And Another Rate Cut

Yes, he did it again. Bernanke cut the Fed Funds Rate by fifty basis points, bringing the benchmark rate to 3%. Now that the price of credit is officially below inflation, could the economy finally recover? I don’t think so. Although I’ve read some analyst opinions that some – very, very slim – chances exist that the Fed’s policy will succeed, the reality is that too many problems in the financial and housing sectors need to be solved. Home prices are more than 30% higher than they should be by historic standards, with California median prices 60% above the reasonable level. Until those come down, and that will be a slow, painful process for many a household, bank, lender, and investor, the Real Estate market will not begin to operate properly. With all the mortgages that are about to fail will come huge writedowns and losses at banks all over the world, slowing U.S. economy, higher rates of inflation and unemployment, and all the doom and gloom that those bring along. I don’t really see how changing the interest rate can warp the reality and all the inevitable processes that are slowly unwinding, but the Fed has a job to do, and they’re doing their best. Who knows, it might just work. And by the way, I’m not really keeping score but isn’t it funny how for three meetings in a row, there’s always one – and only one – member of the Fed that votes against a decision. It’s always a different person but I’m beginning to feel there’s a reason why they appoint someone to disagree with the majority. Perhaps it would “scare the markets” if everyone voted for the rate cut? Well… I think they’re quite spooked already; could it really get any worse?

Real Estate: Still Gloomy

Housing has been a source of concern for regulators, bankers and consumers for more than a year now, and signs of improvement are nowhere to be seen. According to the latest NAR report, existing home sales dropped 2.2% in December to a seasonally adjusted annual rate of 4.89 million units, compared to 5.00 million in November, down 22% year-over-year. Total existing home sales for 2007 came in at 5,652,000, down 12.8% when compared to 2006 results but still the fifth highest level on record. The inventory of unsold homes currently on the market is more than twice the normal supply. The December level was the highest in history for that month. The median price for a single-family home dropped 1.8% in 2007, the first decline since the NAR started tracking prices in 1968. Looks like it can only get better from now on but who knows, so many problems need to be solved first.

By the way, the latest Fed rate cut has helped bring down mortgage interest rates: on average, the 30-year fixed home loan carried an interest of 5.48% this week, the lowest level in almost 4 years. It stood at 5.69% last week. 15-year fixed-rate mortgages dropped to 4.95%, from 5.21% last week, 5-year adjustable-rate home loans averaged 5.13%, compared to 5.40% a week ago, and one-year ARMs stood at 4.99% this week, compared to 5.26% last week. Lenders are expecting a refinancing boom.

The Fed Panicked

A 0.75% rate cut - both the discount rate and the Fed Funds rate. 1 week before a scheduled Fed meeting. This is huge. A cut like this would be remarkable even at a normal meeting, but Bernanke chose to slash rates at an emergency meeting. He must have been really scared about the stock market and the economic prospects if he couldn't wait for another week. This feels disappointing. The last time the Fed slashed rates at an unscheduled meeting was after the terrorist attacks of Sept. 11, 2001. It's just plain wrong to go this far, Bernanke is sending the wrong signals and tinkering with economic fundamentals that will greatly impact businesses and the lives of individual consumers. Well, at least those who wanted a 1% cut will be happy - the Fed will meet on Jan. 30 and it might cut some more then. For the time being, happy 3.5% Fed Funds Rate.

Banks Tighten Credit

The Fed’s efforts to add liquidity to the markets are being offset by banks such as Citi, which announced that it will be raising interest rates and reducing consumer lending. Mortgage lending and credit cards will also be trimmed. Lending, to anyone, in any form, is too risky right now, and while the market is trying to deal with the mortgage and mortgage-derivatives mess, there’s fear that other areas of the financial system may fail as well: credit card lending, commercial Real Estate loans, and the list goes on. To help revive the economy, the Fed will probably cut rates again at the end of January (or, as some like to believe, perhaps sooner), but maybe a serious crunch is what the economy really needs after all. Short term, tighter credit will only extend the crisis in housing, because home buyers won’t be able to secure financing. No wonder the immense inventory of unsold homes (currently above 10 months’ worth) is not moving and home builders are struggling. With or without the Fed’s help, housing will take years to get back to normal, as consumers learn to save, budget and prioritize expenses.

Speculation Grows Ahead Of Fed Meeting

The next Federal Reserve meeting is scheduled for January 30, but with all the dismal economic data in recent weeks and the expected disastrous earnings results at top banks (Citi has just reported an $18 billion writedown in mortgage investments), plans may change. Although the date for the next meeting is only 2 weeks away, there’s belief that Bernanke may summon an inter-meeting to discuss a quarter-, or even half-percentage point rate cut. According to analysts, he may cut some more at the actual meeting. The market is suggesting a 0.75% rate cut, a rare event in the Fed’s practice, with some economists demanding a whole percentage point cut – an unlikely scenario, given the Fed’s concerns over inflation, oil prices, and the dollar’s weakness. Chairman Bernanke signaled that the Fed is ready to take radical action to save the economy, but after all, there’s a chance that it won’t be necessary. I guess the Fed will rather wait for a couple of weeks than summon an emergency meeting.

Unemployment Rises

Unemployment rose to 5% in December, according to the Bureau of Labor Statistics, up from 4.7% a month earlier. Unemployment was expected to grow a modest 0.1% to 4.8%. A significant jump in unemployment like this one may indicate that a recession is coming. A year earlier, the jobless rate was 4.4%. The losses were mainly in construction, retail trade, financial activities and manufacturing, while health care, mining, management and technical consulting services added jobs. It is widely believed that actual unemployment is significantly higher than official statistics would suggest, because the data may be distorted by various adjustments. Unemployment rates for some months in 2007 were revised upwards.

It is believed that weak employment data may pressure the Fed to cut rates at its next meeting on January 30. According to analysts, a half-point rate cut could help the economy avoid a recession, but concerns about the high price of oil and surging inflation remain.

Single-Family Home Building Declines

Spending on private residential construction dropped 2.5% in November, its biggest decline in 5 years. This was the 21^st consecutive drop in home construction, which illustrates a slowing trend for private home building. Non-residential building, however, showed an increase of 2.1%, which offset the drop in residential construction. Total construction spending increased by 0.1% in November. Meanwhile, the Institute of Supply Management’s manufacturing index dropped from 50.8 to 47.7. Any number below 50 indicates contraction in manufacturing. Stalling home building and manufacturing will most likely lead to slower economic growth and affect the overall GDP. These results are closely related to the higher cost of credit and the problems in the housing sector, both of which result in lower consumer spending. What we get next is either (or maybe even both) of the following: another rate cut or recession.

Another Fed Rate Cut

The Fed cut its benchmark interest rate again, by 0.25% to 4.25%. The discount rate was lowered accordingly to 4.75%. Economists who had expected a half-point cut in the Fed Funds Rate were disappointed, as recent bad news was expected to prompt more aggressive action by the Federal Open Market Committee (FOMC). The Dow Industrials dropped nearly 300 points after the cut. Stocks of mortgage lenders and large banks suffered, including those of Countrywide Financial, Wells Fargo, Fannie Mae, Freddie Mac, Morgan Stanley, Merrill Lynch, Goldman Sachs and others. Shares of home builders Pulte Homes, Toll Brothers, Lennar and Beazer took a hit as well. The Fed’s statement suggested that they’re worried about the economic slowdown and lower consumer spending, while “some inflation risks remain” too. Meanwhile, holiday shopping has slowed down, and the holiday season’s start wasn’t that impressive after all. Analysts believe the Fed may cut again in January if holiday shopping data is weak and the financial markets remain in freeze mode.

Citigroup’s Chief Economist Forecasts Large Rate Cuts

Lewis Alexander, Citigroup’s chief economist, said he expects the Fed Funds rate to drop 1 percentage point by mid-2008. He believes the Fed will not be concerned about the dollar’s stability because the currency’s value doesn’t affect consumer prices. Alexander, who’s worked at the Fed before joining Citi, is also optimistic about oil prices and the housing market, and believes the U.S. will not go into recession.

All of this is highly debatable, given all the evidence to the contrary we’ve seen so far. Recession is probably around the corner, or already beginning in some local markets, and the dollar’s weakness does affect the prices of imported goods. While a weak dollar benefits the GDP and the job market, its advantages do not offset all the trouble it causes. While a 3.5% Fed Funds rate is not impossible, a great many companies and financial structures will need go under before the Fed cuts this deep. They’ve seen what happened the last time they cut interest rates too low, and they’ll probably look for other ways to prop up the economy. Alexander said energy prices are unlikely to rise from now on, but should the Fed cut, as it is expected to, on Dec.11, oil may well skyrocket beyond $100/barrel, despite the recent drop in prices. Perhaps Alexander is being optimistic, or perhaps he knows something most of us don’t. However, we’ve already seen too many top economists denying the obvious to believe in things the just seem illogical.

Will The Fed Cut Rates Again?

They may want the Wall Street to believe a rate cut is not imminent, but investors are already counting on a 0.25% cut. The central bank released its economic outlook, in which it projected slower growth in 2008, and, quite surprisingly, declining unemployment. The economic growth forecast was revised downwards from 2.5-2.75% to 1.8-2.5%. Meanwhile, turmoil in financial markets is in full swing, with the two largest mortgage financiers Freddie Mac and Fannie Mae reporting higher-than expected quarterly losses.

Shares of Freddie Mac dropped more than 28% after the mortgage giant announced quarterly loss of $2 billion and said it has trouble meeting its capital minimum, which may prompt it to cut its dividend. The company also warned that deeper losses may be coming in the future. Consequently, Countrywide got downgraded by Fox-Pitt, Kelton analyst Howard Shapiro on fears that Freddie’s trouble may mean less financing for the mortgage lender. Countrywide promptly released a statement saying it has “ample liquidity”, but analysts have trouble believing this. So, the Fed may have to cut rates on December 11^th, especially if something big happens as a result of the current chaos. Inflation and the price of oil, however, are still pretty troublesome and if the latter hits $100, the chances for a rate cut are minimal. Time will show.

Dollar In Freefall

The dollar hit yet another record low against the Canadian dollar, which traded at $1.1040. This is the lowest rate since 1950. The Greenback fell against other currencies as well, and quite significantly. It hit a 26-year low against the pound at $2.1052, and a 23-year low against the Australian dollar, which was priced at nearly $0.94. The Euro traded at $1.47 yesterday, the highest since the inception of the 13-nation currency.

China announced that it will diversify its foreign exchange reserves, which may further weaken the dollar. Chinese officials no longer regard the dollar a “world currency”, according to Xu Jian, a central bank director. Analysts believe that further weakening of the dollar is likely, although some indices would suggest a bottoming out of the dollar’s freefall.

The dollar’s weakness pushed crude oil prices higher to a new record of $98/barrel, while gold reached a 27-year high. Good news for anyone trading in those commodities and for export companies. Add to this the facts that the economy isn’t exactly booming and troubles in the Real Estate market are far from over. And one of these days someone may officially call a recession. The world is changing…

PIMCO’s Bill Gross expects more rate cuts

Bill Gross, the chief investment officer of the world’s largest bond fund, said the Fed “cannot afford to let homes go down by 10 to 15 percent”, so it will inevitably cut rates. Gross expects the Fed Funds rate to fall to 3.5%. He estimates the total cost “of subprimes and Alt-As and basically garbage loans” at $1 trillion. Gross has been calling on the Fed to act to save housing for months, but apparently his bailout scenario doesn’t even incorporate such economic indicators as the dollar exchange rates and inflation. He warns that $250 billion in non-prime loans are about to default and those could hurt banking giants like Merrill Lynch and Citigroup. Hey, in fact that’s already happening.

According to Gross, reducing the Fed Funds rate to 3.5% will result in 30-year fixed mortgage rates dropping to 5.0-5.5%, which will magically solve all the problems in financial markets. A simple solution, isn’t it? What’s the Fed waiting for? His monthly market commentary gives a nice analysis of the economic situation at the moment, but I don’t think a drastic rate cut is a solution. When the Fed cut rates in September, mortgage interest actually increased instead of dropping. Perhaps a drastic cut will actually lower the 30-year mortgage rates, but it may also wreak havoc in other sectors of the financial market and it will most probably result in monster inflation. Gas at $5/gallon, anyone? Blame financial innovation, not interest rates.

Fed Announces 0.25% Rate Cut

The Fed cut the Fed Funds Rate yesterday by 0.25% to 4.5%, no surprises here. It also announced that further cuts are unlikely, which sounds logical in the market environment we see. Easing the interest rate some more would prompt [even] higher inflation, so the Open Market Committee is probably done cutting for now.

The dollar dropped to a new low against the Euro yesterday, briefly breaking the psychological barrier of $1.45 per Euro. The currency showed some weakness even before the Fed started cutting rates, but since the September meeting it has been trading at record-low rates against the European currency. According to analysts, $1.50 against the Euro is possible in the near term.

… Which may be bad for the prices of imported goods and oil, but has positive effects on domestic product: the Commerce Department said that economic growth was at 3.9% in the third quarter, the highest level in more than a year. The next Fed meeting will be on December 11^th.

A Rate Cut Seems Likely

As the next Fed meeting approaches, the likelihood of another rate cut seems pretty high, although some doubts remain. The Government is manifestly not concerned about the dollar, as Treasury Secretary H. Paulson vetoed proposals to use the G7 final statement to warn of problems affecting European economies due to a weak dollar. This may mean that the currency will be allowed to fall further, should the Fed decide to cut rates to boost economic fundamentals.

However, another rate cut could accelerate inflation, and with oil hitting the psychological barrier of $90 a barrel, this could be a serious concern weighing on the Fed’s decision. Housing data for September coming later this week will be important for the Fed’s decision, too. There is no doubt that existing-home sales and new-home sales will fall, the question is whether the drop will exceed expectations, and how the Fed will interpret the data.

Mortgage rates this week

Mortgage interest rates dropped this week after two consecutive increases, according to Freddie Mac data. 30-year fixed-rate mortgages carried an interest rate of 6.37%, down from 6.42% a week ago. 15-year fixed-rate mortgages averaged 6.03%, down from 6.09%. 5-year adjustable rate mortgages were at 6.11% compared to 6.15% last week. One-year adjustable home loans carried an interest of 5.58%, down from 5.60%.

A year ago, 30-year mortgages had an interest rate of 6.30%, 15-year fixed loans were at 5.98%, 5-year ARMs averaged 6.00% and 1-year ARMs carried an interest of 5.46%. Back then, however, the Fed Funds rate was higher. Well, this is supply and demand, and there ain’t much of the former in mortgage lending right now, so rate cuts can’t help borrowers. I’m reading a lot of grim forecasts for the months ahead, does the Fed (or anyone for that matter) have other fresh ideas?

Pending Home Sales Dropped Again

Pending sales dropped 6.5% to a record low in August, according to the National Association of Realtors. The drop was larger than forecast, and reflects stricter lending practices, higher borrowing costs, and low mortgage availability, especially for the so-called jumbo loans or loans for more than $417,000 which are not guaranteed by Government-chartered enterprises Fannie Mae and Freddie Mac. Pending home sales were down 22% year-over-year.

Pending sales are an indicator of future activity, so the August results could mean that September and October home sales will be lower as well. Although banks are seeing signs of improvement in credit markets, problems in the housing sector are far from over, which may prompt the Fed to cut interest rates again before the end of this year. The next Fed meeting is at the end of October.

Dollar record low vs. Euro

This is yet another of the “Fed-rate-cut-related” news, the U.S. dollar hit a record low vs. Euro on Monday with Euro trading at $1.4130. Counter-intuitive as it may sound, some analysts seem to be of the opinion that a weaker dollar is good for the economy, because it will make U.S. goods more easily affordable for other countries, which will allow higher exports. This, in turn, creates more work load for U.S. manufacturers, thus strengthening the job market. The Fed is expected to cut rates again before the end of this year, which may result in further weakening of the greenback. This may boost exports, but prices on imported goods will probably rise, reducing affordability. Economists believe hardships are far from over for consumers, but some of the largest banks are already saying they’ve seen the bottom and things are going to get better from now. Bloomberg.com cites officials at Lehman Brothers and Bear Stearns saying that the worst is “behind us”, and Goldman Sachs said the market is beginning to improve. Is this the beginning of an upward slope?

In spite of rate cut, mortgage rates edge up

After the Fed cut the Fed Funds Rate on Tuesday, one would expect mortgage interest rates to ease. What they did, however, was climb higher. One possible explanation Freddie Mac’s chief economist Frank Nothaft gave is the increased number of mortgage applications after last week’s 4-month low in interest rates. One way or another, analysts are saying Ben Bernanke’s decision missed the mark. Oil, gold, and stocks moved higher, and those were doing quite well even before the rate cut. The Canadian dollar traded at $1.0001 for a while, something that hadn’t happened in more than 30 years, and is currently priced at $0.99 and above. The U.S. dollar fell against the Euro, too, and all this against a backdrop of a weak job market and high personal debt.

Furthermore, Ben Bernanke himself said we’ll see more foreclosures soon, and borrowers will keep defaulting on their mortgages in spite of the recent moves. He added that the Fed is monitoring the situation and is ready to step in if needed, but that doesn’t really sound like a good long-term plan. President Bush said the financial indicators are good and he is confident the economy will remain strong. Tell this to all the pessimists out there.

Interest rates on 30-year fixed-rate mortgages averaged 6.34%, up from last week’s 6.31%. 15-year fixed home loans were at 5.98%, compared to 5.97% a week ago. 5-year adjustable-rate mortgages increased from 6.21% to 6.17%, and 1-year ARMs carried an interest of 5.65%, somewhat lower than last week’s 5.66%.

Regulators lift caps on Fannie and Freddie

Not so long ago, the Bush administration rejected a proposal to raise the limit on how much the two government-chartered enterprises can hold in their portfolios, but a new move by the OFHEO does exactly that. As of October 1, Freddie and Fannie can increase their mortgage portfolios by up to 2% annually, and the caps on both are now at $735 billion, compared to $727 billion for Fannie Mae and $724 billion for Freddie Mac until recently. This is much less than the 10% Fannie asked for, and the company didn’t fail to mention this in its statement: “the more effective response, given the extent of the market disruption, would be to raise our portfolio cap by at least 10 percent so that we can more fully address the ongoing turmoil”.

Christopher Dodd, Chairman of Senate Banking Committee, also criticized the move as “timid and inadequate”, but some analysts fear that lifting the caps on the two GSEs in unwise. Indeed, the Fed already did a lot by cutting the Fed Funds Rate by half a percent, essentially flooding the market with money, so allowing Fannie Mae and Freddie Mac to purchase more loans would trigger another short-lived iteration of the housing bubble. Pulling at levers to find out what happens could be very costly right now, so why not leave the market to fix itself? The rate cut is quite a dangerous experiment already, watch how the economy behaves until the end of the year and then decide what to do next. Now that Fannie and Freddie got their caps lifted a little, I guess it’s best to leave them as they are for a while, because it may take months to see the results of this week’s actions.

The Fed cuts rates

We had some doubts, but finally the Fed did cut rates – by half a percentage point, to 4.75%. And what we have now is plenty of opinions on what’s next. According to economists, the Federal Open Market Committee (FOMC) is likely to cut rates again before the end of this year, at least by .25%. The next cut could happen as early as October, at the next Fed meeting. Analysts seem to believe that the rate cut will be only a temporary relief to mortgage lenders. For borrowers, interest rates may change little, or not at all, depending on their loan terms and the index their interest rate is pegged to.

For some, however, the new rate may bring a big improvement for their monthly payments. Bank of America, for example, reacted immediately on the news, cutting its prime lending rate. Rates on credit cards are expected to drop, too.

Investors fear that the rate cut will have a negative impact on the dollar and the bond market, potentially driving the economy into a recession. Gold and stocks rose significantly after the cut was announced.

In other news, Accredited Home Lenders and Lone Star have amended their merger agreement. The new price for Accredited stock is $11.75, well above its market value at the moment.