Oil, Dollars, inflation and Fed rates - great expanation here!

Fed leaves the rate alone today as expected – if you are curious about how some of these things relate to one another, read below. This is clear and easily grasped. Be the expert at the dinner table tonight!

Barry Habib is an analyst for CNBC and writes for his Mortgage Market Guide website. Many of you have seen this sight in my office, we watch it closely every day in order to advise our clients about locking rates.

Enjoy!

Oil,Dollars, Inflation and Fed Rates

By Barry Habib, CNBC Analyst

We actually agree with a more hawkish view - and although the Fed will not hike, we hope they decide to do so sooner than later. There is a possibility of a hike in August but it is not likely. The Fed is in a tough spot - the economy stinks, housing is struggling, confidence is low and costs are rising. You need only look at your last receipt from the grocery store or gas station to see how quickly things have changed. And a walk through your local shopping Mall tells another story of individuals who are less able to spend. That is the Fed's problem...the smart move is clearly to hike. Inflation is rapidly eating away the value of money. And while food price increases hurt, oil is the real story. So why has oil risen so wildly? The answer...The Fed. The evidence is too clear to ignore.

Let's take a look at where we were before the first Fed cut on September 18th. The Fed Funds Rate was at 5.25%, Oil was at $73 per barrel and the Euro was $1.35. Not great, but not bad. Fearing a recession, the Fed did the right thing to stimulate the economy - they cut. But cutting rates in the US makes higher rates in Europe appear much more attractive. So the Dollar began to tank against the Euro and just got worse as the Fed continued to cut. Now it takes $1.56 to equal one Euro. That is a huge swing. And here is where it gets interesting...Oil is priced in Dollars, so as Dollars decline, Oil price per barrel must rise.

Oil has gone from $73 a barrel before the Fed cuts began in September '07 to yesterday's close of $137 a barrel. And the European Central Bank President, Jean - Claude Trichet, has been talking about a rate hike in Europe even though they are headed for a recession. Remember there is a big difference between the US Fed and the ECB - the US has a dual mandate, fight inflation and promote growth. The ECB just fights inflation. And just the talk of a hike from the ECB has sent oil even higher.


Again, oil prices are surging mainly because of the Dollar weakness and the Fed cuts. Think about it - has demand for oil suddenly skyrocketed in the past 8 or 9 months? Sure it has gone up, but oil had already doubled in price when it was at $70. And higher prices for oil hurts everything. Sure at the pump and for heating, which allows less to spend, but travel, manufacturing, shipping...the list goes on and on.


Back to this morning's news - New Home sales for May were reported at 512,000, inline with expectations. The inventory of New Homes rose to a 10.9 monthly supply. This report suggests the new home sale market is still struggling.

The more "hawkish" the Fed statement, the better it will be for Bonds. But if the Fed does not at least talk tough, Bonds will be pressured and Oil will move higher.

March Madness - The Fed Cuts Again

The madness isn't just on the hardcourt.

You may have heard that the FED cut rates again last week; another .75%, bringing the fed funds rate to 2.25%. Contrary to popular opinion this does not translate to a lower 30 yr. fixed rate, in fact rates have started to rise again.

When you look at the last 5 rate cuts dating back to 9/18/07, the fixed rates have increased each time within days of each cut. The simplified explanation for this phenomenon is that fixed rates (bonds) dislike inflation and the rate cuts tend to be inflationary long term.

There's a lot of debate about how involved the FED should be in bailing out banks like Bear Stearns and other banks that took a "gamble" on these high risk loan portfolios. The free market people are calling for passivity and less involvement so the market can self correct.

A large segment of the investors that are or will have a lot to lose are asking for help to mitigate their losses. They argue that to let a bank like Bear Stearns collapse would be detrimental to ALL investors and the entire banking system.

We tend to side with the free market side of the argument. A lot of the self correction has already occurred and the people who took extra risks to get a better return need to be held accountable to their choices.

We also agree to a smaller extent that some intervention needed to happen in the Bear Stearns case because of the long ranging effects of it's collapse. We ALL would've been negatively impacted by a loss like that.

Why is the FED being so aggressive with their rate cuts? We believe that part of it is because banks are no longer loaning money to each other like they were prior to Aug. '07, so the banks need another source of money to meet their deposit requirements.

But, even more than that, we believe the FED has been agressively cutting rates to mitigate the impact of $400 billion to $600 billion in Adjustable Rate Mortgage (ARM) resets in this year alone. By agressively dropping the Fed Funds, the other short term rates like the LIBOR, CMT, MTA and the T Bills also drop.

For instance the 1 MTH LIBOR has dropped over 3% since August '07. Now when these ARM's start to adjust this year, the new rate will be closer to the starting the rate and the payment shock will be less which means more people should be able to keep making payments which means less defaults and foreclosures. This in turn helps to stimulate the housing market again.

Stay tuned for more madness, both the good (Spartans win the Championship) and the not so good.

FED Rate Cuts: How Low Can They Go? part II

After yesterday's emergency .75% rate cut by the Federal Open Market Committee (FOMC), I have received numerous calls and questions as to how low will the FED go and how low will Fixed Rates go? If you read my previous post on the FED Rate Cuts, you know that the two rates don't always move in the same direction, in fact they more often than not, move in opposite directions.

The FED has tried to be as transparent as possible, especially under the leadership of Ben Bernanke. The goal of transparency is to limit "surprises" in what the FED does and says. In some ways the Fed has met this objective by releasing their notes from their scheduled meetings on a timely basis. The challenge arises when the voting members don't agree with each other on policy.

If you want to learn how to guage the direction of interest rates, here are some basic guidelines that I learned from Jim McMahan, a Mortgage Broker in Texas. These are some guidelines that the FED tends to follow:

1. The FED's goal is to keep Core Inflation (C.I.) at 3% or less. (the PCE is currently at 2.16%)

2. Everytime we've had a recession, the FED has taken the Real Interest rate to a negative number in order to stimulate growth:

Real Interest (R.I.) rate = Federal Funds Rate (F.F.R.) - Core Inflation (C.I.)

(1.34% = 3.5% - 2.16%)

3. Real Interest rates have never increased 8 quarters in a row unless inflation (C.I.) was present at 4.5% or greater.

4. Mortgage Rates in the U.S. have been at or below 7.5%, 85% of the time in the last 80 years.

5. Mortgage rates tend to gravitate towards Core Inflation (C.I.) + 3.5% (2.16% + 3.5% = 5.66%)

If the FED continues to follow these guidelines, we could see fixed rates in the 5.6% range.

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FED Cuts Federal Funds Rate by .25%

Contrary to what you'll be hearing in some of the media outlets, this .25% cut in the funds rates does not equal a .25% cut in long term interest rates. Yes, it will affect short term rates like the Prime rate (this is the rate a lot of the Home Equity Lines of Credit - HELOC and credit cards are based on) and the LIBOR.

In fact, since the announcement was made, the Mortgage Bonds are actually showing signs that fixed rates will be rising tomorrow. Additionally, the expected non-farm jobs report to be released on Friday, 11/2/07 at 8:30 am EST is expected to be stronger than estimates and could trigger long term rates to rise even more.

Here's a good article explaining what the FED talked about during their 2 day meeting and what their projections are for the economoy and inflation.