Advice, Community & Common Sense

Markets had a mixed reaction on Wall Street yesterday after the 1/4% cut in both the Fed Funds Target rate (now down to 2.00%), and the Fed's Discount Rate.  This uncertain reaction is likely due to two immediate issues detailed below, in addition to the usual forces caused by the inevitable follow-up question after every Fed cut or hike: What's next?

First, this was largely perceived as a 'pause' or a 'last move' by the Fed, as they sit back to watch all the previous cuts work their way into the economy completely.  It can take from 6 to 18 months for the full effects of any change in the Fed's rate to realize its full potential effect.  I for one agree this was a prudent move, and probably would have voted for NO cut had I been asked.  Maybe someday.

Second, Friday, May 2, 2008 brings the most recent "Jobs Report", or some say Unemployment Report -- which of late has been more accurate, for the month of April.  These Jobs Reports have become more crucial of late, as the last 3 have shown a decline in job growth, fostering the risk of an official recession.  Any big market bets ahead of key Jobs Reports are rare.  Once April's Jobs Report is released at 8:30am ET (5:30am PT), Friday, May 2nd, watch out!  All the traders are presently wound up like a coiled spring, and when that Report hits the wires...bang!  Everyone who hedged correctly will be ready to take profits, and those who hedged wrong will jump to cover their bets.  Not a day for the weak of heart. 

The results of that report will help line up the near term future of mortgage rates.  Why?  Because coupled with the Fed's 'pause' stance, it will give bond traders a feel for inflation risk and recession risk, and they can then place their bets for the next few weeks as to where yields should be in return for the risk of tying up their money for 6 months, or 2, 5, 10 or 30 years.

Great for the bond traders, but what about us, you ask?

Main street (aka "the consumers", or you and I) will get even smaller payments on our equity lines of credit ("HELOC"s), and possibly on some credit cards.  This because a large portion of these are tied to the Prime Rate, which for the last 15 years or so, has moved nearly in lock step at 3% above the Fed Funds Target Rate.  However, our passbook and CD rates may also go down again soon as a result of lower short term rates.  Lock in those longer term CD's soon if you don't need the money.

Wall street (aka "business") will get some cheaper funds to carry itself along, and it may help to heal the current liquidity crunch in the credit markets.  It remains to be seen if today's cut was enough to fix it, however.  I strongly doubt it was at this point.  Problems with liquidity are expanding globally, requiring more than just rate cuts to correct the still-spreading problem.

What about Mortgage Rates?  Historically, a Fed cutting period produces HIGHER mortgage rates in the not-too-distant future.  We'll just have to see how this cycle plays out, as history is no guarantee of future results.  The fact the Fed signaled a 'pause', may open the door to flat or even lower mortgage rates as long as inflation stays low.  Yesterday's mortgage market rallied, setting the tone for rates to improve, at least in the near term.  However, every Fed rate cut induced rally of recent history usually meets with a 'sobering up' period, and profit-taking, causing rates to return to pre-meeting levels, or higher.  Today's mortgage market finished 'flat', meaning traders are undecided until they see that Jobs Report tomorrow.

Longer term, inflation will be the key to what mortgage rates do.  Mortgages, of the fixed rate 30 year variety, will react in relation to inflation expectations, as mortgages today are an investment for the receiver of those monthly mortgage payments, and those investing in them must stay ahead of the inflation rate, or else they are losing money in real terms.  If inflation expectations are accelerated, as Fed cuts tend to do, then rates will rise soon for longer term fixed rate mortgages.  If inflation remains contained, then rates will hold or possibly fall.

Stay tuned as the real story unfolds...... We'll be here to help!