A Little Ditty On Interest Rates

Twas the night before the FOMC meeting, when all through the financial community, not a bond trader was stirring, not even Alan Greenspan whispers could be heard hoping that the Big Ben takes advantage of his new opportunity....

Fed predictions were crafted by economists who care, in hopes that Fed Chairman Bernanke would announce a Fed Funds increase to 4.75% delighting those who trade like a bear.....

Real estate professionals were nestled snugly in their mortgage beds, while visions of lower interest rates danced in their heads, but new Fed Chairman Bernanke seems confused and his actions could cause Wall Street to soon see red.

Tomorrow is the BIG day and the beginning of a new ERA in Fed history, one that we have only seen five times in the last 50 years. Yes everyone is expecting a 25 basis point increase in the Fed Funds rate to 4.75% (Prime rate will be increased to 7.75%) but these "experts" are also expecting a equal increase in long term interest rates. Yes the Fed is probably surprised and frustrated that long term rates have not risen as they have with previous Fed tightening over the past 40+ years. It all comes from inflation and the fact that despite higher commodity (oil, metals, etc.) prices overall inflation indexes have not risen in the past few years and are NOT rising in 2006. The Fed's key measure of inflation is the PCE index (personal consumption index) and the February reading will be released on Friday (3/31) and it will again show a CORE (ex food and energy) reading of sub 2%.The good news is that despite growing fears of inflation long term rates (10yr. Treasury) have risen only 41 basis points in 2006 despite a very strong seasonal trend that has seen rates rise an average of 99 basis points between February and April of every year since 1966 (except 1995).

Just in case Mr. Bernanke and the members of the FOMC need a little help with their Tuesday decision......The average spread between the Fed Funds rate and the core PCE index over the past 40+ years is approx. 2.5% and with the Funds rate at its current 4.5% and the PCE at 1.8% that gives a differential of 2.7%......Enough to stand pat for the next few months and then IF inflation increases they can raise the Funds rate...For those worried about wage inflation, the ECI (Employment cost index) is up less than 3% in the last year and that is down from 3.8% in 2004. YES commercial and industrial loan demand continues to increase at a 12% rate but much of that is for purchases look for an unchanged Funds rate with a statement that the Fed policy is neutral and will follow the path of inflationary expectations and NOT worry that a strong economy equates to higher inflation....That's a policy that worked in the 70's and 80's but not in 2006...

The best news for the many real estate professionals that read this post and desperately want and need long term rates to fall is that the interest rate boat is now overflowing with experts that are predicting higher short and long rates. In today's USA Today business section there was an article entitled "Economic prognosticator sees minefield of risks ahead for interest rates." The article surveyed the "top 10" US economists and everyone of them predicted higher Fed Funds rates at the end of 2006. The Wall Street Journal Q&A column lead question was how can the small investor bet on higher interest rates. The market's biggest enemy is uncertainty and until 11:17am tomorrow morning we will not have the answer to the most often asked question of each day: "What is the Fed going to do and what are they going to say??" Both questions will be answered tomorrow and an expected "relief rally" in the bond market which will push long term rates lower for the next few weeks. Whatever the announcement from the FOMC we will finally have some degree of certainty until at least the next Fed meeting on May 10th.

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Scottsdale Mortgages/Loan Brokerage
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