What’s The Path Of Least Resistance For Interest Rates?
Several readers want to discuss the cost of capital. “Topic suggestion: How much further will the ten year treasury note yield have to increase (a lot of mortgage rates are being effected too) before the housing markets really implodes.”
Another said, “Now that Ben Bernanke has been on the job for 60 days, any revised thoughts on where his policies will take the US economy? Some possibilities:
1) Business as usual, as advertised when he took over. Under this scenario, the housing bubble, commodities bubble, and hedge fund bubble (did I forget any?) keep inflating until they eventually pop in a catastrophic, mutually-reinforcing collapse.
2) A return to normalcy. Under this scenario, he stays the course on tightening until the speculative mania is choked to death. Overvalued stock, housing, and commodities prices suffer collateral damage and T-bonds turn out to have been the place to invest.
3) Other scenarios?”
A reply, “3) It doesn’t matter, either way, the damage has been done; we are in debt up to our eyeballs with the record US deficit, trade deficit and household debts. There’s no end to the madness and any number of scenarios could bring down the whole house of cards.”
Some related reports. “The words of the Kansas City Federal Reserve Bank President Thomas Hoenig explain the inevitable. While speaking at a breakfast organized by the St. Joseph Missouri Chamber of Commerce on Friday, Hoenig said, ‘Only with that constant incoming data will we know where we are in the policy cycle.’ The conclusion? Stay tuned to each incoming economic report, as the Fed has left the markets and the economy guessing regarding its future course of action.”
“‘Even though the Federal Reserve has been raising interest rates, they are also increasing the money supply,’ Paul Levine said. ‘You also have a lot of money that was going into real estate going into stocks now, since the housing bubble is bursting.’”
“‘The problem is that the ten-year note yield is currently standing at 4.85 percent and is pushing toward 5 percent and our friends at the Fed are not telling us when rate hikes are done,’ said Ram Kolluri. Last week, the benchmark 10-year note surged to a 22-month high amid bets that interest rates are set to rise.”
“‘We’ve got a lot of economic news between now and the next Fed meeting in May,’ Art Hogan said. ‘The path of least resistance is higher, but there’s a bumpy road.’”
There is a thrift in Prescott offering 6 month CD’s at 6.25% with a minimum of $10,000.
6.25%??? That’s awesome! Greenspan really is gone then. It’s time savers were no longer punished for setting aside money.
Do you have more info on the thrift? (web site?) That’s a great rate.
My ING account pays 4.75, no minimum deposit, and I can withdrawl at any time.
I don’t think that 10-year Treasuries have to rise any further in order to bring about a housing collapse. They affect 30-year fixed-rate mortgages, and my guess is that what few borrowers of this type remain are the more responsible ones and the least likely to over-reach. Nevertheless, the bubble is a psychological phenomenon first and foremost, and the psychology has already turned against real estate investing. Furthermore, there’s a tremendous amount of formerly hidden inventory that speculators are now bringing back to the market en masse — this is creating a classic “demand shock” that will - by itself - bring prices down significantly. Lastly, I don’t believe low interest rates (particularly fixed rates) ever played a truly significant role in inflating the bubble. It was the total abandonment of lending standards by the banking industry, coupled with widespread appraisal fraud and patently fraudulent loan instruments like “stated income” loans. The overwhelming reliance on adjustible rate loans, even as fixed-rates were the lowest in 40 years, shows that long-term rates have been almost irrelevant in this bubble. I believe that as this unwinds we’ll see some spectacular hedge fund implosions that will drag down some major lending institutions. The public will come to learn that hedge funds were employing some extremely risky, speculative strategies in search of yields, and further compounding the risk through the unprecedented and massive use of leverage. Bank regulators and Congress, both of whom have been asleep at the switch as this train careened out of control, will explain to us that the structure of the lending industry (especially as it relates to the secondary market) changed faster than the regulatory framework could keep up.
Do you think that the FED will let the funds implode, or do you think there will be a massive bailout like LTCM? I think they will inflate. Same thing if GM goes bankrupt. Everyone get’s their money, it’s just worth a whole lot less.
Hard to say, Jeff. I would think that the Fed’s first inclination would be to mop up the mess, as they say. However, this disaster-in-the-making is so big, I’m not sure they could inject enough liquidity into the system without collapsing the dollar and the bond markets. This may be a case where the treatment could kill the patient.
I agree with John in VA. The huge run-up in short rates is already killing the speculative fever. Increases in the long rate will just be the proverbial icing on the cake.
Ditto. Higher short term rates have destroyed the attractiveness of ARMS - eliminating speculators and marginal buyers.
Long term rates are going to deter more conservative buyers.
As for Ben, I think he’s going to try to do what’s right for the US economy, and he isn’t going to use obtuse language at the FOMC meetings. OTOH he has a very very difficult path to navigate the Exxon Valdez (economy) through. We are in a very delicate place where if they tighten too much and the housing bubble explodes it could easily drag the world into an ugly depression. Still needs to (and seemingly has) stop this crazy credit bubble where it makes more economic sense to go deeply into debt on cheap credit than to save. An ugly vise to be caught in.
We should all wish him luck.
I think the low interest rates got the ball rolling (the ballon inflating?), along with equity withdrawls from the stock market once that ballon started deflating. The increase in the supply of money naturally lowered it’s value, making housing more “expensive”. However, I think the relaxed standards and other factors you list kept it going.
Actually even if the FED was to stop rates at 4.75%, U.S. rates would still continue rising because of our huge government debt and the increasing rates of the ECB and Japan which makes our IOUs less desirable. Last time the ECB (European Central Bank) raised rates by .25, the 10 year note rocketed. With Japan reversing course on low rates and the ECB signaling at least 4 more increases this year, I expect the 10 year to be north of 5% soon and 30 year mortgages at 8% by early 07. Good luck then financing any of these bubble properties.
NO: 10-year rates in Europe are now even lower than before the ECB started raising. And mortgage rates and interest on savings accounts is just 0.1% higher than before the two 0.25% rate increases (at least in the Netherlands, and probably in most of the other euro countries as well). Real rates in the EU have been negative for some years and I’m 100% sure they will remain like that for at least some years to come.
Increasing rates in Japan? well, maybe if you study them with a microscope but I haven’t noticed anything.
If the FED looks just at rates in the EU and Japan, there is no need at all to keep increasing, they are far above their central banking friends elsewhere in the world.
Do they have to do this because our dollar is really worthless? What would happen if the US dollar collapses in value?
Do you now see the dilema?
The issue isn’t that their rates are lower than ours right now but the delta of the rates. As long as the ECB and japan are in the raising rates course our rates will have to follow because of our huge deficit that requires billions of foreign money each and every month. BTW, the 10 year note hit 4.9% today. Over 5% soon.
This things going to be really bad. I wonder how GM is playing into all of this. A bankruptcy in the June/July timeframe would take the whole house of cards down. If the rates go up, the house crumbles to. The inevitable economic slowdown will cause the derivatives market to implode. We are so screwed.
RE: GM bankruptcy…The in-depth Fortune Magazine article on GM’s trouble indicated Ford would be forced to follow because of the competitive leverage GM would receive from the bankruptcy filing. Adios UAW.
You don’t see much discussion of the prospect of a GM bankruptcy in the financial press. But the facts on the ground suggest the possiblity is real, and also that the financial press is in a collective state of denial or ignorance.
We are already on the verge of storming Washington and removing our defunct government from power. A major crash would push the people over the edge. They can’t let that happen, or rather, they will do ANYTHING they can to prevent that from happening. The Fed will, by any means necessary, let the air out of this bubble as slowly as they can being very very careful not to burst it. All the while praying nothing else bursts it either… for their sake.
The Fed will, by any means necessary, let the air out of this bubble as slowly as they can being very very careful not to burst it.
I agree with you insofar as that would be the Fed’s intent; however, bubbles are by nature unstable things and Fed policy is a blunt instrument. I’ve seen thousands of soap bubbles pop; I’ve never seen one successfully deflated. As an economist said the other day, “the next time a housing bubble deflates gently will be the first time a housing bubble deflates gently.”
CBS MarketWatch had a good article the other day — they think the Fed could continue to raise short-term rates two to eight more times to bring them in line with the historical average.
“[T]he real interest rate: that is, the fed funds rate minus the inflation rate…[between 1994 and 1998] averaged 3.1%, two full percentage points higher than today…” That would be eight more quarter-point raises.
And, given very credible arguments and numbers that say that inflation is actually at least two or three percentage points higher than the increasingly fraudulently-produced 2-3% numbers, there theoretically should be much more of an increase to the interest rates than that.
But the housing market will collapse under its own weight long before the Fed gets honest about what they say and do about inflation. I’ve said it before and I’ll say it again, we’re gonna have a disastrous “spring selling season” and by the time the homebuilders’ quarterly reports for the period come out, we’ll be seeing real-estate meltdown.
Thats why I think BB will only go up 1% more . Than after that he will go down .50
I have a theory here that the next meeting could be the big one for the bubble.
This is based on observing the difference between the seasonally adjusted and the unadjusted sales figures on the NAR site. Basically the seasonal adjustment factors smooth out the normal BIG jump in actual sales between February and March, of the order of 40%. Did that happen this year? Reading (from afar, I’m Australian :)) this anecdotals on this blog the answer would appear to be “No”.
So in seasonally adjusted terms we might see a LARGE decline in sales numbers when the March figures come out towards the end of April. The RE industry will then have about 2 weeks to cry “the sky is falling, you can’t raise again” before the next Fed meeting.
The Fed is then caught between a rock and a hard place.
If you are right, then we may as well all go out and buy McMansions before the Great Inflation of the 2000s drives their price up by a factor of four over the next ten years…
LIBORs are touching 5% now. Many adjustables are tied to this, and the “real rate” after the teaser ends may be 5 to 7 percent *plus* the LIBOR.
In other words, there are people who could easily see payments bump up to 12% interest on their adjustables over time, even if no futher changes take place.
I remember the days when they just put a 2% spread above the cost of funds index to determine rate . Wow these new loans suck .
As a student of charting markets I can make the following observations. The interest rate downtrend that began in 1981 has a tops line of resistance in the 4.85-5.00% area. This declining line has turned back every interest rate advance for 25 years. It will probably create some resistance over the next few months and allow rates to drop or go sideways. I would then expect the rates to advance and break this trendline probably this fall. Next resistance would be around 6 1/2% or the rate seen in December 2000. Long term it would mean the 25 year period of declining rates is over and a long term bear market in bond prices or higher rates should be in order for years. Short term for 2006-07 it would mean a 1.75% hike in 12 months. Realestate RIP.
It is common knowledge that the invironment of high rates in 1981-82 was a perfect time too buy stocks and realestate. They had the benefit of declining rates for years. It amazes me that todays stock and real estate investors do not understand that the condiions are exactly opposite. We can propably look forward to years of rising rates. The long term driver of higher rates? Foreign investors demanding higher rates too support the dollar.
the big question is: why would rates brake the 25 year downtrend this time?
In Europe there is no sign of higher rates; despite 0.5% higher ECB credit rate, mortgage rates and interest rates on savings accounts are still within 0.1% of their all-time lows.
The most likely outcome is much higher inflation, while the FED and ECB keep pumping the money supply to keep market rates down and keep ‘improving’ the CPI calculations to suggest everything is OK - which is in fact their policy of the last 5 years.
In that case chasers of the housing bubble will do relatively well, while people who save so they can afford to buy a home in the future will be punished just like in recent years. I agree this cannot continue forever, but why not another five years or so? The statistics are already totally out of wack with the real economy so I don’t see why this couldn’t get even worse.
Even if mortgage rates start rising seriously, as long as money remains ‘free’ everywhere it doesn’t really matter; we will just get more fraud, crazy lending and homeowner subsidies.
>>>In Europe there is no sign of higher rates
Huh??? Try again.
Economists: ECB rates may rise faster than expected
http://breakingnews.iol.ie/news/story.asp?j=177588652&p=y77589358
Economists: ECB rates may rise faster than expected
29/03/2006 - 11:26:10
Irish economists are reportedly predicting that interest rates may rise faster than expected this year.
The European Central Bank raised rates by a quarter of a percentage point earlier this year and analysts had predicted another rise in June and one more before the end of the year.
However, reports this morning said a number of economists now believed that the next rise may come in May and on another two occasions during the rest of the year.
The predictions are reportedly based on new figures showing an improvement in business conditions across Europe, as well as ongoing high levels of borrowing.
This morning’s reports said the new increases forecast for this year would add around €200-a-month to a €300,000 mortgage.
However, asked about the matter in Dublin today, Finance Minister Brian Cowen played down the significance of such a hike.
“Up to recently, we’ve had real interest rates of practically zero when you take into account inflation,” he said.
“From Ireland’s point of view, maintaining strong public finances is within our control and that’s what we intend to do.”
you are completely missing my point …
YES, the ECB has increased their credit rate with 0.5 basis points and ‘maybe’ we will get another 0.5-0.75% in the next year (also Trichet also hinted both times that they are already near the end of their ‘tightening’).
But this does NOT translate into higher mortgage rates or interest rates on savings accounts. So I see the official ECB rates as no more than a scam to suggest they are doing something about easy money.
Clearly they are NOT doing something. Why do you think that all the Dutch banks increased by 0 or at most 0.1% after the ECB raised rates by 0.5%. One could think the Dutch banks are charity institutions, but I don’t think so.
Anyway, even if the mortgage rates would rise by 1% real rates are still (close to) negative. And nothing has changed here regarding lax lending standards, ridiculous leverage, plain fraud that nobody wants to look at etc. so in fact mortgage rates do not matter at all - people can still get all the money they want, thanks to the ECB.
“The most likely outcome is much higher inflation, while the FED and ECB keep pumping the money supply to keep market rates down and keep ‘improving’ the CPI calculations to suggest everything is OK - which is in fact their policy of the last 5 years.”
So your theory is that BB will make the same mistake as G. William Miller and let inflation run amuck? This man is too much a student of economic history to follow that path.
P.S. Here is a very gracious eulogy from Bill Miller’s successor at the Fed:
http://tinyurl.com/qwow2
hopefully he did not learn more about economic history than the Nobel prize winning guys from LTCM, because that would sure increase the risk of a crash of biblical proportions.
Amen, brother bear!
I agree - the charts of 5, 10, and 30 year interest rates all point to lower not higher rates in the near future. The USD chart though points down and the oil price up…. one possibility is that a steep oil price rise causes the Fed to announce a stop to the rate hikes. As a result foreign investors dump dollars, domestic investors buy long bonds and sell stocks…
At least this is what the charts are telling me the market is predicting will happen.
Two things your professor may have forgotten to teach you in chart-reading class bear mentioning:
1) Charts generally point down until they start pointing up.
2) Interest rates cannot go negative; historically they have only stayed as low as recent levels for a short period before reverting to a long-term uptrend.
Agreed. Either that or lower interest rats means the dollar dies! Either way Real Estate RIP in 2007!
the price to rent ratio in dc is not as out of whack as it is in some areas. true sales prices will come down, but there very strong rental market. as sales prices drop, rents will go up. recently witnessed two open house in dupont circle for a one bedroom. the guy selling was very lonely, but the renter was busy, busy, busy.
http://www.dcbubble.blogspot.com
I think it depends on the area the rental is in and the price. I’m pretty close to this since I’ve been looking for a new rental lately. I found a swell house over in the U street area for $1900. Within days, the guy had 5-6 applicants, and I didn’t get it :(. On the other hand, I’ve seen other properties on Craig’s list stay for days and days. I’m not really sure about this. Any advice that you might be able to offer me on finding a house to rent in DC proper in a decent area for around $1800?
http://www.novabubble.blogspot.com
10 yr note has to hit 5% or greater to start getting everyone’s attention.
Only 11 or so basis points to go last time I checked…
Sorry - 15 bps for the 10-yr, 11 bps for the 30-yr. And the risk premium only returned after the latest Fed meeting.
well, it doesn’t get my attention before it is over 6.5% (still low by historical standards). But I’m probably taking a longer-term view.
Gets everybody’s attention at 5%. Everybody panics at 6%! By 2007.
I know this is still low by historical standards. But history has never faced the hugh combined debt of consumers, corporate, and gov., income derivied from credit spreads (derivitives), lack of industry to support real job growth, and 30% yoy rising energy costs.
Historicly speaking, we are on new ground.
To John in VA,
” I believe that as this unwinds we’ll see some spectacular hedge fund implosions that will drag down some major lending institutions.”
That may be true, but some of these fellows work quickly and cunningly, and I suspect that a lot of worthless,heavily discounted MBS will be palmed off to retiree’s looking for high income yields.
I agree that they’re clever, but they’re already playing with other people’s money. The retiree you mentioned is already holding the bag; he just doesn’t know it yet.
A lot of these fellows work off the LTCM-bailout / too-big-to-fail model of operation. The problem created by government bailouts is fraught with similar difficulty to the DOD policy of only attacking countries without WMDs. The inadvertent message in each case is “If you want the US govt to leave you alone, get some of those WMDs, and quickly!”
P.S. As Buffett points out, the WMDs favored by hedge funds are known as deriviatives…
The recent price action in gold and silver looks great (to those who own the stuff, of course). Soaring metals prices make for bad press, with the media - especially abroad - beginning to publicly question the credibility of the dollar. In this climate, the Fed cannot safely consider reversing direction on short rates.
That is correct. There would be a number of dire consequences if BB stops tightening at this point:
1) The “Helicopter Ben” label would be indelibly branded on his forehead.
2) Wall Streeters and anyone else who makes their living by gambling would instantly recognize the sign that the Fed is soft on inflation, threatening to crash the bond market, and send gold and other commodities prices soaring through the roof. (Not that commodities prices aren’t already soaring, but they could inflate faster and higher…)
3) The dollar would be at severe risk due foreign creditor perceptions that BB will not hold the course on controlling inflation.
For those (like the absent and dearly missed Mr D) who believe the Fed can endlessly manipulate l-t bond yields and official inflation figures to hide a firestorm of inflation, I submit that markets are smart in the long run.
Bernanke, for all his previous rhetoric, may turn out to be more Volcker than Greenspan.
Assuming that neither Bernanke nor others in the Fed are as ignorant as they pretend, then they must know that they have a potentially catastrophic problem on their hands with a liquidity bubble. Therefore, it is more prudent to water the punch (i.e. raise rates and keep them up to precipate a controlled recession) rather than let the party continue until the drunks precipate a full-blown Depression.
I believe that Greenspan was similarly aware, but he had to spike the punchbowl for Bush to get a second-term that would have been denied if a recession hit earlier. Now that Bush is well into his second and final term, and now that Greenspan has retired a ‘hero’ of stewardship, Bernanke’s thankless task will be to correct the market before it corrects itself with extreme prejudice.
At first I thought Bernanke would be a worthless Greenspan mimic. But it’s possible, he plans to act on his own and not want to be constrained by the legacy of Greenspan. I’ll admit he hasn’t been there long enough to make that call one way or the other.
Real economic imbalances will force his hand regardless. It is not possible to use price manipulation to endlessly fool the markets.
not endlessly, but just a few additional years would be enough to make the mess so big that there is no other way out than a total failure of the worldwide banking/credit system.
As long as that comes after the elections, I don’t think the guys on Capitol Hill care very much about it. Up to now Bernanke seems to me someone who can listen VERY well to politics and act accordingly, maybe even more than Greenspan.
agree 5%+ 10 year will be a turning point
-deflation wins out
JOHN IN VA- inventory growing
Betamax said:Bernanke, for all his previous rhetoric, may turn out to be more Volcker than Greenspan.
Beta, I agree that Bernanke is looking more like Volcker than Greenspan. Funny, no one talks about Volcker at all,maybe no one know who he is? I’m sure that will change in the future.
Actually, Greenspan raised interest rates twice in 1999, and six times in 2000. Rates didnt start going down until 911, at that time Greenspan immediately started to lower rates and consumers went into even more of a buying frenzy. I dont feel sorry for those who thought they could get rich buying those huge, energy consuming mcmansions.
My opinion is globalization will constrain inflation in the near term. Higher commodity prices will be absorbed by reduced output and not higher prices of final goods in the developed economies.
if you say ‘globalization will contain the CPI in the near term’ I agree.
But I don’t think real inflation is going to be constrained. Just look at the commodity indexes, energy prices, the metals etc. No doubt about the direction, and no doubt that this is translating into hefty price increases for almost anything that you can’t live without.
How can anyone say that inflation is (or will be) constrained in the short (or long) term, when the FED is expanding the money supply (M3) at historic rates. Energy prics are up 30% yoy for three consecitive years now. Inflation fighters my ass! Our money is worth 5% of what it was worth when the FED was created. The are the opposite of inflation fighters.
Surprising but true: Many arsonists have day jobs as firemen…