The other day, we kicked around the idea of Fed Chairman Bernanke’s condundrum: He is cutting rates, yet many long term rates – including fixed rate mortgages – are going up.
So, since Mr. B spent the last two days testifying before congress, it might be a worthwhile excercise to tease out his thoughts on the same in an attempt to get an idea what this may portend for Mortgage Rates.
First from Forbes, while not in so many words, we have Bernanke confirming the ‘conundrum’:
‘We have a problem, which is that the spreads between the Treasury rates and lending rates are widening…So in that particular area, it’s been more difficult to lower long-term mortgage rates through Fed action,’ he said.’
Yet, by all indications, and even in the face of what appears to be increasing inflation, the Fed will continue to cut. From Chairman Bernanke:
‘…downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.’
So what then, about inflation – the primary reason many lending rates have risen in the face of the Fed cuts? Again from Mr. B:
‘The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation.’
And therein lies the key: The Fed has placed a bet that we are in a (potentially nasty) recession, and if true, inflation will take care of itself.
The key takeaway: If the Fed is right, and continues to ratchet down short term rates, we can expect fixed rate mortgages to fall in 2008 (ARMS have already dropped.) That is a big bet, and we hope a correct one.