Fixed-rate mortgage rates have behaved very well, still close to 5.75 percent in the face of oil falling below $50/bbl, stocks in an up-side technical breakout, improving economic data, and the Fed showing every sign of continuing to raise its rate.

Tending to hold rates down: heavy bond-buying by China and Japan as they try to keep their currencies low to preserve their exports; inflation on hold slightly below 1.5 percent annualized; and despite opportunities that may flow from Arafat’s death, Middle East worries maintain a substantial bid in the Treasury market.

Fixed-rate mortgage rates have behaved very well, still close to 5.75 percent in the face of oil falling below $50/bbl, stocks in an up-side technical breakout, improving economic data, and the Fed showing every sign of continuing to raise its rate.

Tending to hold rates down: heavy bond-buying by China and Japan as they try to keep their currencies low to preserve their exports; inflation on hold slightly below 1.5 percent annualized; and despite opportunities that may flow from Arafat’s death, Middle East worries maintain a substantial bid in the Treasury market.

October retail sales rose .9 percent (ex-autos), better than forecast and a solid performance; and the first read on consumer confidence in November jumped back to late-summer levels, presumably in relief that the election is over.

The Fed’s .25 percent hike to a 2 percent Fed funds rate was no more a surprise than the assault on Fallujah, and neither had detectable effect on interest rates. However, the Fed’s post-meeting statement was painful, a photocopy of the statements following the prior three hikes this year: “…Even after this action, the stance of monetary policy remains accommodative… policy accommodation can be removed at a pace that is likely to be measured.”

Federal Reserve Chairman Alan Greenspan has not given the slightest hint of the location of a neutral stopping point, nor even the criteria to be used for approximation. In particular, we don’t have any idea what sort of “real” interest rate the Fed has in mind; that is, the spread between inflation and the Fed funds rate. A 2 percent real rate might leave the Fed on the tight side – the low yield on long-term bonds says so – and all should begin to think about a 3 percent to 3.5 percent funds rate by mid-2005, even if the economy stays in a sub-4 percent GDP range with herky-jerky job growth.

Consumers do not understand that the “prime” rate to which their home equity lines are tied floats 3 percent above the Fed funds rate: by next summer, HELOC balances may cost 6 percent, up from the three-something teasers of the last four years. One credit card company has this TV ad for its “Prime Lock” card: “You’ll never have to worry about the interest rate again.”

Uh-huh. Sure.

A 3 percent to 3.5 percent funds rate would put the one-year T-bill index at 3.75 percent or so, plus a typical 2.75 percent margin would mean adjustment notices in the mail to 6.5 percent – for many borrowers, a maximum two-point adjustment. And, to those a couple of years into their five-year hybrid, or on a lagging index like COFI or MTA, a warning.

This warning: unlike the rate spikes of 1988-89, 1994 and 1999, after the upward adjustments coming, rates will not go back down and borrowers will not have a chance to refinance off their adjustable-rate mortgages to cheap fixed-rates – not until the next bad recession. The Fed’s current rate increases are a one-time rise from an emergency trench, not a cyclical increase against an overheating economy. A 3 percent to 3.5 percent funds rate will be the low end of neutral, and short-term rate risks (ARM index risks) will continue to be upward from there, guaranteed upward if inflation appears.

Contrary to widespread non-expectation (shared here), the election did cause a couple of changes in the financial markets. The day after the election, stocks jumped out of a very bad pattern: maybe because President Bush’s tax policy will continue, maybe because of hopes for private Social Security accounts as big buyers of stocks. Second, the dollar fell hard – odd, with the Fed raising rates, not so odd with no resolution of the deficit in prospect in a new Bush administration (nor with widespread foreign disdain for Bush).

We’ll spend considerable time in future weeks on the interlocking economic and political web of interest rates, the dollar, the trade and budget deficits, and pensions.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

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