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The information below indicates trends and is not a predictor of what rates are going to do in the future. You might tend to agree or disagree with the information below. This is not Cypress Mortgage's opinion nor my opinion. Many of us look at trends and have established opinions of our own, supplying data to back up your opinion is important and here Is some data that supports these observations.

The Fed, Wall Street and Sesame Street


The Fed does NOT control the level of long-term interest rates. The Fed does NOT control the level of long-term interest rates. The Fed does NOT control the level of long-term interest rates. The Fed IS able to change the rate of the overnight Fed Funds rate and today lowered the rate by 50 basis points to 3.00%. The overnight Funds rate is very important to banks as it represents the price of money borrowed from other US banks for one night. In the past 8 days the Fed has lowered this rate by 125 basis points from 4.25% to todays level of 3.00%. Unfortunately for corporate and individual borrowers the 10-year US Treasury rate has risen in the same 8 day period with a move of 20 basis points from 3.44% to todays level of 3.64%. The Fed would rather have long-term rates following the Funds rate lower but long rates are influenced by inflationary expectations NOT the overnight Fed Funds rate. This is frustrating and confusing for the typical mortgage borrower as press reports of Fed action always lead to expectations of lower long-term rates.

The long end of the US government bond market was judge and jury for the Fed in the early 80s when the Fed was lead by inflation slayer Paul Volcker. At todays rate of 3.64% the 10-year is composed of an inflation expectation component of 2.31% and a real expected growth rate of 1.33%. On the surface these rates seem normal but when we review the last few weeks of market activity it becomes obvious there is a growing problem that the Fed will soon face when deciding upon future changes in the Funds rate. On December 26th with the stock market at much higher levels the 10-year was trading at 4.28% with the inflation component at 2.35%. Today we are 64 basis points lower but the inflation component has fallen only 4 basis points. The stock market is lower, the Fed has cut the Funds rate by 125bp but inflation expectations are unchanged. Would former Chairman Greenspan have eased this much in such a short period of time? With the Funds rate at 3.00% the Fed doesn’t have much more room to maneuver and the closer we get to 0.00% the more the markets will begin to worry that the Feds ammunition no longer has the effect on the economy it had in the past 25 years.

The yield curve

Three weeks ago you read here in the Interest Rater Update about the best bet for 2008 with the spread between the interest rate on the 2-year versus the 10-year widening to much higher levels. On January 7th this spread was 108 basis points. Today that spread is at a new high of 151 bp for the year with the 2-year at 2.13% and the 10-year at 3.64%. This spread will widen dramatically if inflationary expectations continue to rise while the Fed continues its easy money policy. The Fed has a dual mandate of economic stability and low inflation but they seem to be focused entirely on an impending economic contraction. You must be very concerned that the Fed has lost its leadership role and is now playing a game of follow the leader as it changes the Funds rate based on declines in the stock market. Can you picture the popular PBS children’s show Sesame Street where Big Bird leads the neighborhood children on a merry march to visit his pals. Of course everyone is happy and singing and that seems to be where Big Ben sits tonight as the stock market leads the Fed to the destination (lower Funds rates) it desires. While Wall Street leads the Fed, the bond market has begun to bristle because lending money to the government is only a good investment if the interest rate is higher than inflation until final maturity. The Fed is totally focused on improving banks profitability so balance sheets can grow enabling banks to lend money again to its best borrowers.

Jobs are growing?

Fridays jobs number is important because last months weak number sent the stock market tumbling and bond prices soaring and forced the Fed into panic mode. Expectations (based on todays ADP report) are for an increase of 150,000 which would send those predicting an imminent recession back into the hole they were hiding in before last months report. The government is notorious for huge revisions to these reports but Fridays report is for January and that has been the one month of the year where the seasonal adjustment number (birth/death model) has been negative. The markets are not set up for a disappointment in the number and any decline in the 10-year towards the 3.50% is the signal to lock.. The weather in January was unusually warm in most parts of the country but this shouldn’t have too much positive effect on the jobs number.

The British Pound

The Pound continues to act weak considering the Fed is easing and thus widening the spread between British and US short-term rates. A few minutes before yesterday's FOMC announcement the Pound was at 1.9854 and now is trading at 1.9850 after bouncing to 1.9950 after the Feds announcement. A great rule that has stood the test of time is when a market doesn’t rally on good news (Fed cut) it is going to fall fast on any other news and continue to expect a dramatic fall for the Pound this year to the 1.80 level.

Housing and mortgages

Yesterday the House passed a bill that would raise the conforming limit from $417,000 to as high as $729,750 in expensive home areas. This increase would expire on December 31, 2008. The Senate has yet to pass anything that there will be a conference committee that will ultimately decide the fate of this provision or initiate a completely different limit level. Be careful because long-term rates may be higher and the value of many houses have fallen to levels that make it impossible to refinance. The key to a housing bottom is NOT interest rates; rather the availability of credit and a perception that prices have stopped falling.

Watch the flag

The yellow flag is flying as a cautionary sign to everyone that 2008 will not be an easy one for those who need long-term interest rates to hit new lows. The Fed is done for now but unless Big Ben stops following Big Bird long rates will rise thus increasing the spread between long and short-term interest rates. This is great news for banks (big profits) but bad news for an economy that needs the oxygen of credit to have any chance of avoiding the worst economic contraction since 1932.