I heard this on the radio yesterday: several Fed members wanted to stop raising rates. Well, they didn’t get their way! Bernanke will keep raising until inflation is contained, and to keep foreigners buying our dollars. He doesn’t care if housing tanks.
The effect of raising interest rates has a 6-12 month lag in the economy. The 4.75% effect won’t be felt until fall or spring 2007. That’s why the Fed has to be careful, so they don’t overdo it. They won’t know they’ve overdone it until it’s too late. We also must be patient for the effect of raising interest rates to be felt in the economy. Look, banks are still making record profits. Did you read the U-T today? Banks are down on the lending side,but up on fees (I assume credit card late fees). Only subprime lenders are shutting down. The big banks are not affected, (yet…)
Let’s all remember that we’ll have about $1trillion of ARMs resetting next year, and $330 billion this year. When those ARMs reset, even if interest rates stay at 4.75%, folks with intro rates of 1% or 2% will see their payments go up 50-100%! The Fed is expected to raise to 5% in May. Anyone with an ARM is screwed, and they won’t know it until later this year, or sometime next year.
What happens if the Fed actually lowers the rate? It could save housing, unless the psychology against housing is too strong, and monetary tightening is keeping lenders from making those silly loans.
It’s unlikely the Fed will lower to save housing. First, they don’t care about housing per se. They need to contain inflation, and keep foreigners buying our dollars. This requires keeping rates up.
The Fed has additional reasons to keep raising. First, competition. The European and Japanese Banks are raising their rates. I think the Fed will have to keep raising, to entice those foreigners to buy Treasuries instead of euro or yen notes. Second, inflation. The commodity bull market is good for investors, but bad for inflation, as the higher cost of materials will get passed on in increased costs of goods.
Long term mortgage rates are set in the bond market, which gets their lead from short term rates, but is held artifically low by excess demand from foreigners. As their demand wanes, prices decrease and rates go up. That’s one reason that the rates on long-term bonds went up recently: Japan purchased less than usual at the last auction.
A little off-topic: at what point will foreigners really shift from buying our debt to buying our assets? On one hand, China must support the dollar, bec. they need work for those millions of peasants moving into the city. They need to keep the USD strong, since we are their biggest customer.
At some point, their consumer spending will pick up, and they will no longer need to keep their currency weak enough to support our purchasing. Then they can buy US assets, like ports and buildings and oil companies, instead of our Tnotes. They can buy euros, francs, and invest in their own factories. They will, but I just don’t know if the shift will be this year or in 5 years.
