Friday, September 21, 2007

The FED cut and rates are higher?

As clients are learning, mortgage rates are higher now than last week, back up to 6.5 percent for vanilla 30-year and 7% for Jumbo mortgages. Yes, higher.
Federal Reserve Chair Ben Bernanke probably has the same frustrated shoulder sag that we do: he played this thing exactly right, and has gotten nothing for his trouble but a run on the dollar.
The Fed's 0.5 percent was actually two quarters: the federal funds rate had been trading near 5 percent, 0.25 percent off-peg, for a few weeks. That was an inter meeting ease not formalized, a deft piece of central banking: if formalized, and then the crunch dissolved by itself, the Fed would have had to execute an embarrassing formal reversal. Instead, Sept. 7 news of sinking payrolls (an economic fade additional to and independent of housing and the crunch) made it easy to cut. At this moment the economy receives some dinky benefit from the cut (Construction money is 0.5 percent cheaper -- wanna build a house? Short-term rates are down -- how about a nice new neg-am pre-pay-penalty ARM? No?), but the crunch is still in place, especially in Mortgageland.

Other benefits have been cancelled as well. The 10-year T-note, driver for all long-term credit, has soared from 4.35 percent to 4.62 percent. The dollar run has been to the euro (now all-time high vs the dollar at $1.41) and to hard assets: gold at a 27-year high $744 and oil at one moment yesterday $84.

A great deal of domestic money has joined the run, buying into the fingernail-on-blackboard theorizing: there was no reason for Fed action; it guarantees a resurgence of inflation; it's just Bernanke's Put; and all bailouts all the time are bad.

This run has foreign fingerprints as well; Asia's currencies are dollar-pegged, but a race to hard assets is typical of our Persian Gulf friends and their several-trillion-dollar-hoard. Big currency moves often involve confidence, and it is disturbing in a time of financial crisis to find money running away from the dollar, the historical safe-haven. Confidence has aspects beyond interest rates and inflation: at some point, the average Persian Gulf observer of U.S. leadership, present and forthcoming, might well conclude that we don't have the good sense that Allah gave to the camel.

I like a good chart to see what happened in the past to see if it can give a little insight into the fog the future. Below is a chart of the U.S. dollar index which is our currency vs a basket of foreign currencies(Euro, Yen, Pound, Australian Dollar, etc.). Immediately below is the chart of the 10Y Treasury rates during the same period. In order to strengthen the dollar, rates need to rise to attract investment and/or taxes need to be reduced to drive growth. Taxes were cut during the early 80's, the growth engine revved up and interest rates dropped dramatically. I don't think with medicare, social security and a war machine at full speed the government can lower taxes. The FED is in a bind. The hope is that as they trash the dollar, this expands our export economy. Reviving growth, increasing tax receipts and paying back all the treasure we borrowed over the last few years. The US government owes 8.9 trillion dollars in bond money.
I believe rates across the board will need to rise in order to attract investment in our economy and to encourage investors to buy mortgage/ government debt. What's your take? I'm sure Bernanke and the new President could use you in Washington the next few years to sort out the problem.