rates are directly related to purchasing power and affordability! With the 10YR moving significantly higher over the past few months, it tells me that the bond market is a bit more worried about inflation and future monetary policy than the stock markets. Whatever the reason, it should cause lending rates and your credit card rates to RISE over the next month or so. Sorry to be the bearer of this news. If lending rates do trickle higher as I expect them to, purchasing power will be restricted as affordability goes down due to the fact that money is more expensive to borrow.

Buyers Should - Keep a close eye on interest rates; money may be more expensive in the near future restricting your budget. If you recently signed a contract and haven't locked in your rate yet, consider doing so as long as the time on the rate lock coincides with when you expect the deal to close. If your not sure, as your mortgage broker if they would give you a 5-10 day extension on the house should the deal close after the lock period expires.

Sellers Should - Understand that if borrowing rates do rise, that this means buyers will be able to afford less. Purchasing power will decrease. If you have a time pressure to sell, consider a price reduction sooner rather than later to stimulate activity in buyer demand. Ideally, you want to get a deal now rather than to wait a month or so when lending rates could very well be higher. We still have the fed meeting coming up so one thing I assure you, this rate environment will be volatile.

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Flood of Data: Here's What It Means

A: Just a follow up to yesterday's post. The overall message that came from todays economic data is that the economy is doing very well, jobs are healthy, inflation improving slightly but still of concern, and housing is showing signs of stabilization. However, the housing data must take into account the very warm weather that we have had over the past months as that allowed builders to finish their products at a faster pace; so look at this particular report as evidence the housing market is hanging in there rather than rebounding. Bond yields rise as a result of this data which may cause lending rates to trickle higher in the coming week.

Lets get right into it.

US Economy is Strong & Housing Stuns Doomsdayers

Jobless Claims Fall to 11-Month Low - The Labor Department reported Thursday that applications for jobless benefits totaled a seasonally adjusted 290,000, down 8,000 from the previous week when claims had fallen below 300,000 for the first time in six months. The back-to-back improvements pushed claims to the lowest level since the week of Feb. 18, 2006.

The latest decline came as a surpise. Claims had been expected to start rising again, given weakness in such key sectors as housing and auto productions

Housing Construction Rises For 2nd Month - Construction of new homes rose for a second consecutive month in December, raising hopes that the severe slump in housing may be leveling off. Analysts cautioned that the December figure could be overstating the extent of the rebound since it was probably influenced by warmer-than-normal weather last month.

NOTE: Tons of incentives offered to new buyers are stimulating demand. Something to keep in mind as the homebuilders work to selloff inventory across the country. Doesn't really apply to NYC real estate, although some developers here are offering incentives as well in closing costs and upgrades.

Inflation Has Best Showing in 3 Years - The Labor Department reported Thursday that consumer prices rose by 2.5 percent in 2006, the best showing since prices had increased by just 1.9 percent in 2003. The improvement came in spite of the fact that consumer prices jumped 0.5 percent in December, as gasoline prices staged a momentary rebound.

UrbanDigs Says: Lending rates are directly tied to short term bond yields and as a result of today's strong economic & housing data, yields jumped. This should lead to a trickling higher of mortgage rates in the coming week or so. The US economy is strong and the surprisingly positive housing data (whether the result of weather or not) throws out ANY chance of a rate cut in the near future. In fact, the fed funds futures markets switched gears and went from a slight chance of a rate cut to a slight chance of a rate hike over the next few quarters. All in all, Mr Bernanke is looking more and more like a miracle man in his quest to balance economic growth and control inflation. Kudos for a job very well done thus far with monetary policy.

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Fed Update: Oil & Housing Data

A: With a spectacular correction in oil prices (recall my 2007 predictions I published Jan. 2nd when oil was trading at $61/Barrel) and lack of doomsday data from housing over the past few weeks, there really hasn't been much to talk about on the monetary policy front. The fed will easily hold rates steady for the first half of the year, giving all the rate-cut arguments less chances of success. This week has some important data coming out so short term expectations on interest rates may drastically change.

Oil Plunges Below $51/Barrel

Warm weather, growing inventory, and a cancellation of an emergency OPEC meeting all contributed to the plunge of more than 16% of light sweet crude prices since the start of the year. As noted in the CNN article:

Oil prices plunged more than 3 percent back near $51 a barrel Tuesday after Saudi Arabia said OPEC production cuts were working well and that there was no need for an emergency meeting of the producer group. The Organization of the Petroleum Exporting Countries (OPEC) agreed to cut 1.2 million barrels per day (bpd) of output from Nov. 1 and then to cut another 500,000 bpd from Feb. 1.

In relationship to interest rates, lower energy prices will help keep the fed on the sidelines. With the hard and fast correction in oil over the past few weeks, I would expect contrarian traders to start buying with the very short term expectation of oil being oversold, and a small rally back to $55 or so where a new trading range will be formed.

Economic & Housing Data

This week brings us a few very important pieces of economic data that will ultimately affect short term expectations on future monetary policy. If the economy is heating up or housing reports show strength, expect NO rate cuts and possibly a hike before the year ends. On the flip side, if the economy is showing weakness, especially in housing, the fed might jump in quicker than previously thought to cut rates to prevent the economy from slipping into a recession.

For all those who dont understand why I talk about this stuff, its because it affects monetary policy; and its hard to argue that monetary policy is directly linked to real estate cycles. As affordability goes down due to rising borrowing costs, buyer demand softens and inventory rises ---> leading to a slowing real estate cycle and a correction in price appreciation. Simplicity applied to the real world. I like to look to the sources of such change, that is, what makes monetary policy become restrictive or stimulative.

On tap for this week includes:

TODAY - Core PPI Report
TODAY - PPI Report
TODAY - Crude Inventories
TODAY - Fed's Beige Book

JAN 18 - Building Permits
JAN 18 - Core CPI Report
JAN 18 - CPI Report
JAN 18 - Housing Starts
JAN 18 - Initial Jobless Claims

Lots of data to digest! I'll certainly be keeping an eye on the most recent evidence that the economy is staying strong or starting to show signs of weakness. We will also get good data on the inflation front, but its too early to see the results from the plunge in oil prices over the past 2 weeks. That should start to show up in economic data in 2-4 months or so.

NEXT FED MEETING JAN 30-31 - Expect NO CHANGE in rates. Inflation will still be a concern for fed members as changing their stance as tough against inflation will have negative affects. We need a hawkish fed, at least one that portrays that image, and thats exactly what they will do.

On a side note, Calculated Risk reports on Dr. Edward Leamer's (Director UCLA Anderson Forecast) prediction on whether or not the housing recession will infect the overall economy:

The models that rely on history suggest that the extreme problems in housing currently being corrected will almost surely infect the rest of the economy, but that history does not take into account two important facts:

• Manufacturing is not poised to contribute much to job loss.

• Real interest rates are very low and there is no evident credit crunch, now or on the horizon.

These facts make the problem in housing less severe than it would be otherwise, and help to confine the pathology to the directly affected real estate sectors: builders, real estate brokers and real estate bankers.
...

The models say "recession;" the mind says "no way." I’m going with the mind. This time the problems in housing will stay in housing. If you are a builder or a broker, it will feel like a deep depression. The rest of us will hardly notice.

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Housing Data In: Not Too Shabby..but!

A: The housing data came out today showing that existing sales were UP from last month (down year-over-year), but prices declined year-over-year. All in all it sends a mixed message as the # of sales increasing is somehwat suprising and will help keep inventory levels from expanding further which would certainly negatively affect housing fundamentals going into 2007. But the price declines from this time last year tell me that buyers are starting to jump in a bit and pick up bargains; a sign of general strength. While this data is lagging and is often revised at a later date, it should lead to a further psychological boost going into wall street bonus season in early 2007, and give sellers a few more months of healthy buyers to prey on. As for hopes of a rate cut, you can kiss that goodbye until at least mid-2007 or later; I'm even starting to think a few more hikes might occur first.

According to CNN Money article released this morning:

The National Association of Realtors reported that the median price of a home sold in November was $218,000, down 3.1 percent from the $225,000 in November 2005. The pace of home sales picked up in November, coming in at an annual rate of 6.28 million for the month. That's up 0.6 percent from the 6.24 million rate in October, and it beat the forecast of a 6.15 million rate from economists surveyed by Briefing.com. But the sales pace was 10.7 percent below year-ago levels of 7.03 million units.

Homebuilding, one of the most battered sectors of the U.S. economy in recent months, showed surprising strength in November, according to a government report Wednesday. New homes sold at an annual pace of 1.05 million, up from the revised annual rate of 1.01 million in October. Economists surveyed by Briefing.com had forecast that home sales would rebound to a 1.02 million pace.

Still, John Tomlinson, an analyst with Majestic Research who covers the major publicly traded builders, said the government report is missing some signs of weakness in the new home market, including orders for new homes that are cancelled by buyers or incentives offered by builders, such as covering closing costs or extra features on the homes for free, in order to support sales in the weak market.

"I'm not so sure that the pricing has bottomed here," Tomlinson said. "There's still a ton of inventory on the market. When inventory comes more in line with demand, we'll be ready to see an upturn."

The slight increases in sales were not enough to halt a slide in home prices. The median price for an existing home sold in November dropped to $218,000, down 3.1 percent from the price a year ago. It was the first time on record that sales prices compared to a year ago have fallen for four straight months. The report on existing home sales offered further hope that the serious slump in housing that has occurred this year may be bottoming out. It followed a report Wednesday that showed that new home sales rose 3.4 percent in November, the third gain in the past four months.

As for how this affects monetary policy, it throws out the window any chance of a rate cut in the next quarter or two. That is why you are seeing bond yields start to rise a bit after these reports; as the likelihood of a fed rate cut gets put off for a while longer. In fact, a rate hike might be more likely. Here's why:

GOLD/PRECIOUS METALS ARE STILL HIGH - The price of gold and other precious metals are still trading at very high levels. These guys are inflationary and take time to funnel through the economic system when producers start to feel the pain of rising costs that eventually get passed on to the consumer. I recently heard Steve Forbes debate on CNBC that as long as GOLD trades above $500, there will be distortions in inflation readings that may trick the fed into raising rates. His thinking is a fed move of HIGHER RATES, not lower, in 2007. This is Steve Forbes so its hard to just discount his way of thinking altogether.

STOCK PRICES ARE FLYING - Anyone else notice this? Equities are hitting historic highs in the DOW and 3-4 year highs in the NASDAQ. And to boot, global markets are following suit. So many countries are experience surging equity markets, making me nervous. Remember that stocks are leading indicators of the economy, NOT LAGGING, and as such are obviously pricing in a soft landing, NOT A RECESSION, as corporate profits are strong, wage labor is strong, and the decline in energy prices gave even more ummph to earnings.

Keep an eye out. If housing data doesn't get worse and stocks continue to fly, how on earth will the fed cut rates? They won't! If anything they will have to raise rates to combat inflation and slow down the economy a bit more.

US DOLLAR WEAKNESS - Continue declines in the US dollar are inflationary. As the greenback continues to slide, the fed will have to step in and control the currency. After all, the 2 most important jobs of the federal reserve is to control inflation & maintain pricing stability. A weak dollar is not good news for future inflation and might cause the fed to get more hawkish in future issued statements. Keep your eyes open.

So what does this all mean? Who the heck knows. The two things I will keep an eye out for in 2007 is inflation pressure and energy prices. The stock market will continue to surge as long as energy prices decline. The housing market will continue to stabilize as long as the economy is strong, jobs are stable, and incomes are strong. The question is, what will happen that will affect what Ben Bernanke and company decide to do with short term interest rates.

For now, the housing market should enjoy a few strong months as the lack of horrible data and continued surge in equities should provide for a healthy buyer pool in the next few months. Things to look out for in 2007 that will cause the housing market to retreat:

1. Weaker Economic Data Showing Weakness in Jobs & Wages

2. Lenders Tightening Loan Restrictions & Ease of Borrowing Ending Years of Credit Giveaways

These are the two biggest threats to housing's future and will occur if the bond market is right in predicting a recession in late 2007 or 2008. But for now, the stock market is getting the headlines as equities bet on a soft landing! So, who's right!

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Fed Update: What Will 2007 Bring?

A: It's been a little while since I talked about the economy, inflation and monetary policy here on UrbanDigs. For a little while I was starting to think the fed actually got it perfectly right, slowing down the economy enough to ease inflation pressures, but not enough to cause an outright recession. Couple that with a correction in oil prices and the 4 month stock market rally is explained. But with today's PPI # and housing permits released, reality is starting to settle in. We are NOT out of the inflation woods yet!

A little over a year ago I wrote a post here on UrbanDigs about a fundamental shift of investing from housing to stocks. It was before I sold my apartment and was still struggling to make do with my enormous living costs. As much as I would have liked to just flip a switch and cash out my housing profit to put into stocks, things just don't work that way!

In the post titled, 'Will Growth Shift From Housing To Stocks', that I wrote back in November of 2005, I made a few statements as to why I thought the stock market was ripe for big gains in the coming year or two. If only I had the cash to follow my own advice!

I quickly learned the illiquid nature of housing as I listed my apartment for sale in January, took 5 months to find a buyer, and closed in early July with an all cash deal expedited by no financing. However, in that time the stock market already started to run and I stayed on the sidelines. A poor decision.

But you must move on! Buying into the stock market right now seems a bit risky to me after the 6-8% gains that were enjoyed in the past 6 months or so. As a contrarian investor, I like to sell high and buy low, even if that means holding onto no gains for a while if I don't time the investment perfectly. Who does. Looking forward, I am perfectly fine with my money getting 5.05% in a no-risk online savings account as I await future economic data to come in.

Today's economic data is a dose of reality! Inflation is not dead yet as the stock markets would have you believe with its unsustainable rally of recent months. According to CNN Money:

The Labor Department's Producer Price Index jumped a larger-than-expected 2 percent in November. The measure of prices paid by businesses posted their biggest gain since 1974. Core PPI , which strips out volatile food and gasoline prices , rose 1.3 percent, spurring inflation worries

The Producer Price Index, which measures inflation pressures before they reach the consumer, was up 2 percent last month, the biggest advance since a similar increase in November 1974, the Labor Department reported Tuesday.

Economists had been expecting a rebound in wholesale prices following two months of big declines. However, the 2 percent jump was four times bigger than the 0.5 percent increase they had forecast. Even excluding volatile energy and food prices, core inflation posted a 1.3 percent advance, the biggest jump in 26 years.

The 2 percent rise in wholesale inflation followed four straight months of benign readings including outright big declines of 1.3 percent in September and 1.6 percent in October.

In those months, energy prices were falling sharply, a situation that reversed in November.

Food costs showed a small 0.1 percent rise last month after a big 0.8 percent decline in October as increases in the price of dairy products, eggs and soft drinks offset declines in vegetable and fruit prices.

The thing about housing is its illiquid nature. Once housing turns from a booming market to a slowing one, it doesn't just get one peice of good news and turn back around to good times. It takes time to work through inventory buildups. It takes time to get back to a interest rate environment where 30YR mortgages are below 5%. It takes time to get the all important 'time on market' indicator back down to where it was a few years ago. These things TAKE TIME to work out!

The housing boom lasted a good 4 years or so if you start the boom after 9/11 and end the boom in mid 2005. Others will argue that the housing boom started way earlier with 9/11 just a short term blip in the run. I'll buy that as I was priced out of the housing market for years before 9/11 showed a few opportunities. So whether the boom was 4 years or 7 years, it really doesn't matter. The point is it lasted a good period of time. With the peak in housing occurring around mid 2005 (in hindsight), we are now about 18 months into a slowdown. What if the slowdown lasts 4 years? What if it lasts 7 years? Only time will tell and we must follow all the signs that will forecast a brighter future for housing down the road. These include lower interest rates making housing more affordable, less time on market indicating strength in the buyer pool, lower inventory keeping supply lower than demand, and a strong economy generating enough income for people to buy new homes.

I'll leave it to you to decide when to re-enter. As for monetary policy, here is what I think the fed will do.

NEXT MEETING: No Change. Inflation remains a concern.

WHAT WILL MAKE THE FED CUT IN MID 2007: Easing inflation #'s and a continued softening of the housing market will make the fed cut rates in 2007.

WHAT WILL MAKE THE FED RAISE IN MID 2007: More economic data like today's PPI #. If energy continues to rise above the $70/Barrel mark again. A strengthening housing market and a continued rally in equities will tell the fed the economy is very strong and might need to be slowed.

I think 2007 will be flat to down for housing as we iron out the fundamental bumps of inventory and weak speculators. Those who bought between 2003-2005 with short term interest only loans will have some problems and might be forced to sell. Stocks will have another up year, but not as good as 2006. Inflation's true face will either show or go away in 2007. I will certainly be keeping my eyes on inflation and energy prices as I think these 2 guys will be the best indicators of future monetary policy, equity direction, and housing's level of correction.

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Interest Rate Update: Fed Will Hold

A: Been a little while since I talked about monetary policy. The main reason has been that I was waiting for some more economic data to come out to get a clearer picture of what the fed might do with interest rates. The bottom line, expect the fed to keep rates where they are for some time.

The fed has been on hold for a few quarters now while officials guage the effects of past rate hikes on the economy. The ultimate goal was to keep inflation from infecting economic growth. Today's CPI report seems to confirm this with one issue: ENERGY PRICES. The price of energy has fallen nicely from earlier year record highs and remained there. The results are now being felt in economic data. As the cost of energy falls, corporate profits rise and inflationary pressures ease a bit.

According to today's Yahoo Finance article titled, "Falling Gas Prices Help Push CPI Down":

Consumer prices, helped by another huge decline in gasoline pump prices, fell for a second straight month in October, providing more relief to Americans battered earlier in the year by soaring energy costs.

The second 0.5 percent fall in consumer prices was better than the 0.3 percent dip that many analysts had been expecting. And core inflation, which excludes volatile energy and food prices, was also well-behaved, rising by just 0.1 percent, the smallest gain in eight months.

The news on inflation was certain to cheer officials at the Federal Reserve.

There is only one problem with all of this. That is, what we are experiencing now (higher stock prices and tamer inflation data) are largely due to the drop in energy prices and specifically light sweet crude oil from $76/Barrel to $59/Barrel today. Here is a 1-Year chart showing the drop that oil has had in relation to when it was at record levels:

What happens if this winter is colder than expected and stockpiles of fuel reserves start to fall? What happens if geo-political concerns in Iran, Nigeria, Venezuela, or Iraq worsen causing a supply imbalance of oil? What happens if consumption starts to rise again?

Well according to CNN Money's article today titled, "Oil inches over $59 on Strong Demand":

Distillates stocks in the U.S. fell by 3.6 million barrels last week, nine times more than forecasts, while gasoline supplies dropped by an unseasonably high 3.7 million barrels, the Energy Information Administration (EIA) said on Wednesday.

"The strong demand in gasoline and distillates is very surprising," said Tetsu Emori, chief strategist at Mitsui Bussan Futures.

Total U.S. oil demand is up 4.8 percent from a year ago, the data showed. Demand for distillates is up 9.5 percent.

"If the trend lasts a few weeks, prices may be taken higher. But crude oil inventories are still very high so the potential upside could be limited."

If you were expecting a recession in early 2007 resulting in the Fed cutting interest rates and making mortgage/credit/auto payments cheaper for everyone, then I think it's time you wake up to realty. If there is a recession coming then why is the stock market rallying to new highs? Remember that the stock market is a LEADING INDICATOR of the economy while rate hikes/housing data/energy prices are LAGGING. To get the best idea of where the US economy is heading in the short term, you should look at what stock traders are betting on.

HOW THIS WILL AFFECT HOUSING: With the fed on a short-medium term HOLD with interest rates, expect mortgage rates to remain at levels they are at today, with minor fluctuations. Any new buyer demand as a result of lower mortgage rates will NOT OCCUR until the beginning of 2008 at the very least; and that is assuming the fed starts to cut rates in mid-2007 which is not a sure thing yet. If you recall, I talked about when to re-enter the housing market and included "...when the fed is nearing the end of a rat-easing campaign" as one of a few key peices of data to look for.

Consider the drop in oil a godsend for those with resetting ARM's and other types of adjustable mortgages as without this price drop the fed will have most likely raised interest rates again by 1/4 point at one of the next 2 meetings. Instead, it seems the fed has found a sweet spot with the fed funds futures at 5.25% that is neither restricting or stimulating the current economy.

WHAT TO WATCH: The price of oil. If the price of oil rises to above $70, expect the stock markets to give up their recent gains and future economic data to show inflation becoming a threat again.

For a more in depth look at what I discussed here, read CNN Money's article titled, "Beware: No Rate Cut Until 2008" which points out details from the minutes of the last fed meeting.

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Fed Update: A 2-Day Meeting?

A: Its been a while since I delved back into the true me, and focused on trading and the equity markets, and why stocks have been rallying since early August and what that all means in terms of the fed's next move, (not next meeting). And whats up with the fed extending its usual 1 day meeting to a 2 day one; as I just saw reported on CNBC? Here are some thoughts.

The fed's 2-day meeting ends Wed Oct. 25th at which time we will most likely get a NO CHANGE - RATES REMAIN UNCHANGED decision from the FOMC. What we do NOT know is the accompanying statement that will be issued and whether or not more hawkish words are included as the war against inflation continues.

Fact is, inflation is being very stubborn right now while energy price declines sparked a recent stock rally; at least this is my opinion. Since the price of one gallon of gas starting plunging close to 35%, stocks began going higher. Now energy prices are at year lows and equity markets are at 5+ year highs. The equity markets are PRICING IN economic data that is expected to come from corporate America. That means GOOD NEWS in the coming months regarding the economy...

...And THAT MEANS, more inflation worry's and rate hikes to think about to slow things down by the fed! For all of you getting caught up in the recent business headlines that promise rate cuts by mid 2007, I say...DON'T HOLD YOUR BREATH!

I would expect rates to stay where they are, if not rise a little more, in the near future. We must remember that fighting inflation now and risking a recession later is better for our long term economic health than if inflation goes unfended. Rates are STILL at very low levels, historically speaking, and it would be narrow-minded to think the next move could ONLY be a cut.

Factors that should be watched to see why the fed would raise rates again:

STOCK MARKETS CONTINUE TO RALLY

Equity markets are a leading indicator of publicly traded corporations. Investors have the opportunity to invest in the near-term prospects (6-18 months generally) of any public company in the hopes that future revenue growth will meet or exceed anaylst expectations (preferably exceed obviously); like Google, NASD: GOOG, has been doing lately!

Right now, with equity markets charging full speed ahead, I'm thinking its the cost savings in energy that is going to be one of the main reasons for higher reported income by corporate America in the coming 3-6 months; hence the rally. If all else stays as predicted, but sky high energy costs suddenly plunge in a very short period of time, than corporate profits rise as costs shrink.

Or is it some other fundamental? Probably. But who cares. Stocks have been going higher and thats all that matters right now. Money is betting on a good economy, not a slowing one, and the fed knows this. Check out this 6 month chart of the DOW JONES Industrial Average, courtesy of Yahoo Finance:

If stocks continue to gain, expect the fed's chances of raising rates (as estimated by the fed funds futures) to RISE!

ENERGY COSTS BOUNCE BACK

Energy prices have corrected beautifully over the past 3 months giving relief to millions of Americans, corporations, and at the same time giving headaches to hedge funds and traders still long the commodity. Check out this nosedive of a chart for crude oil:

Its a double edge sword with the price of oil. If oil prices rise then the added costs may trigger iinflation down the road by making products more expensive too (companies have to add on those extra costs somewhere). On the other hand, if energy prices fall then both the consumer and the company show more money at the end of the day that could eventually be used to SPEND, helping to fuel the economy. Either way, it seems inflationary.

I would think that the former is more on the fed's radar though and that as energy prices rise, so do the chances of another fed rate hike!

HOUSING #'s COME IN STRONGER THAN EXPECTED

What the heck am I talking about here? Housing #'s coming strong? Why not! Take a look at the latest Housing Starts numbers that came in last week:

According to CNN Money:

Home building may be ready to shake off its 2006 slump, as housing starts posted the biggest jump since January, according to a government report Wednesday. The report also showed that building permits, seen as a sign of builder confidence, fell more than expected.

The number of new projects that home builders started rose to an annual pace of 1.77 million in September, according to the Census Bureau, from the 1.67 million pace in August. The 6 percent increase in September contrasts with a decline in starts in six of the previous seven months.

If housing news is good, than the fed will have the clear 'go ahead' to fight inflation by raising rates.

BOND YIELDS CONTINUE TO RISE

Hard to argue the bond market. When you start to see short term yields on the rise it means that bond traders are betting on either a firm hold for longer than thought with current rates or another rate hike. Take a quick look at short term bond yields since yesterday, last week, and last month:

Bond yields will rise with the anticipation of firmer monetary policy ahead!

WHAT I THINK THE FED SHOULD DO: No Change; Change of wording indicating inflation is STILL a hazard and that the 'further firming might be needed' phrase be re-inserted or similar.

WHAT WILL FED PROBABLY DO: No Change; No notable change in wording. Inflation still a concern but no new phrases added.

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Fed PAUSES! Fed PAUSES!

A: The fed ended a 2+ year interest rate hike campaign today with a PAUSE and leaving the fed funds rate at 5.25%. However, they issued a statement saying, "some inflation risks remain and continued tightening may be needed"!

The decision was NOT unanimous (9-1) as one voting member of the fed wanted to bump up rates another 25%! Also, the statment was a bit on the dovish side as the fed stated that inflation expectations are for a moderation in inflation as past fed moves kick in and the economy continues to cool.

NOTE: A pause does NOT mean the fed is done completely! Yes, if the economy continues to slow, inflation will seem to dissipate, and the fed may have to cut rates to stimulate the economy again. But the timing of such rate cuts are probably further down the road than people think! For the short term, another future rate hike is much more certain as future inflation #'s will reflect the lagging effects of very high energy and commodities prices!

Plan accordingly and expect the last 3-4 fed rate hikes to still trickle through the economic system and affect all of us over the course of the next 8-10 months!

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Betting on a Rate Pause

A: The fed meets next week to decide the next move with monetary policy, and I have to say that this meeting is by far the most confusing one in the past 2 years as to whether or not there will be an 18th consecutive 1/4 point rate hike or a pause. The markets are betting on a pause. Here is the skinny!

FED FUNDS FUTURES ARE 36% FOR HIKE & 64% FOR A PAUSE

The fed funds futures contracts are bets made by traders as to whether or not the fed will hike at their next meeting. Right now traders are betting on a pause!

This is mainly due to Bernanke's speech to Congress a few weeks ago where he mentioned that he believes a 'cooling economy will help keep inflation pressures at bay'. I do not agree but then again he is Big Ben and I am UrbanDigs.

All in all, the fed funds futures are betting on a PAUSE!

EQUITIES MARKETS RALLY AHEAD OF FED MEETING

The equities markets are rallying in anticipation of a pause at next week's meeting. A party too early? Perhaps! However, with the fed funds futures predicting a pause, money is following suit in equities. Should the fed pause, a slight temporary rally in stocks should be expected as the recent rally is already pricing in a pause. Should the fed raise 1/4 point, stocks will fall. Should the fed raise 1/4 point and issue dovish remarks (that means they mention the rate hikes are pretty much done), the equities markets will probably fall at first but then rally after.

All in all, the stock market is betting on a PAUSE!

BOND PRICES RISE AS YIELDS FALL

The bond market has experienced a runup in prices and a dropoff in yields as bond traders are predicting a pause at next weeks fed meeting! Remember, as bond prices rise yields fall and vice versa.

The 2YR, 5YR , and 10YR treasury notes all had a significant drop in yields as they predict an end to the 2+ year interest rate hike campaign and bet on a upcoming US recession (via an inverted yield curve) where the fed will have to cut rates to stimulate the economy.

All in all, the bond market is betting on a PAUSE!

MORTGAGE RATES & US DOLLAR DROP

Freddie Mac reports 30-year sinks to 6.63% on weak GDP numbers, warns that number will drift over next few months. The average rate on 30-year fixed-rate loans fell to 6.63 percent for the week ending August 2 from 6.72 percent the week before.

The weak GDP # technically means inflation is not as bad as first thought, that the fed can pause with a slowing economy, and therefore mortgage rates reacted as such.

Also, the US dollar has been getting hit as currency traders devalue the greenback as most other tradable markets predict a rate pause at next weeks meeting. Recall that the US dollar rises as the fed raises the fed funds rate and makes fixed asset investments more attractive! With a pause now predicted, the dollar is weakening.

All in all, lending rates and US currency traders are betting on a PAUSE!

MY THOUGHTS

The case for another 1/4 point hike is certainly very compelling given the recent jump in core inflation and the surprising strength in US manufacturing data; which shows inflation rising and US economy still strong. Recall that Bernanke started this whole PAUSE chain of thought by saying that a slowing US economy will keep inflation at bay! Oh boy, I hope he's right because most economists would agree that inflation is far worse than a recession, and should take priority as monetary policy is set to control price stability.

This is how I see it:

With the core inflation number well above the fed's stated comfort zone I just don't see how they can solely rely on a predicted slowdown in the US economy to ease inflation pressures on its own. An 18th consecutive 1/4 point rate hike is needed and will show the markets the hawkish nature of the fed and their willingness to fight inflation. That would be the right move. A fed funds rate of 5.5% is NOT restrictive historically speaking as we were at 6.5% in the mid 2000 when the fed tried to slow down the booming dot com equity markets. All homeowners should keep an eye on next week's move as it will eventually affect their monthly mortgage payments!

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Where Mortgage Rates Are Headed

A: Every homeowner and buyer knows the importance of where lending rates are headed because it directly affects the monthly payments that they will be responsible for. As rates rise, so do your monthly payments making a property a bit less affordable depending on your income. Here are some thoughts on lending rates as reported by the blogosphere.

LENDING RATES ARE CORRELATED WITH THE FED FUNDS RATE WHICH NOW STANDS AT 5.25% AND CONTROLLED BY THE FOMC AND FED CHIEF BEN BERNANKE. THE FED FUNDS RATE IS RAISED IN TIMES OF ECONOMIC BOOM AND INFLATION WORRIES TO SLOW DOWN THE ECONOMY. THE FED FUNDS RATES IS LOWERED IN TIMES OF ECONOMIC SLOWDOWN AND DISTRESS TO STIMULATE CAPITAL & CONSUMER SPENDING TO HELP SPUR ECONOMIC GROWTH. RIGHT NOW WE ARE IN THE FORMER ENVIRONMENT.

Mortgage Reports: A great blog focused on mortgage rates and the like by Dan Green. He reports:

I am predicting that rates will remain unchanged over the next 30 days, but that doesn't mean you should necessarily follow my advice when choosing whether to lock a rate, or float it. My advice may not be appropriate for your individual situation.

If you are shopping for mortgages and the idea of not having a rate lock commitment makes you nervous -- regardless of my predictions -- I recommend that you go ahead and lock in your rate. There is just too much financial risk in floating a mortgage interest rate -- especially given the volatile nature of the markets.

Mortgage Matters: Holden Lewis's blog on bankrate.com tells it like it is and how surveys of top lenders turn out. He reports:

In this week's Bankrate.com survey, the average rate on a 30-year fixed fell 12 basis points. Actually, though, rates have been at a standstill -- all or most of that drop occurred a week earlier, during and immediately after Bankrate's July 19 mortgage rate survey. Because of timing, we didn't catch that decline, so it spilled over into this week's survey.

Yeah, it's confusing.

The Complaint:

I need to lock in a rate in the next week for a house in Silver Spring and have been shocked by how much the rates change from one day to the next.

Specifically, what the Loan Consultant was referring to was the fact that the 10-year treasury benchmark had dropped in the previous couple of days to its lowest in 4 months. However, your writer is comparing this to the Freddie Mac rate which is a backward logging rate - always looking back about a week or so whereas most lenders tend to move with the market. In other words, the writer was not comparing apples to apples. Unfortunately, it seems that consumers are often misled - or tend to misunderstand - the relationship to mortgage rates of these Freddie Mac announcements.

It's usually best to lock in a rate in the morning since most lenders tend to increase their margins at the end of the day and put out their best price in the morning to encourage applications and locks.

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Fed Watch: Bernanke Getting Grilled

A: With his 2 day testimony to Congress finishing up today, I can tell you right now that fed chief Ben Bernanke is getting grilled as the members of the Committee of Banking, Housing, & Urban Affairs put Big Ben on the hotseat as the fed tries to strike a balance in monetary policy in a very uneasy environment of inflation pressures, geo-political tensions, and a cooling housing market and US economy.

The reason why equities markets rallied yesterday was a combination of being oversold over the past few weeks and Big Ben's comments to Congress where he declared:

Should that moderation occur as anticipated, it should help to limit inflation pressures over time

Very interesting as fed chief Bernanke and the other voting members of the FOMC are dealing with a very unstable environment and still dangerously high energy prices. I just dont see how all of this will come to resolve itself with a cooling US economy. Inflation is far more damaging than a future recession and Bernanke & Co. know this all too well. So why take chances?

The Skinny: Even if Bernanke pauses down the road, don't expect rate cuts to happen so fast. Big Ben even said that:

"The increase in energy prices is clearly making the economy worse off both in terms of real activity and in terms of inflation. There is no question about it," Bernanke told the House Financial Services Committee. Surging energy prices are acting like a double whammy on the country's economy, crimping growth even as they push up inflation.

Are you beginning to see why I talk about the fed and monetary policy so much here on UrbanDigs! Of all the great comments I get about the content of the site, I have received a few emails saying to stay away from fed talk. I disagree with this as I feel it is so important to monitor our new fed chief and how he reacts to environments such as the one we are in now, and especially pay attention to what rising interest rates ultimate affect on housing turns out to be! It will only help all of us invest more wisely in the future.

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Fed Watch: Expect Another 1/4 Point Hike

A: All eyes are on Ben Bernanke & Co. as the fed finishes its 2-day meeting today with their final say on monetary policy. Expect a 1/4 point rate hike as the fed continues to view the data and the lagging effects of 16 consecutive 1/4 point rate hikes over the past 2 1/3 years going into today.

Bernanke must show the tradable markets that he is in control and being aggressive in the fight against inflation. The biggest thing to look for in today's 2:15PM EDT decision on interest rates is NOT whether he will raise, we know he will, but the issued statement that goes along with the rate move. I would expect more of the same with a 'data-dependent' fed leaving the door open for another 1/4 point interest rate hike in August.

Today's 1/4 move will bring the fed funds rate to 5.25% and will mark the 17th consecutive rate hike since Alan Greenspan started back in 2004.

For all you newbies to UrbanDigs, the fed controls the fed funds rate to control price stability and guard against inflation creeping into the US Economy. As the fed raises rates, lending becomes more expensive directly affecting the minimum monthly payments that debt holders have to pay on mortgages, ARM's, HELOC's, credit cards and other rate sensitive debt. In short, the fed is trying to slow the economy by tightening credit making it more expensive for people/corporations to take out loans and making it more attractive for people/corporations to invest in fixed asset securities such as CD's. As interest rate's rise, cash becomes more attractive while investments buoyed by 'cheap money' (i.e. housing, new business loans, etc.) become less attractive.

WHAT THE FED WILL DO: Raise 1/4 point to bring fed funds rate to 5.25% and issue an unclear, 'data-dependent' statement bringing undertainty over their next move in AUGUST even though consensus currently calls for a 75% chance of another 1/4 point hike

WHAT THE FED SHOULD DO: Raise 1/2 point, issue a clearer statement that the 2+ year rate hike campaign is now over

There is a growing debate why the fed should raise rates by 1/2 point and get it all over with (including me), but that will not happen. There is also a growing argument that former fed chief Greenspan should have raised rates more aggressively when he first started 2+ years ago, which would have put the results of monetary policy (which are lagging and take about 8-12 months to have an effect) on a faster timetable. This didn't happen so there really isn't much to talk about other than how the fed can learn from past mistakes.

For those of you seeking to buy a home in the near future, be prepared for lending rates to continue to rise and plan accordingly.

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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 CHECK

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.

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Fed Update: Issues With Data Dependence

A: Wow, wow, wow. This morning started off with an unwelcome Core CPI rise of 0.3%, exceeding estimates of 0.2%. Fed Funds futures briefly trade beyond 100% in predicting a June rate hike.

According to CNN Money article:

The core CPI now is up 2.4 percent over the last 12 months. That's well above the target of a 1 to 2 percent 12-month rise in the core CPI which is traditionally seen as within the Fed's comfort level.

Fed Chief Bernanke has said repeatedly over the past few months that future monetary policy will be more 'data-dependent', sending shivers down the spines of investors and traders because if there is one thing the markets don't like, its uncertainty!

Now, the Core CPI data that came out this morning resulted in the fed funds futures contracts briefly going beyond the 100% mark in pricing in another rate hike at June's meeting! Thats bad for all those laymen out there with credit debt or adjustable rate mortgage products. The reason why 'data-dependent' judgement has issues is because technically speaking this Core CPI reading released this morning (which is showing a rise in inflation pressure) is really the result of monetary policy/economic activity from 9-12 months ago!

I talk about this alot here on UrbanDigs. US Economic data is lagging, meaning it is reported from data that happened months ago, yet the fed is monitoring it today and making monetary policy calls from it that won't have an affect for at least another 9-12 months! Get it? This is why the fed is stuck between a rock and a hard place.

Super high energy prices and precious metal prices from the periods of OCT 2005 - PRESENT are yet to show their ugly face in economic readings. Meanwhile the fed has no choice but to act on data it gets. The next 2 meetings are sure to be tough on equities investors and adjustable debt holders as more rate hikes are on the horizon. Even if the fed does pause, it is very possible that future data still will show the effects of past higher energy prices/commodities prices and will result in more rate hikes anyway.

WHAT THE FED SHOULD DO: Raise 1/2 point! Get it over with, issue a clearer statement saying the fed will now PAUSE and watch the effects of monetary policy. That will make everyone happy and prove that Bernanke is tough on inflation.

WHAT THE FED PROBABLY WILL DO: Raise 1/4 point and issue another 'data-dependent' speech in which 'further policy tightening might be needed' to combat inflation pressures.

EFFECT ON STOCKS: Interest rate hikes in general are bad for equities as the fed acts to hinder economic growth. Stocks are forward/leading indicators and as such will price in a slowdown in advance of it actually happening. Just look at the last 2 weeks and ask any stockholder how it is to own equities in inflation fearing times. There's an old saying in the stock market world, "Don't Fight The Fed"!

EFFECT ON US DOLLAR: As interest rates rise, the US dollar & fixed assets become much more attractive;. Short term CD rates right now are about 5.41% for a 1YR CD at Countrywide Bank. Not too shabby. Expect CD rates to continue to rise even AFTER the fed pauses. So, if you are going to invest in a CD, take out a short term one, 6 months say, and then lock in a higher rate when that expires!

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Fed Watch: Expect A Rate Hike

A: What a crazy past 2 weeks in the precious metal markets as those hedge fund/speculative investors continue to dump a huge amount of holdings causing the current correction. Core PPI readings were higher than expected and energy prices, although not at highs anymore, continue to be at uncomfortable levels in this inflation-fearing world we currently live in.

Precious metal prices have been absolutely hammered over the past 2 weeks as traders unload huge positions and take profits after almost 1 year of incredible gains. Nothing uncommon about this and as far as the fed is concerned, keep it coming down! The higher precious metal prices are the more worried the fed will be that it will eventually cause inflation.

Check out this 1 month chart of NY Gold courtesy of Kitco.com:

...and silver prices:

Energy prices remain close to the $70/Barrel mark and US Economic data, specifically Core PPI, continues to show inflation pressures as the fed gets closer to their June 28th meeting.

According to CNN Money article:

...the core rate of inflation, which excludes food and energy, was up 0.3 percent in May, compared with more modest gains of 0.1 percent in both March and April. That was slightly higher than the 0.2 percent increase analysts had been expecting.

The 0.3 percent rise in core inflation, excluding food and energy, was the biggest rise since a 0.4 percent increase in February. Wall Street has been plunging over the past five weeks as investors have grown increasingly worried that rising inflation pressures will prompt the Federal Reserve to continue pushing interest rates higher.

Energy prices are still too high for the fed to sit tight as the inflationary pressure of higher energy prices is LAGGING, and doesn't show its ugly face until down the road! So, if energy prices are still high today, the fed has to worry about its effects 10-12 months from now!

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Fed Watch: Will Rates Rise in June?

A: The fed meets at the end of June in what is setting up to be a very interesting debate: WILL THE FED PAUSE RAISING INTEREST RATES? Because Bernanke is so new I just have no idea whether he will throw a curve ball and PAUSE at the next meeting.

According to NewRatings.com:

Analyst Alexander P Paris of Barrington Research says that the Fed Funds futures market is pricing in a 72% chance of an interest rate hike on June 29.

If I were to break it down and guess what the chances are for a hike or not, it would look something like this:

75% Chance of 1/4 point hike (25 basis points)
17% Chance of a PAUSE
8% Chance of a 1/2 point hike (50 basis points) w/ clearer statement

Why not! Its just a guess right. Since energy prices are still high and climbing (Oil near $73/Barrel), I just don't see how the fed can sit tight and wait. If anything, they must show their willingness to combat this very dangerous inflationary pressure. But who knows. Its a new fed chief and he might carve his own little personality into it and become the best fed chief we ever had. Maybe not. Certainly keep an eye on this upcoming meeting as we'll get our first insight into how Bernanke reacts in times like these!

OTHER NEWS SOURCES, MARKETS & BLOGGERS THOUGHTS

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Lending Rates Update

Here are the current rates for June 1st:

30 YR. FIXED (up to $ 17,000)---> 6.625%
30 YR. FIXED ($417,000 to $1,000,000)---> 6.75%
15 YR. FIXED (up to $ 417,000)---> 6.25%
15 YR. FIXED ($417,000 to $1,000,000)---> 6.25%
10/1 YR. ARM* ---> 6.375%
7/1 YR. ARM* ---> 6.25%
5/1 YR. ARM* ---> 6.125%
3/1 YR. ARM* ---> 5.875%

*INTEREST ONLY ARM LENDING RATE WILL BE APROX. 1/8% POINT HIGHER

Rates are still heading NORTH with positive economic news. If you've been on the fence and waiting for rates to drop, it doesn't look good. Now is a good time to lock as the market seems to be steaming ahead.

Q1 productivity revised to a stronger 3.7%; unit labor costs component revised lower to 1.6%...(6/1/2006)

Year-over-year, productivity is now up 2.5% while unit labor costs are up only 0.3%. This is good news for the inflation-anxious as strong productivity continues to hold down underlying business costs and the need to drive prices higher.

Best,
Steven

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Mixed Messages - Interest Rate Hike Unclear

A: Don't read too much into todays released #'s because articles are saying one thing while the markets/experts are interpreting them in another way.

The big piece of data was the Core Inflation # excluding food and energy that came in at 2.1%, which MET wall street estimates. This is ABOVE the fed so called 'comfort zone' for this number which tends to be between 1-2%. So, its 0.1% above the comfort zone and some might argue that the fed is overly concerned about it. However, this 2.1% number did meet expectations and the street took the news positively as stocks are moving higher; basically the street felt relieved that this number wasn't higher!

If anything, today's report will tell the fed that inflation for the most part is CONTAINED thus far, and that a pause at the June meeting is a distinct possibility.

UrbanDigs Says: Its just too early to make any educated guesses right now. I'm still leaning towards a 1/4 point hike because as energy prices and precious metal prices remain high, inflation can trickle down at a later time; so the fed must be vigilant. Also, Bernanke MUST show that he is tough in inflation fearing times like Greenspan was. To do so means another 1/4 rate hike!

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Interest Rate Check - Confusion Sets In

A: As of right now even the experts are confused about whether Bernanke & Co. are going to raise the fed funds rate for the 17th consecutive time at June's meeting. In the past week or so I've noticed precious metal prices correct beautifully, but energy prices remain high. Today's GDP # showed a still strong US Economy but not as strong as wall street expected; in the end I think wall streets estimates are more important which tells me the markets view the latest GDP # as a sign the economy is not as strong as expected and inflation fears are not as troubling as expected.

Lets break it down this way in terms of what helps and what hurts the chances of another 1/4 point rate hike in June:

DATA FAVORING 1/4 RATE HIKE

The inflation leading indicator of high energy prices are still pointing towards a rate increase since there has yet to be a sizable correction in this market. Geopolitical concerns in Iran, Nigeria, & Venezuela are still leading to supply concerns for the oil markets keepin the price of light sweet crude around $70/Barrel.

For the fed to consider pausing at June's meeting we need the price of light sweet crude to correct to below $60/Barrel. At least that would warrant a 'WAIT & SEE' attitude by the fed.

To check oil prices & other commodity prices click here.

DATA FAVORING A PAUSE

The prices of precious metals have corrected substantially over the past 4 weeks, mainly as speculators (who have helped prices boom) took profits off the table and lowered their risk tolerance after the huge runup enjoyed over the past 6 months.

We are not out of the woods yet as the prices of precious metals need to stay down or even correct some more to convince the fed to pause at June's meeting. Here is a 6-Month chart showing the original runup and recent correction in the price of NY Gold:

The price of Copper, Silver, Platinum, & Palladium have had similar corrections over the past 4 weeks as the did NY Gold as shown above. The correction in precious metal prices will only help in convincing the fed to pause at June's meeting.

In addition to precious metal prices, US Economic data has shown that the economy is NOT as strong as wall street expected.

According to CNN Money article:

The nation's economy picked up speed in the first quarter, the government reported Thursday, but it didn't pick up as much strength as Wall Street was expecting. Consumer spending was up at a 5.2 percent annual rate, but that was down from the original reading of 5.5 percent growth. That was greatly responsible for the report coming in lower than forecasts according to Anthony Chan, chief economist for JPMorgan Private Client Services.

But Chan said the report was a positive for markets because it calmed inflation fears and gave the Federal Reserve more flexibility to not raise rates at its June 29 meeting if it decides to do so. A closely watched inflation measure in the report, which measures prices paid by consumers for items other than food or energy, remained at a 2.0 percent annual gain, the same as the initial reading, which lessened inflation fears in the markets.

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Interest Rate Checkup: Will The Fed Tighten?

A: Inflation fearing people out there had a rough few days as some economic data came out showing a rise in prices beyond food and energy. Core consumer prices rose 0.3 percent in April, higher than expected and feeding inflation worries. This is why the stock markets took such a big hit the past 2 days because the data that came out will only strengthen the case for the Fed to raise the fed funds rate again at their June meeting.

Equity markets do NOT like inflation because that means the fed will be raising interest rates to slow down the economy by making borrowing costs more expensive and fixed assets more attractive for investments. On a side note, expect a stock market rally once we get clear word from the Fed that they will pause on their long interest rate hike campaign (16 consecutive 1/4 point rate hikes so far).

Lets take a quick look at some data/markets to see where we stand RIGHT NOW:

1. US ECONOMIC DATA: According to CNN Money:

Consumer prices jumped in April, sparking a fresh round of inflation worries on Wall Street, and economists say the report gives investors and the Federal Reserve good reason to worry.

The Consumer Price Index rose a surprising 0.6 percent in April, the Labor Department reported, compared with the 0.4 percent rise in March. Economists surveyed by Briefing.com had forecast a 0.5 percent rise in the government's key measure of inflation.

The so-called core-CPI, which excludes often-volatile food and energy prices, rose 0.3 percent, the second straight month that the closely watched reading came in at that level. Economists had forecast there would be only a 0.2 percent in core CPI in April.

2. Energy Markets: A week ago I predicted a correction in the energy markets to the low 60's for oil; which looked like a winning prediction until that Iran letter turned out to be more damaging than peaceful. Since, the inventories of light sweet crude and gasoline have jumped a bit higher than expected bringing with it some selling pressure in these markets.

According to CNN Money:

Oil slid towards $68 a barrel on Thursday, pressured by rising U.S. gasoline inventories and concern that high energy costs are leading to inflation that could slow demand. U.S. demand for crude and petroleum products in April fell by 1.5 percent from a year earlier, with high pump prices cutting gasoline use by 1.9 percent, industry figures showed on Wednesday.

But wait! We still have geopolitical concerns in Iran & Nigeria that could change these markets at any moment, and in any direction. This fact will keep these markets volatile until we get a clearer picture of what is really going on in these two countries. In meantime, expect a trading range of about $66 - $73/Barrel for light sweet crude oil; any drop below or above should be a signal of deeper fundamentals kicking in.

For the fed to PAUSE at the next meeting we will need the price of oil to drop to $60/Barrel or below! I recently suggested a price under $68/Barrel but no longer think that is low enough to warrant a pause by the fed in June!

NEXT FED MEETING: June 28-29th

WHAT TO EXPECT: Lets do it this way. If the news out of Iran & Nigeria remain generally positive (i.e. no more violence in Nigeria and just no news out of Iran will suffice) and the price of oil drops to about $60 or below, than I am 75% sure the fed will PAUSE to wait for future economic data.

However, if news out of Iran and Nigeria continues to be negative and uncertain and the price of oil hovers above the $68/Barrel mark, then I am 85% or so sure that the fed will tighten again by 1/4 point bringing the fed funds rate to 5.25%.

HOW IT AFFECTS HOUSING: Should the fed raise by 1/4 point again in June than expect lending rates to trickle higher for an extra few months down the road and buyers to feel a bit more pressure to buy NOW rather than wait. A 1/4 point rise should be enough to continue the slowdown that is affecting most of the nation; especially overheated highly speculative markets such as Miami, Phoenix, Las Vegas, Boston, & Los Angeles.

If the fed pauses then expect a short term positive rally (which might present itself by providing a bottom in today's slowing markets) with media coverage suggesting 'the end may not be near' style of articles. After that initial jubliation, expect a flat to down market for as long as lending rates continue to trickle higher; which should be another 6-10 months or so. Once we hit a top in lending rates the housing market will flatten out until we get a clear picture on what the next long term fed move is going to be. Should the US Economy start to show signs of an impending recession, the fed will act quickly to stimulate the economy by lowering interest rates and bringing lending/borrowing costs down again!

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Mortgage Report: Week of May 15th - 19th

After last weeks hike in rates, all is dependent on the news this week. Inflation is the arch enemy of Mortgage bonds and home loan rates. The Producer price index comes out Tuesday and the Consumer Price Index comes out Wednesday. If the market shows signs of heated inflation, home loan rates will likely worsen. If inflation appears to be controlled, the markets will breathe a sigh of relief and rates may see some moderate improvement.

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Fed Ups Rates & Is Now Data Dependent

A: The fed raised the fed funds rate by 1/4 point yesterday to 5.0%, the 16th consecutive 1/4 point interest rate hike which started 22 months ago. If you read UrbanDigs interest rate commentary both the rate hike & the issued statement should not be a surprise. The fed has decided to become data dependent and did NOT take a hard stance towards raising or pausing at the June meeting.

Use this philosophy for determining whether or not the fed will raise at the next meeting:

IF OIL REMAINS ABOVE $68/BARREL OR SO EXPECT THE FED TO RAISE THE FED FUNDS RATE AGAIN 1/4 POINT IN JUNE

Excerpts From Fed Statement: Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures. "Some further policy firming may yet be needed to address inflation risks but ... the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information," the Fed said in its statement.

What the fed is doing is leaving the door open to both raising or pausing at its next meeting. It appears that Bernanke truly doesn't want to overshoot on interest rate hikes which might push the US Economy into a recession down the road; something Alan Greenspan became notorious for doing as he viewed a recession as a welcomed side effect to stopping inflation! By being more DATA-DEPENDENT, Bernanke and Co. will be able to monitor the effect of all previous rate hikes to date to see what effect they are having on the current inflationary pressures.

The problem is that right now oil is being burdened by geopolitical tensions mostly, as the surprise growth in inventory gave us a false sense of hope a few days ago. Right now the price of oil is being affected by:

1. Tensions In Iran: The letter that the Iranian President sent to President Bush did not include what the US was hoping for in terms of solving this crisis diplomatically. Instead, the Iranian leader discussed the poor state of the current world and the growing anonymocity towards America. He also included talk of democracy failing worldwide and why Israel shouldn't exist. Not exactly the best way to help with oil prices. The growing tensions in Iran are keeping oil supply fears in the minds of energy traders everywhere.

According to CNN Money:

Iran's top nuclear negotiator called the surprise letter a new "diplomatic opening" between the two countries, but Rice said it failed to resolve the dispute over the Iranian nuclear program -- the focus of intense U.N. Security Council debate this week.

The three foreigners kidnapped in Nigeria on Thursday are employees of Italian oil contractor Saipem (SPMI.MI), and at least one of them is an Italian national, industry sources said. Attacks by the Movement for the Emancipation of the Niger Delta (MEND) have forced multinationals to cut Nigerian oil exports by a quarter, and the group had threatened this week to carry out more attacks on oil industry targets and individuals.

AS LONG AS ENERGY PRICES REMAIN HIGH THERE IS NO WAY THE FED CAN PAUSE IN RAISING INTEREST RATES. THE BEST WE CAN DO IS HOPE THAT GEOPOLITICAL TENSIONS EASE AND THE PRICE OF OIL CORRECTS IN TIME FOR JUNE'S MEETING SO THAT BERNANKE HAS REASON TO PAUSE AND SEE IF MARKET FORCES KICK IN TO CORRECT THESE INFLATION FEARS.

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Fed Will Raise 1/4 Point on Wednesday

A: Expect Fed Chairman Bernanke & Co. to raise the fed funds rate to 5.0% on Wednesday with another 1/4 point rate increase. What we need to look for is any change in the issued statement, and certainly expect one, after the mis-communication and Bernanke's first mistake since being elected fed chief.

Ben Bernanke must be clear and concise with this next statement after going through some learning curves with just how seriously the street and other tradable markets cling to his every word. He must learn to CHOOSE HIS WORDS MORE CAREFULLY if he ever wants to continue the same environment that Alan Greenspan created.

WHAT TO EXPECT: 1/4 point rate hike

WHAT TO LOOK FOR: Change in issued statement hinting at an end to future rate hikes. My feeling is he will clearly state that future moves will be DATA-DEPENDENT and will NOT take a hard line towards raising or pausing. If he does steer towards one side, expect it to be towards the side of raising rates again in June; that way he doesn't appear to the markets as being soft during inflation-fearing times such as now.

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Oil Freefalling & Interest Rate Policy

A: The price of oil is tumbling today below $69/Barrel with the last trade at $68.60 a barrel. Feel free to 'call me a god, not the god', if you like as I talked about the price of oil starting a quick correction late last week, with the rise in inventory #'s, hard stance on Iran, and Nigeria supply of 500,000 Barrels/Day expected to come back online in coming weeks.

KEEP FALLING BABY!! The price of oil is SO important to savvy real estate investors because of the critical markets and global conditions that play a role in its pricing and the fed policy moves that are a result. As geo-political concerns in Iran show a glimmer of hope and Nigeria getting closer to supplying the global markets with an extra 500,000 barrels/day, expect oil to correct! Read my post last Thursday, "Oil Tumbles Below $70/Barrel"; I'm still predicting a correction to low 60's for the price of oil during the next 3-4 weeks or so.

With every drop of oil prices, inflation fears are eased a bit. As inflation fears ease, fed chairman Ben Bernanke can put the brakes on the long interest rate hike campaign that began over 3 years ago. It will only help consumer confidence/wall street once interest rates are done moving up, which in turn should add confidence to the buyer market in housing as well.

Keep tuned into UrbanDigs for follow up on these fundamentals that power the NYC housing market!

~ Oil Tumbles As Iran Hopes Rise

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Mortgage Report: Week of May 1st - 5th

This Friday will bring the Jobs Report showing how many jobs the US economy added during the month of April. Bernanke and his team will dissect this report very closely because the next Fed meeting is on Wednesday. Bonds have been trying to stabilize recently but have been on a clear downtrend in recent weeks causing home loan rates to rise. If news this week continues to be strong and positive for the economy look for home rates to continue to tick higher.

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Rate Update - Bernanke Shows His Cards

A: While I'm still getting back to my normal schedule after a week in California, I did my best to stay on top of things since my last post on what the Fed is keeping an eye on as they decide whether 1 or 2 more 1/4 point interest rate hikes are ahead of us. Among the most important developments I see are that Oil is still high, the Economy is still showing strength, Gold prices continue to rise, and that fed chief Bernanke made a bold and telling move in a public appearance to Congress.

Lets get right into it.

Energy Prices Remain High As Light Sweet Crude Stays Above $70/Barrel

The price of oil remains at high levels above the $70/Barrel mark which will keep Bernanke & Co. on inflation alert. According to today's CNN Money article:

Oil rose above $74 a barrel on Tuesday, pushed higher by persistent fears about supply disruption, especially from Iran, and aggressive fund-buying across the commodities sector. U.S. light, sweet crude rose 47 cents to $74.17 a barrel, while London Brent crude gained 41 cents to $74.30.

US Economy Still Strong

Another CNN Money article titled, "A Hot Time in the Old economy" describes our situation well. Although energy prices and interest rates have risen over the past few years, the GDP #'s posted its fastest pace of gains in almost two years. Some key points of the article stated:

A number of economists say much of the first-quarter strength can be explained away by saying the economy was playing catch-up from weak fourth-quarter growth of 1.7 percent annual growth following the hurricanes, coupled with a boost from the warmest January on record. But with a number of March economic numbers such as home sales and durable goods orders showing much better-than-expected strength heading into the second quarter, it's not as easy for economists - or Fed policymakers - to discount a big first-quarter gain.

Gold Prices Continue To Soar

The price of Gold continues to rise as investors and speculators pour money into this historical safe haven. It's very common for the price of precious metals to be in demand in times of political and economical uncertainty; such as today. Add in a weaker dollar from the fed recent remarks and it looks like Gold will soon be at $700 an ounce. According to the Dow Jones Newswires:

Spot gold gained $9.50 on its New York close Friday to mark its latest quarter-century high of $661.60 a troy ounce as markets continued to digest the implications of Iran's defiance of a U.N. Security Council deadline Friday on ceasing its uranium enrichment program. Another driver of gold's accelerated uptrend is U.S. dollar weakness given the metal's status as a dollar hedge, participants said.

Laymakers prefer a vigilant and tough fed chief when it comes to inflation and the negative effects rising prices have on a nation-wide economy. Former Fed Chief Alan Greenspan had a history of being that kind of leader as he was known for 'overshooting' on interest rate policy when it came to inflationary pressures; which means he would lead the fed board of governors to raise interest rates high enough to be certain inflation remains in check. By implementing this restrictive measure, there were times that his moves eventually hurt the US Economy by slowing its growth too much.

A few days ago we saw the first big move made by new fed chief Ben Bernanke as he addressed Congress. Bernanke states:

"We're much more data-driven," Bernanke said of the Fed. "We need to continually re-evaluate our forecasts and think about the prospects for the economy and make our decisions based on what the information is that's coming into our hands...There's always the possibility that, if there's sufficient uncertainty that we may choose to pause simply to gain more information, to learn better what the true risks are and how the economy's actually evolving," Bernanke told lawmakers.

We have to get used to the fact that Greenspan's style of addressing Congress and his actions to back up his words are GONE! According to a recent CNN Money Article:

The Fed chairman also said that he planned to stay on the path of his predecessor Alan Greenspan regarding increased openness at the central bank. During the past few years, the Fed, under Greenspan, was far easier to read and did a good job of telegraphing its interest rate moves to Wall Street. "We will continue Greenspan's movements toward greater transparency to reduce uncertainty in the financial markets," Bernanke said. "We have no desire of changing the basic operating procedure for the Fed."

It's becoming clear that Bernanke may choose to pause AFTER 1 more 1/4 point rate hike as he sits back and watch's whether all previous interest rate hikes do their job 6-8 months down the road.

Bottom Line: We need to see whether Bernanke gets tough and continues to raise rates UNTIL the inflation red flags go away or NOT! Should Bernanke pause after 1 more 1/4 point rate hike with inflation pressures as they are today, well then that tells you something about his style; uncertainty. Personally, I expect 2 more 1/4 point rate hikes ahead of us to help combat inlfation pressures.

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Mortgage Report: Week of April 24th - 28th

With all the reports coming out this week(Existing home sales,New home salses, GDP, ECI)we need to concentrate on one factor- inflation. Any signs of inflation in the economy will pressure Mortgage Bond prices lower and cause home loan rates to rise. There is some room for improvement in the coming week however it will all be based on how the news releases this week and what they say about inflation.

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Rising Interest Rates & Your Plan

A: When it comes to interest rates and the effect of rising borrowing costs on our daily lives, recent history probably carries much more weight than ancient history. In this post I will try to analyze the psychology behind a 'more expensive' world in the hopes of finding the best way to invest in it.

Ancient History will tell us that borrowing costs are still 'historically low' and that even if 30YR fixed rates climb above 7% we should be just fine. On the other hand, recent history tells us that those who locked in 30YR fixed did a very wise move!

Lets take a fictional property that sold for $520K 3 years ago compared to the same property that is asking $550K today with rates higher (the market slowdown started around June of 2005 so 3 years ago asking prices and lending rates were lower). Lets also assume the fictional buyer puts 20% down:

3 YEARS AGO $520K - $104K Down Payment (30YR Fixed @ 5.10%):

Monthly Mortgage Payment = $2,258.67

TODAY $550 - $110K Down Payment (30YR Fixed @ 6.375%):

Monthly Mortgage Payment = $2,746.47

Hmm...yea...interesting..the monthly payment for today seems kind of expensive compared to 3 years ago. It seems that RECENT HISTORY is more painful financially than something that happened 30 years ago! Heck, I'm only 30 years old why should I care if mortgage rates right now are still historically low? They certainly are a lot higher than they were a few years ago and will only continue to rise slowly over the next 12 months (since fed rate hikes take time to funnel down the economic system). By this time next year I wouldnt be surprised if 30YR fixed interest rates are around 7.25% - 7.5% or so (unless something unexpected happens that would cause the fed to lower rates).

But forget housing for now and lets consider credit card debt. Whether you know it or not all of these fed rate hikes actually do end up having a negative impact on all that debt you piled onto those Capital One cards! According to Sun-Sentinel.com:

Credit card debt is usually the most expensive kind of household debt, which is especially tough for consumers when interest rates are heading up. "Card rates are rising faster than the rise in general interest rates," said Justin McHenry, research director of the Cleveland-based survey firm.

The higher interest rates will add a few dollars to minimum monthly payments. But over time, that can add hundreds of dollars to consumers' debt loads. Interest rate hikes can actually sneak up on consumers. That's because most credit cards in use today carry variable rates, which card companies can change without notifying customers in advance.

If your housing + credit expenses have risen over the past few years than chances are you will be forced to sacrifice the luxuries in life that you may have gotton used to such as dinners out or weekend getaways.

FACT IS: Rising Interest Rates affect more than just housing! Here's how I view it:

BORROWING/LIVING COSTS GET MORE EXPENSIVE --> PEOPLE HAVE LESS MONEY TO SAVE/SPEND ---> PEOPLE TIGHTEN SPENDING ---> CONSUMER DEMAND EASES ---> INFLATION STAYS IN CHECK/CORRECTS

WHEN IT COMES TO INVESTING IN HOUSING: Use the philosophy of 'If you can afford it, than find the deal and buy it". NYC Rents are rising to levels that in my opinion makes buying much more attractive. Plus rental inventory is so tight now (NYC Vacancy Rate at 0.89%!) that people are settling, instead of getting something they truly like. If you have a secure job w/ sufficient salary (see Brady's post on What Co-op Board's Look For), good credit, sufficient liquid assets, and a 3+ YR timeline to live there than BUY NOW! It is still a buyers market and there are deals out there. If you wait to buy for another year or so you will also have to hope that asking prices across Manhattan come down to compensate for higher interest rates (cause there going up!).

REMEMBER: With real estate you are being forced to save by building equity, you are entitled to tax benefits when you file your return and on gains when you sell, and you can live in and upgrade your investment!

If you plan to sell in 2 years or less now may not be the best time to be buying. I'm still flat to down on the NYC housing market for the short term and wouldn't be surprised if it remains that way the next few years. The only reason to buy now with a 2YR timeline to sell is if you find a deal that can't be missed!

IF YOU DON'T HAVE ENOUGH MONEY NOW: Be smart. Sacrifice living style and do what you can to get the lowest rental poss