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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 secret envelope will be opened at 11:17am on Tuesday, September 18th with the contents revealing the FOMC decision on the Fed Funds rate accompanied by a most important statement. If you have been following the Fed and interest rates for 40 years and don't remember a time where uncertainty prevailed about the future of Fed policy. We have three distinct forecasts by the "experts" concerning next Tuesday's Fed announcement and after 19 years of Greenspan's "gut feel" leadership we are now face to face with a very different leader (Bernanke). Setting the table for Tuesday finds one set of forecasts urging the Fed to not move the Funds rate and let those that took risk through the purchase of mortgages to suffer the consequences of a bad investment. The second camp seeks a Fed decision that lowers the Funds rate by 25 basis points which would put place the Funds rate at 5.00% which is the average level that the Funds rate has traded for the last 30 days. If the Fed chooses this route they will have followed the market's action and showing the markets that it has forgotten its duty to lead the economy. With the 3 month Libor rate comfortably trading at 5.65% this decision would clearly not have a positive effect on market psychology. The last choice for the Fed would be a 50 basis point decrease to 4.75% accompanied by a statement that the Fed clearly understands the general economy is now showing signs of a slowdown and that inflation is no longer the #1 problem. The prediction will be given at the end of this letter but regardless of the Fed's next move long term interest rates are headed much lower before the end of this year.

The key borrowing rate

Do you know anyone whose borrowing rate is tied to the Fed Funds rate (5.25%)? Most home loans (variable rate) are tied to Libor and many fixed rate loans are a function of the spread to Treasury note rates. Prime used to be an important interest rate to borrowers but now is mostly used for credit lines with Libor clearly the important rate to corporate borrowers. In the last six weeks the Libor and commercial paper rates have risen despite a decline in Treasury market rates, so the typical individual or corporate borrower has seen an increase in their borrowing costs. Effectively the Fed has tightened in the past 30 days as the normal relationship between the Funds rate and Libor is about 10 basis points. Do you believe the Fed wanted this to occur in an environment where the economy has turned down and most likely begun a recession? The Fed is fearful that if they lower the Funds rate to 4.75% and Libor does NOT move down by an equal amount they will have used up precious ammunition when they really don't have that many bullets in their holster.

The consumer is stumbling

Last Friday's surprise was the jobs number and this morning we saw that retail sales grew by 0.3% in August. When you combine June and July with last month we have three months of 0.00% growth and it is clear the consumer has begun a major retrenchment in spending. Oil at $80 per barrel will seal the deal as gasoline is generally an inelastic item with demand not responding to price changes for many months. Consumer credit stats released earlier this week showed that credit card debt continues to rise as borrowers have been shut off from house loans due to much tighter underwriting guidelines by those mortgage lenders still in business.

Home builders & car dealers

Each Friday newspapers around the country are filled with full page ads from car dealers offering "special, once in a lifetime" prices for this weekend only. We have become accustomed to these ads and they have become a normal part of the shopping process for a new car. This morning Hovnanian Enterprises (home builder) announced a three day sale of 1,000 homes this weekend with discounts of up to $150,000. The CEO also told anyone who would listen that the bottom of the housing market is "very near." http://www.bloomberg.com/apps/news?pid=20670001&refer=&sid=abeRSoffdWIU Should we have expected anything but unbridled optimism? They are stuck with a huge amount of inventory and must reduce prices to stop the hemorrhaging of red ink on the income statement. This reminds me of the ad last year by the National Association of Realtors http://www.realtor.org/files/home_buyers___sellers/good_time_to_buy_ad.pdf telling everyone it was the best time ever to buy a house but also saying it was the best time ever to sell a house. They did get 50% of their statement correct but this ad blew the little credibility the NAR had with realtors and they have since revised their predictions of a real estate bottom to more reasonable levels. It is almost impossible for a residential RE agent to be objective about market conditions since there is no effective and liquid way to go short (bet on lower prices) the housing market. Because we only see the future from our past scoreboard most agents tell us that real estate prices always rise.....yes, but not always at a greater rate than inflation.

A view from across the pond

Sometimes the picture is clearer from a long distance as the emotions of the moment don't impact your views. Wednesday (9/12) Mervyn King, Governor of the Bank of England (similar to Bernanke's position) sent a letter http://www.bankofengland.co.uk/publications/other/monetary/treasurycommittee/paper070912.pdf  to John McFall, member of Parliament, clearly explaining the causes of the most recent mortgage meltdown and addressed the subject of a central banks options to solve these problems. The Bank of England clearly believes that any aid given to those who purchased mortgages should only be assisted with injections of liquidity at much HIGHER interest rates to not encourage further risk taking in the future. Mr. King felt that the financial system was functioning properly and this short-term problem was simply a matter of markets under pricing risk and that economic stability would return quickly. Mr. Bernanke read this letter and probably speaks with Governor King frequently as they seem to have very similar views regarding market intervention by central banks. This morning Governor King had a quick change in policy as the Bank of England quickly came to the rescue of Northern Rock with an emergency loan (3rd largest British home lender with 800,000 mortgage customers) as they found rising short-term interest rates (Libor) and a lack of liquidity for their mortgages created a need for funds in the next 24 hours.

A bottom forming in Detroit real estate?

Do you like to bottom fish? Do you have a lot of patience? The really big money in real estate has always been made by those who have long term vision and deep pockets. Could Detroit be the next turnaround or just another dream for those who have been down this road in the past? A story in today's Detroit Press http://www.freep.com/apps/pbcs.dll/article?AID=/20070914/BUSINESS06/709140345/1002/ could be the early beginnings of something positive for a city that has been at the very bottom of the real estate boom of the past 20 years. A $100 million dollar fund has been created to support an economy less dependent on auto manufacturing and the key to a bottom is always recognition that things have changed and a new trend will start with risk taking and a change in outlook. It's early but the returns could be interesting in a few years. Detroit is definitely a city no one would consider so properties are very cheap but a huge amount of patience is needed for investors.

Next week

The big news is Tuesday and everything else is secondary but CPI (inflation) is released on Wednesday at 5:30am and should show inflation well under the 2% key rate. Markets hate uncertainty and usually rise after an event is known no matter the result so we may see a relief rally after Tuesday's Fed statement. The 10-year reached a low of 4.31% in Monday evening trading and bounced back to 4.46% today which was expected (my daily readers received any e-mail Monday night warning that a pull back was imminent) and needs to rest a little more before attacking the 4.25% and below regions. Recognition that the US economy is much weaker (led by a decline in consumer spending) than anticipated will pave the way to much lower long-term rates before year end. The dollar's weakness has garnered headlines but the Treasury (Paulson) sees this as a necessary ingredient to prevent the economy from slipping even further into a long recession.

The Fed will........

The consensus sees a 25 bp decrease with the optimists at 50bp decline and the pessimists at no change. A 375 bp decrease placing the Fed Funds rate at 4.875% and giving a little room for the effective rate to drop and allowing the Libor rate to fall from its lofty level of 5.65%. The really important point to note is that the Fed does NOT lead market rates but simply follows them in the new Bernanke regime and that is a major change from the Greenspan Fed. Every Fed Chairman leaves a legacy based upon action or inaction and it took Volcker a few years to make his mark as an inflation fighter and Greenspan a few years to become God-like so Bernanke is only in the 2nd inning of his term and a long 9 innings of work is ahead of him and his FOMC team. Very few leaders have succeeded by governing from a consensus and Mr. Bernanke must be commended for encouraging everyone to give him input before making a decision that will please everyone. Monetary policy is tough and highly risky but the best Fed Chairmen have a "sixth sense" about economic conditions and although not always making the right decision we as a country are much better off "economically" today than we were 10, 20, 30 years ago so it is time for Mr. Bernanke to roll up his sleeves and make a few really tough decisions and not look back......Volcker did it, Greenspan did it and Bernanke can do it now.