Worth a read...fed cut doesn't really help mortgages

[optimusprime_IHB]

Sorry for the font change etc..

September 19, 2007, 12:55 pm

The Yield Curve’s Downside

Posted by David Gaffen

The Treasury yield curve (remember that thing) has steepened in response to the Federal Reserve’s surprising half-percentage point rate cut. This is not good news for the housing markets and for aspiring consumers looking to take out fixed-rate mortgages, as they may see rates increase at a time when most would be hoping for lower rates to ease some of the pain in the housing industry.

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The 10-year Treasury note was down sharply on the day, boosting the yield to 4.548%, widening the spread between it and the two-year note’s yield. Bond analysts expect this steepening to continue, and that raises the prospect of cannibalizing the impact of the rate cuts.

“We could easily see the Fed cut followed up by higher long-term interest rates,” writes Guy Lebas of Janney Montgomery. “By cutting interest rates, the Fed is in part sending the signal that it is sacrificing long-term inflation for the sake of short-term growth. Higher inflation is likely to mean higher interest rates on the ten year and beyond portion of the yield curve, despite any Fed rate cuts.”

And while lower rates may increase confidence among some lenders who need to know they can borrow easily if needed, the same may not occur for consumers. The housing market, meanwhile, is already struggling with inventory overhang, and mortgage lenders are working with tighter lending standards (finally).

“This type of movement is going to be negative for fixed mortgage rates which are more tied in with the long-term interest rates,” says Celia Chen, director of housing economics at Moody’s Economy.com.

 

[No_Such_Reality_IHB]

Stagflation.

 

[IrvineRenter_IHB]

FromPredictions for the Irvine Housing Market

Interest Rates

Another key factor impacting the fundamental value and thereby the bottom is interest rates. As was pointed out in the comments on a previous post, interest rates went down during the last price decline which softened the impact. Mortgage Interest rates are near historic lows, and will likely increase. As lenders and investors in Mortgage Backed Securities (MBS) get burnt during the decline, they demand higher risk premiums. This increases the spreadbetween the FED funds rate and mortgage interest rates, which is right now at a historic low. So even if the FED were to lower interest rates, the increased risk premiums demanded by lenders and MBS buyers will likely drive up mortgage interest rates. Higher interest rates mean lower prices and a lower bottom.

 

[Major Schadenfreude_IHB]

“By cutting interest rates, the Fed is in part sending the signal that it is sacrificing long-term inflation for the sake of short-term growth. "

If I'm understanding this statement correctly, then it would behoove the cash rich nations which have been buying a lot of the 10-year T-Notes lately, to scale back these investments. It's like our government is saying, "Go ahead and buy our 10-years! We need the money! We'll pay you back as specified, although since we are cutting rates and flooding the market with money NOW, it aint gonna be worth as much when we pay you back in the future! LOL!"

The hope is that these nations will not act like knuckleheads and scale back the purchases. Then the government will have to make it more attractive for them to buy them by increasing the 10-year bond interest rate. And since mortgages rates trend these long term rates, they too will increase, REALLY putting pressure on house prices.

WOW!

 

[awgee_IHB]

Major S - Foreigners had already been scaling back their purchase of US notes before the rate cut, and devaluing the dollar probably will not make US notes more attractive. If you want the actual numbers, I will dig them up, but I already posted them someplace else on IHB.

My take, (suspect already), is that interest rates, in one direction or another, will not have nearly as much effect on home sales, or the lack of them, as the availability of credit. If the secondary market does not want to buy mortgage related paper ...

 

[optimusprime_IHB]

Totally agree...the biggest factor will be availability of credit and based on the fact that many banks/investment shops are closing down their subprime units....we all know where credit is heading.

Tighter and higher rates and better credit scores....that means 60-70% of the people who are in need of re-financing or looking to purchase a home will not qualify...oh well.

 

[Major Schadenfreude_IHB]

I also agree that the credit squeeze will be presently the biggest and most immediate factor.

However, if the cash rich countries get insulted over the Fed's actions of lowering the short term rate, then they may scale back even further their 10 year T-Bond purchases. Or if the world suddenly lacks the cash (or desire) to buy the bonds and this translates into much higher T-Bond interest rates and corresponding higher mortgages rates, then this effect may exert an equally or perhaps even greater downward pressure on house prices.

The credit squeeze and (possible future) higher long term rates will be a ONE - TWO punch, respectively. The number two punch has the potential of being pretty powerful, I think.