Interest rates comments from HSH Associates

Excerpts from 3/31/06 newsletter:

With economic growth holding steady to firm, and short-term interest rates rising below them, there's no place for mortgage rates to go but up. If you think of the Fed Funds rate — an overnight lending rate, possibly the shortest term for a loan as a "floor" underneath all yields (interest rates), then raising that floor will ultimately have some effect on all other loan rates, to a greater or lesser degree. The Fed has been raising that floor for what is closing in on two years, and while ARM prices have been affected to great degree all along, only recently has that rising floor begun to affect long-term rates in a more permanent way. In essence, the flattening of the yield curve seen over the past 21 months — where short-term interest rates have marched higher while long rates have been mostly stable — has given way to a sort of "rising tide lifts all yield boats" relationship of late.However, that relationship isn't a linear one by any means. Movement of the shortest interest rate has only a muted effect on those at the other end of the curve, such as 30-year fixed mortgage rates. By example, the Fed Funds rate was lifted again this week by one-quarter percentage point at the close of the latest FOMC meeting. It was the fifteenth consecutive FOMC meeting which featured a lift in interest rates. In typical fashion, the Prime Rate rose by a like amount, but other rates along the curve moved to a lesser degree, as their yields are partially determined by inflation pressures, economic growth, and demand for a given instrument.

At the same time, while what the Fed does may have little direct influence, what the Fed sees and is reacting to in the economy is germane to fixed mortgage prices. This week, the Fed revealed that it believes that the economy has "rebounded strongly" after a slow Q405, where GDP expanded by just 1.7%. That rebound was accompanied by price increases which have now had a "modest effect on core inflation" (The Fed's prior characterizations noted "relatively low" levels of core inflation).

The market judged that a "modest effect" is somewhat more than "relatively low" and longer rates moved up fairly strongly as a result; the ten-year Treasury moved from 4.7% on Monday to about 4.85% by Friday, amid rising expectations for more Fed moves in May and beyond.Absent a recession looming in the foreseeable future (and caused by a Fed which has overshot in its tightening campaign), long-term rates have no room to fall; they are literally at the floor along with short-term rates. Interestingly, though, unless inflation really flares higher from these levels, or mortgage or Treasury bonds fall out of favor as a preferred investment, they have little reason to bound higher. However, they are likely to move upward as the floor moves upward, perhaps a bit more or less at times as inflation concerns wax and wane.

About mmegowan

I am a realtor with Remax Estate Properties in Palos Verdes Estates. Visit my website at
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