June 30, 2005

The BIG news is that the Fed has increased the Fed Funds rate 25 basis points to 3.25% which represents the ninth consecutive time since June 30, 2004. Since 1958 the average tightening cycle lasts 19 months which would put us in January 2006. (Chairman Greenspan’s retirement date). After reviewing the FOMC statement the only change from May 3rd is the mention of energy prices having risen further (than the Fed expected). This does NOT change my forecast that short rates will continue to rise until they exceed long term rates and this will occur sometime in the fall of this year. The bond market’s reaction to the FOMC statement is positive and the 10 yr. is now trading at 3.95%

Since June 30, 2004 the Fed Funds Rate (short term) is UP 225 basis points from 1.00% to its current 3.25%. The US Treasury 30 yr. interest rate is DOWN 134 basis points from 5.59% to its current 4.25%.

In other news Mr. Greenspan’s favorite inflation indicator (core personal consumption expenditures) showed this morning that inflation is still running at 1.6%. BTW…did you know that the Fed Chairman was captain of his high school wrestling team???

From across the pond comes the news that a report issued by the British CBI (Confederation of Business Industry) showed that high street sales have fallen to the lowest level in 22 years. This is a little strange because most of Britain still has cash to spend from their latest round of cash out refi’s but still is important because it probably shows that consumers fear what’s coming soon…declining home prices. For more info: http://www.cbi.org.uk

The last paper I read each night before I attempt to get my much needed four hours of sleep is the People’s (China) Daily and today’s edition had a couple of interesting items. An article entitled: “Will deflation return to China” tells us that there is still lingering fears from the last bout of deflation that occurred in 1998. It’s hard to believe with raw commodity prices still increasing at double digits that China could see deflation (May CPI +1.8%) but China’s banking system is still fragile. If China does see deflation the US will have a hard time avoiding the storm that is sure to follow.

The US yield curve continues to flatten and with today’s increase in the Fed Funds rate we come closer to end of this Fed tightening cycle which is the good news. The bad news is that the Fed has a disastrous history of always believing that this time will be different when the yield curve inverts. In the last 45 years the curve has inverted eight different times and in seven of those periods a recession followed within a year or so. Most importantly Mr. Greenspan has missed all three inversions with comments like “This time will be different” and of course it wasn’t……Whenever I read something he says I think back to one of his most famous quotes: “I know you believe you understand what you think I said, but I am not sure you realize that what you heard is not what I meant.” Studying the Fed and its announcements, speeches, innuendos, etc. is not easy and is much more an art than a science…..but it does always keep everyone wondering what’s next…….

Have a Happy, Healthy and Safe 4th of July…..

June 29, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 132 basis points from 5.59% to its current 4.27%.

The clock is ticking as we are just about 24 hours away (Thursday 11:15am) from the next FOMC decision to increase the Fed Funds rate by 25 basis points to 3.25%. The actual wording of the press release is what has the bond market on edge as any reference to a final conclusion to a rate rise would be greeted with a buying panic in bond land. The bad news for those waiting for Fed guidance is that the chances of a quick end are somewhere between zero and none. With today’s announcement that GDP growth in the first quarter of 2005 was a robust 3.8% and the price deflator at 2.0% the Fed will remain on its path to an inverted yield curve. (short rates above long rates) The one interesting item from this morning’s GDP news is that residential construction grew at 11.5% clearly showing why 43% of the jobs created in the US in the last 12 months have come from the real estate related sector. For those of you making vacation plans for 2006 the Fed announced this morning their 2006 FOMC meeting schedule: http://www.federalreserve.gov/boarddocs/press/monetary/2005/20050629/default.htm

It’s never too early in the morning for real estate bubble news: A 266 unit apartment building at 800 Sixth Ave. in New York City is in contract to be sold for $195 million which comes to $733,000 per unit and that folks is an all time record!!!

An investment firm in New Jersey is raising $200 million for a fund to purchase distressed properties…..GE is investing $135 million into a $600 million fund that is also seeking “problem properties”….The real problem for both of these funds is that they are having a hard time finding anything to buy as it appears that “problem” properties just don’t exist….the question becomes will they rush in and purchase “non-distressed” properties now afraid that if they don’t invest the $$$ immediately investors will become impatient and demand the return of their $$$??? Remember I believe the bubble will NOT burst until all of this $$$ on the sidelines is invested so that the trap door will be shut only when everyone is on ” the train to real estate heaven”….I am seeing so many pools of $$$ that are going around seeking homes, empty lots, rehabs, etc. to buy, flip, and move on…..these investors are like drug addicts…..is there a rehab for real estate investors?????

The bursting of the RE bubble may have more to do with the fact that there are only 50 states in the US. Early this year I was receiving calls from investors in Arizona, then New Mexico, Oklahoma and now Mississippi as they move east seeking better “opportunities”??? at the same time I was getting calls from Florida, Georgia, Alabama, Louisiana and now Arkansas….what’s left when the West Coast investors meet the East Coast investors and realize that there is nothing left to buy at reasonable prices???? I am waiting for calls from Montana, South and North Dakota to begin soon and then…….

Every economic cycle has its one or two events that are truly memorable…..bulletin board material that never comes down….In 1980 Henry Kaufman (former economist at Soloman Bros.) was quoted in a front page headline in the Wall Street Journal that the Prime rate would hit 30% before declining…I cut out the article and pasted it on my bulletin board where it remains today….(for those of you that don’t remember the Prime never hit 30%) ….National City (residential lender) out of Cleveland announced this week that it would no longer REQUIRE appraisals for loans, it will accept the opinion of RE agents as to the value of properties……no that is NOT a misprint and even more incredible they are a BIG Heloc lender……it appears the residential lending business is becoming very competitive and it is only a matter of time before some of these lenders learn a very painful lesson in Economics 101…

There is an article in today’s London Financial Times (must be a subscriber to access) that suggests an inverted yield curve in the US is not to be feared and that the Fed will raise short term rates substantially above long term rates to prevent a resurgence of inflation…..The good news about the real estate boom is that Mr. Greenspan has learned many lessons from the past and one of these is that bubbles that burst can have a very harmful effect on the US economy especially when it involves such a big part of job growth (see above)…As a result I do not expect the Fed to continue these rate increases in 2006 when we have a new Fed Chairman and that Mr. Greenspan will take care of the hard work (rates rising) in 2005. The best thing that could happen for the remainder of 2005 would be for long term rate to continue to decline so that an inverted yield curve occurs at a relatively low level (4%) for short rates.

Finally I want to touch on a subject that I need to spend more time on…China. As many of you are aware Chevron recently bid $17 Billion for Unocal and then was out bid by the Chinese National Offshore Oil Co. (CNOOC). The $18.5 Billion bid by CNOOC should easily be enough for Unocal shareholders but Washington politicians have voiced major concerns about US economic and national security. I find it interesting that Washington is concerned about Chinese authoritarian policies but somehow has a blind eye to Saudi Arabia’s rulers that have less than a stellar human rights record. In reality we need to be paying closer attention to improving relations with China as they hold over $250 Billion of US Treasury securities and when not if the Chinese consumer begins to purchase more goods and services the first place they will look will be the US. The last message we should be sending the Chinese is that we see their US investments as a threat to our security…..this is really about our insecurity…..

June 27, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 140 basis points from 5.59% to its current 4.19%.

A busy day all over the world and the BIG news is that oil closed at $60.55 in New York trading and no one seems to be bothered by rising gasoline prices. Have US consumers just accepted the fact that filling up their tanks now costs $60 instead of $40??? Or maybe they are just borrowing more from their houses to pay for the gasoline and other luxury items….(For many gas is now priced higher than a luxury item)…

The other BIG item announced today was that Fannie Mae sold $17.81 Billion in mortgages in May compared with $1.68 Billion in April thus reducing their portfolio to $828 Billion. To most people this is a non event but to many in the mortgage business this is the answer to the question I receive daily: “Why are long term mortgage rates NOT falling at the same rates as US Treasuries??” Luckily for many Fannie has been able to sell into bond market strength (declining yields) so the impact has been somewhat muted. But when we go through a period of rising long term rates this same selling by Fannie will put the 30 yr. jumbo rate over 6% and then maybe people will notice that something has happened to alter the normal mortgage/Treasury rate spread. The US government is far from deciding how much Fannie Mae and Freddie Mac should hold in their portfolios and this uncertainty will continue to shadow the long term mortgage market. To the many mortgage brokers/borrowers that read this e-mail I strongly urge that you lock your clients loans on a day that US Treasury rates are declining so that you limit the impact on your clients final borrowing rate. Finally Fannie Mae announced they had reduced their duration in another effort to reduce portfolio risk. (It’s too late to show the government they are ready to abide by the rules)

Housing bubble update: Standard and Poor’s (S&P) made a little noticed announcement last week that their are reducing the ratings on securitized mortgage pools that include “option arms”. This is probably the worst product ever created by the mortgage industry and when the bubble bursts (and it will!!) these borrowers will be the first to drown in the tidal wave of failures that is sure to hit the coastal areas of the US. (highest home prices) The important part of this S&P change is that it will INCREASE the credit-enhancement cost of issuers by 15-25% so this will DEFINITELY increase the cost on option ARMS to the borrowing pubic.

For those that think the housing bubble is only something that happens in other countries comes an interesting item I read last week in of the many housing blogs on the web. Many believe that the increase in the supply of US housing will be easily met by the many immigrants entering the country each year…….It appears that the INS has slowed the process of obtaining a green card and it now taking almost 6 years to obtain this most valuable item for a newcomer to the US…….

According to Loan Performance Inc, a mortgage data analyst, negative amortization loans are increasing at a record pace in 2005. These are loans with artificially low payments and the excess interest is added to the loan balance. As long as home values increase there is no worry but if they start to level off………it’s not going to be pretty.

I went to get my haircut early Saturday morning and everyone in the place was talking about house prices, where to buy (Mississippi) and how easy it was to make a fortune by investing in houses and then selling quickly BEFORE the crash…
When I opened my mouth (It’s really hard for me to not talk about one of my favorite subjects) the whole room fell silent (like the old EF Hutton commercial) and looked at me like I had brought a curse into the room. They proceeded to tell me that even talking about a decline in housing prices could bring bad karma to everyone…….This is getting way, way out of hand….Everyone truly believes this is musical chairs BUT they will be the lucky one to land in the only remaining chair. (get out before the top). Let me repeat…..I have studied bubbles that have occurred over hundreds of years and this is the WORST bubble ever!!!! I am convinced that MR. Greenspan will NOT leave office (01/06) until he has slowed the rate of advance in house prices to a manageable level and this will be accomplished thru higher short term interest rates and tighter underwriting standards for house lenders……

Mr. Greenspan and his band of FOMC warriors will be meeting on Wednesday (6-29) and Thursday (6-30) and announce a 25 basis point increase in the Fed Funds rate at 11:15am on Thursday. Although much was written about over the weekend that the Fed will soon stop its tightening, I firmly disagree and will stay with my forecast that the first easing will not occur until the spring of 2006 when we have a new Fed Chairman. That is also the point at which I believe long term rates will bottom and the inverted cycle will be complete. There was an excellent article in Sunday’s London Times entitled: “Rates set to do the recently unthinkable”: where the press is now talking about the Bank of England lowering short term rates for the first time in many years. Remember it was England that led the US in rising short term rates, lower long term rates, rising home prices, stronger currency…..The Fed carefully watches the movements of the BOE ….

One of the reasons I am so convinced that the Fed is NOT finished raising short term rates comes from Friday’s H8 report that showed commercial and industrial loans rose $7.6 BIllion last week along with real estate loans that rose $10.5 Billion. The Fed is way too afraid that if they stop raising rates it will send a signal to the markets that all is clear to continue speculating in real estate and that is just NOT going to occur…….The problem the Fed is facing is that corporations continue to save their earnings instead of re-investing back into Research and Development. Corporations that are growing are also borrowing and the only borrowing that is happening is for inventory buildup of raw commodities due to a fear of higher prices. Corporations that aren’t net borrowers are saying loud and clear that their expected return on capital is BELOW their cost of capital and that is not a good sign for economic growth in this country. Most of the growth in the US is coming from purchases of foreign made goods and the recent strength of the dollar may curtail this quickly as the prices of products made overseas increases for the remainder of 2005.

The pot is starting to heat up and will soon start to bubble before exploding……

June 22, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 135 basis points from 5.59% to its current 4.24%.

The day started early (4am) for many interest rate watchers as the Bank of England released minutes from their last meeting (6/09) and they revealed that two of the seven members voted to REDUCE short term interest rates. Although this is far from a majority it showed a slight shift in overall monetary policy and a hope that the BOE will soon drop their repo rate thus leading other central banks to allow interest rates to fall. Tuesday morning the Swedish central bank reduced its short term rate a surprising 50 basis points to a very low 1.5%. The Fed is paying close attention to these changes but I still find it hard to believe that their current policy of increasing short term rates will change until a new Fed Chairman takes office in 1/06. Long term US treasury rates are testing their two week old lows as the ten year tries to stay under 4% for more than just a few days. Unfortunately mortgage rates will not drop at the same rate as Treasuries because of the constant liquidation by Fannie Mae and Freddie Mac as they strive towards government goals to reduce their mortgage porfolios. Fannie held a record 57% of all mortgages last year but that number is now at only 43% and will continue to decline for the remainder of 2005.

I found it very interesting that the German Central Bank (Bundesbank) announced this week that in 2004 private households actually paid down more credit than they took out which is unheard of in a growing economy. Paying down debt is something that occurs when people are afraid that there is no good reason to borrow and that is exactly what is happening in Germany. The savings rate in Germany is currently 10.6% and of course that compares with 0.1% in the US. You always have to be careful of getting what you ask for and the Germans wanted a strong currency, trade surplus and for that they have a weak economy with very little consumer demand. I have said it often trade deficits come from strong consumer demand and that is what keeps the US economy going upwards (add in real estate).

Real Estate: There isn’t an hour of the day that passes without more incredible stories from this ever growing bubble…
Let’s start in Chicago where the Wall Street Journal published an article that spoke about the condo market in Chicago showing signs of cooling : http://online.wsj.com/article/0,,SB111939287367765760,00.html?mod=real%5Festate%5Fwsj%5Fhs
This is the area of the market that is the most vulnerable because supply is increasing much faster than demand….
How about a new website for condo flippers: www.condoflip.com I know nothing about this site but I have to believe that it will see a short shelf life…..
From Arizona comes the story of more tall buildings (condos) in the planning stages for people eager to part with their hard earned money…http://www.azcentral.com/business/articles/0622metrolofts22.html

The US Census Bureau said this week that 88,000 houses were for sale but NOT yet started….

The good news from bubble land is that counties, states and cities are seeing record tax collections from real estate centered transactions. Los Angeles County said tax collections are up 9.3% this year due to an increase in property taxes which make up 65% of all revenue.

Finally with the price of oil at just under $60 a barrel a reminder that in the last 23 years oil has had its biggest monthly rise in the month of August and biggest decline in December. It could be a long and expensive summer for US drivers…..

June 20, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 120 basis points from 5.59% to its current 4.39%.

Let’s start with what should be the biggest news of the day…the price of oil closed at $59.70 in New York trading as the FEAR of limited refining capacity is driving the shorts (how could anyone short oil in this environment) to cover…..we wrote many months ago about the NON-inflationary impact of higher oil prices and that has not changed….In last week’s Fed Beige Book the rising price of oil was mentioned many times as having a negative effect on consumer spending. The price of oil is somewhat inelastic (when the price rises the amount purchased does NOT go down) so consumers cut their purchases of other items that are elastic (movies, sporting events, etc.). Although the Fed’s increase in short term interest rates has NOT had much effect on the US economy a rising oil price above $60 will certainly act as a barrier to continued growth in consumer spending…

The housing bubble: As most of you are aware I read 25 newspapers a day from around the world and many more periodicals on the internet and the coming housing price decline is receiving way too much publicity. It’s become obvious to everyone in the US that housing prices have risen too fast and too far……But the market gods always produce a result that harms the majority (although this housing bubble has created many “lucky” investors) so the least expected event is what I am expecting……With so much $$$ on the sidelines praying for a pullback in house prices I now expect a “soft patch” to hit the real estate market over the next few months with everyone excitedly putting their $$$ to work through the purchase of more real estate…the final step will be one more push to new “bubble” highs making every homeowner an instant millionaire before the trap door is set on a 5-10 year “bear” market that will bleed many into bankruptcy…..The supply of housing is increasing faster than population growth in every county of the US. Last Thursday’s (6-16) Orange County Register had the lead story of the business section “Housing Prices a Broken Record” (what else is new??) but inside the article was the important part: The Irvine Company’s plans were approved to build 4,310 new homes with thoughts (not approved yet) of another 12,350. Where are all of the buyers going to come from??? apartments?? speculators??? a ship arriving every hour with new citizens??? I said over a year ago that don’t be surprised if the housing bubble bursts and interest rates don’t rise….the end is coming soon to a neighborhood near you….a great cartoon I saw over the weekend: Snoopy is on top of his dog house with a sign that reads: “For sale by owner…$500,000″

I just finished reading a housing study by Harvard University (good reading if you can’t get to sleep) and they believe that 17% of homeowners today have a 95% loan to value ratio or MORE…..this is very dangerous if housing prices fall even 5% these people will be underwater…..The NAR (National Association of Realtors) says that 42% of all first time buyers in 2004 put down 0.0% on their purchase……and finally 25% of all home buyers today are investors…… the only good news I see from this is that the Fed won’t be able to raise short term interest rates as high as they would like for fear that the effect on the US economy will be devastating to the housing sector. Over 45% of all jobs created last year in the private sector were related to the housing industry and over 80% of all GDP growth in the past few years has come from consumer spending and construction. When the end finally hits it will feel like one hurricane after another as the majority “freeze” and find themselves with few options….

Interest rates: It’s getting crowded in the long end of the market. Many of Wall Street’s top economists (how does one become a TOP economist??) have thrown in the towel and having suffered for over a year are now predicting that long term interest rates will continue to fall…. A great quote from one of the Street’s top honchos: “Emotionally we all believe interest rates should be higher, but they are not and we have to deal with reality.” (OUCH!!!) Although this does not change my forecast of a low in long rates in 2006 it does make me uncomfortable for the course of long rates over the next 2-3 months…..According to the Fed’s H8 report commercial and industrial loans fell $6.1Billion last week…I believe this will be corrected but if not……corporations are cutting back on their borrowings….The bond and interest rate markets have NOT begun to think about the next Fed Chairman (Greenspan retires in 1/2006) and although it appears that Ben Bernanke (new head of the President’s Council of Economic Advisors) is the front runner the markets will NOT be comfortable with a new Fed Chairman until he or she?? has shown they can perform under difficult economic circumstances (the housing bubble will be a good first test) and I expect long rates to rise slightly in the fall as the markets try and guess the winner??? (I am not sure anyone should want that job) Just in case you are looking for a really, really, really long term investment…..Denmark’s Danske Olie (oil company) is issuing a bond that will mature in 3005. (that is not a misprint) I have no prediction on whether this debt instrument will be paid off in full and since I won’t be around in 3005 I am not sure if I should care…..Copper prices are setting new all time highs and scrap steel prices are plunging….China’s demand or lack of is having a dramatic effect on commodity prices….

The dollar: I have said all year that the dollar was my #1 best investment for 2005 even though Warren Buffett and Bill Gates had bet (invested??) $$Billions against the dollar…Mr. Buffett announced today that he was still betting against the dollar even though he lost $30.7 Million in the first quarter on this investment. (Do you know how many homeless people I could feed with $30 Million???)

The fun is just beginning………

June 15, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 119 basis points from 5.59% to its current 4.40%

Let’s start across the pond as the RICs report has just reported that 49% of homes in the UK fell in price in May and this occurred WITHOUT a major increase in the supply of houses for sale. Only Scotland saw housing price increases and the fall in UK prices was the worst since November 1992. Remember that UK prices started to rise well ahead of the US, could we be seeing a top in US housing prices on the horizon??? For more information on The RICS report for the UK please visit:
http://www.rics.org/Property/Residentialproperty/Residentialpropertymarket/RICS%20housing%20market%20survey%20May%202005.html

In the US inflation statistics for both wholesale and retail inflation showed an annual rate of under 2.0% which is consistent with Mr. Greenspan’s favorite indicator the PCE index which also remains under 2.0%. The bond market doesn’t seem to care about this news and is it’s own world this week not sure of what it needs to drive interest rates lower. (How about a 6-8 week rest??) The dollar also looks tired and I would expect a bounce in the Euro from the current 1.20 level to the 1.25 area over the next few weeks.

Not only is the Fed concerned about home price inflation it is soon to issue new guidance to commercial real estate lenders on underwriting guidelines. Yesterday Fed Governor Susan Bies spoke to a group of North Carolina Bankers and prepared them for a change in what kind of loans the Federal Reserve wants these bankers to make and it’s NOT a continuance of current home loans. Please read the following
carefully:http://www.federalreserve.gov/boarddocs/speeches/2005/20050614/default.htm

The benefits of rising real estate prices are being felt in the coffers of state governments as sales and income tax growth is soaring for many of the nations hottest areas. This will certainly help close many state budget deficits where spending cuts are almost impossible to legislate. http://rfs.rockinst.org/exhibit/9017/Full%20Text/RR_60.pdf

The next FOMC meeting is June 29 & 30 and I fully expect the Fed to raise the Funds rate to 3.25% which will take us closer to my long standing prediction of an inverted yield curve where short term rates will be HIGHER than long term rates at least until 2006 (after Mr. Greenspan retires) when the Fed will again lower short term rates and at that point long term rates will hit their lows for the next 5 years or so…….

Lastly it makes me uncomfortable when the media begins to write about something I have been talking about for almost a year….the fact that short term rates are rising and long term rates are falling….Mr. Greenspan calls it a “conundrum”, I call it a cycle that is upside down…it doesn’t matter how it is defined…what is important is that my readers stay far, far ahead of the information curve and see things before the public….one of my favorite expressions is: “to do the impossible you need to see the invisible” and forecasting future interest rates has been described by many as “impossible.” For those of you that have read my e-mails for the last year you have seen the impossible become the “probable” as interest rates have gone in the direction that everyone least expected. That trend will continue with the conclusion to this chapter in interest rate history occurring in the spring of 2006 with a new low for long term interest rates. Until then, sit back enjoy the ride and watch as the majority of pundits (including the Fed) remain in confusion…….

P.S. I’m not sure anyone cares but Pork Belly prices look too low and a rally seems imminent…….

June 13, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 122 basis points from 5.59% to its current 4.37%

It’s all about supply and demand…..for many of you it’s been many years since you had to sit through a boring economics class but the basic premise is that when the price of something goes down buyers appear and when the price of a commodity (houses, etc.) go up supply increases…….and that is exactly what is going on in today’s housing market. It does NOT happen overnight and may take months or even more than a year but when the supply of newly built condos (huge) and homes comes onto the market prices will stop rising and start a gentle decline before a quick rebound and then the fall that will trap everyone…..I read 25 newspapers each day and 50 on Sunday and i have never seen so much written about one particular investment with much of it about how prices keep rising….yes everyone is talking about the real estate bubble but very few investors (other than the smart money) are doing anything about taking their chips OFF the table…the prevailing attitude is the same as the children’s game of musical chairs believing that they will be the one to always find a chair to sit on when the music stops…but what happens if the music stops and all of the chairs are taken away??? Something tells me that this is not the typical real estate cycle where prices keep rising at a slower pace and that is the worst of it…the lenders have become like drug dealers at the corner liquor store offering their wares at cheap prices and promising a great high……
When you read your local paper or magazine or internet article pay close attention to the news about an increase in supply and then ask yourself if the population of your city has increased to warrant this increase or has everyone’s income risen so that they can now afford the mortgage payments…I seriously doubt any of this has occurred…what has happened is greed or the fear of missing out on the ride to the sky and the fallacy that you can get off the train and take your profits before the train crashes ……I would rather make an early exit and live to play another day than get out too late and try to get even over the next 10 years…..Life is all about messages and the message the real estate market has been sending is one of no risk and big profits…that message will soon change…..

Interest rates: After falling under 4.00% the 10 yr. US Treasury has risen back above to a current level of 4.09%. Although I still firmly believe that long term interest rates will continue their decline until the Fed stops tightening (the normal cycle is inverted) we are entering a 6-8 week period when I believe long term rates will rise due to uncertainty over current Fed policy. Mr. Greenspan’s testimony to Congress last week brought nothing new except a confirmation that even the Fed Chairman is confused over the current level of long term interest rates. Normally long term interest rates follow short term rates and that is what the Fed Chairman thought would happen when he began raising short term rates on 6-30-04. The problem that Mr. Greenspan failed to note was that long term interest rates has already risen for more than a year in ANTICIPATION of the Fed tightening that began in 6/04. I wrote in July 2004 that the Fed increase in the Fed Funds rate will only push long term rates lower and that is exactly what has occurred…so when the Fed stops later in 2005 it will set the stage for a Fed easing in early 2006 that will trigger a rise in long term rates. We have inflation statistics on Tuesday (PPI) and Wednesday (CPI) but I really believe that the market has priced in a current low inflation rate (under 2%) and an economy growing at a moderate 3% pace. The market is focused on current and future Fed policy and is desperately seeking some guidance…unfortunately the Fed is more than a little confused about where we are in the economic cycle and this uncertainty will cause rates to rise for a few weeks/months. At some point sooner than later talk will center around the next Fed Chairman (01/06) and this too will create some apprehension on the part of investors.

One of the drivers behind the lower US long term interest rates has been the strength of the US dollar. (my #1 best investment for 2005) The Euro has fallen from 1.35 to 1.21 in just a couple of months and this decline is due for a rest as I have a feeling that the BIG shorts (Gates, Buffett) have covered their positions with HUGE losses. I still believe the dollar will continue to rise but not until later in the year. The Chinese will revalue the yuan in the next 90 days or so but its impact on the world markets will be muted as this too has been discounted by worldwide markets.

Oil rose over $2 today and is trading at $55.62 per barrel with $60 an easy target….the oil market is worried about the winter driving season…when it finally arrives supply will be plentiful but for now the crowd wants to worry and drive prices higher….

A few interesting items from the weekend news: Steel prices in China are falling….60% of all US banks assets are in mortgages…..in 2001 only 20% of home buyers used a piggy-back 2nd for additional financing…in 2004 that number jumped to 42%…home equity loans are now 6.6% of bank assets up from 2.4% at the end of 1999…In the last 12 months US corporations have generated NET savings of $221 Billion (normally corporations are net borrowers) which has been invested mostly in US Treasuries….Corporations are obviously NOT investing the $$$ back into R&D….the corporate takeovers are occurring from borrowed money from banks…Big tanker shipping rates have fallen for the past several months due to an INCREASE in the fleet of ships (price rises bring an increase in supply)… From England comes news that home prices are increasing at a 2-3% annual rate and may begin to fall in late 2005….Portfolio managers are finally increasing their bond portfolios after missing the entire bond market rally so that is another reason long rates will rise in the next couple of months….The yield curve continues to flatten with the 2yr.-10 yr. spread at 40 basis points and on its way to 0.00….a research group in the UK is predicting a loss of 150,000 retail jobs due to falling store sales….Could the Bank of England be ready to LOWER short term rates????….I look for GM and Ford to reduce actual prices soon because rebates and low financing rates are NOT working….Did you know that an broad index of Chinese stocks on the Shanghei Stock exchange hit 8 year lows last week??? The level of under funding of defined benefit pension plans in the US is now at a record $353.7 Billion which is an increase of 27% from last year….Guess who is going to end up paying the bill??? (US government???) Did you know that the total amount of mortgages in this country ($5.5 Billion) exceeds the amount of US Treasury securities ($4 Billion)…I know who buys the Treasury bonds (foreign central banks) but who will buy the mortgage securities if the price of houses begins to fall??? Remember FNMA is a net seller of mortgages and they have been the biggest buyer……I expect the interest rate spread between treasury and mortgage securities to widen as the housing bubble deflates…..

Bottom Line: I know many of you use my e-mail as a sleeping aid and others just want the bottom line as their time is limited. The Fed will continue to increase short term interest rates and long term interest rates will continue to fall until short term rates are HIGHER than long term rates. If you own real estate and you receive an incredible offer from someone who just has to own you property…sell now, walk away…..there will be better opportunities in a few years…..

June 8, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 137 basis points from 5.59% to its current 4.22%

In just a few hours Fed Chairman Greenspan will testify before the Congressional Joint Economic Committee and if he repeats his remarks from Monday evenings (6-06) speech to a Chinese Banking Conference the world will hear that the Fed Wizard has no idea what has caused long term rates to fall while short term rates have risen. (He should be reading my interest rate e-mails….). http://www.federalreserve.gov/boarddocs/speeches/2005/20050606/default.htm . It is worth your time to read his ENTIRE speech at least a couple of times to really understand the confusion at the Fed: He admits that he has no good explanation for long term rates falling and admits that he was hoping that long term rates would rise with short term rates thus helping to slow down the price increases in residential real estate. The most important sentence is: ” Policymakers (Fed) need to to be able to rely more on the markets’ self-adjusting process and less on (Fed) officals’ uncertain forecasting capabilities.” The last three words are the ones that will shake the financial markets if repeated too often, the world wants to believe that the Fed has the answers to all of our economic problems but the Fed Chairman is telling all who will listen that the Emperor’s crystal ball is broken and he doesn’t know how to fix it……If the financial markets start to realize this all interest rates (short term and long term) will rise sharply as an added risk premium enters the markets. Remember markets like certainty even if the news is bad….it’s uncertainty that drives up volatility and prices down (interest rates up). This could turn out to be a big story that the markets are completely unprepared for as no one has focused on exactly who will be the next Fed Chairman and how difficult it will be to replace Mr. Greenspan. Do you remember how difficult it was for Denny Crum to replace John Wooden as the UCLA basketball coach??? Mr. Greenspan has big shoes that will need to be filled and even though his successor may be very qualified I am not sure the markets have discounted a honeymoon period……

Some thoughts on the soon to be real estate bubble that pops!!!! First the good news: There is a pile of $$$ on the sidelines that is just waiting for any pullback (5-10%) in prices to jump in with new purchases. So the first dip will NOT be the start of the big decline BUT after the new cash is sucked in and everyone is finally on board…..then the BIG massacre will occur and most likely it will be just like the really ugly bear markets that just slowly bleed investors to death (Japan from 1994-2004) with everyone hoping that things will turn around but they never do…..The worst part of the upcoming bear market for residential real estate is that unlike the stock, bond, commodities market there will be no short sellers to provide bids on the way down…..It’s going to be all sellers and since the $$$ on the sidelines will have bought the first dip there will be nobody left to buy…it will be all air on the way down…..but don’t worry it’s not going to happen tomorrow or even next month….it will take at least 2-3 years before the trap door is set and locked tight before the ship sinks…..this bloodbath will make the sinking of the titanic look like a rowboat sinking……Remember that in the eye of the hurricane everything is calm and everyone in real estate today is seeing the world from the inside out…..It’s all about messages that markets send to investors, speculators, etc….if you are a real estate buyer today the quick profits on high leverage are sending the message that your are ok..so you buy more and more with no worries until it’s too late….one of my favorite expressions is: never confuse a bull market with brains and today everyone is making money because of a roaring bull market and brain power is not even needed….i have studied bubbles that have occurred over the last 300 years and this bubble is the biggest, baddest one ever…..the ending is never pretty and this time won’t be different….my advice is that it’s time to take the chips off the table and live to play another day…..keep this e-mail in a safe place for a couple of years and then reread it….you will thank me ……

I will comment tomorrow on Mr. Greenspan’s testimony and have some specific interest rate forecasts for the remainder of 2005. (Hint: long term rates lower, short term rates higher and the dollar continues to be my #1 best bet for 2005). If you want a good exercise go back and read some of my e-mails from 3, 6, 9 and 12 months ago……..The Fed may be confused but I have made it clear that the normal interest rate cycle is upside down and that when the Fed tightens it has the opposite effect on long term rates so when the Fed eases in 2006 long term rates will rise instead of falling…..

June 2, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 135 basis points from 5.59% to its current 4.24%.

The BIG question of the day seems to be about when the Fed will stop raising short term interest rates. June 30th is sure to be the 9th consecutive increase with the Fed Funds rate going to 3.25%. By now all of you should realize that the Fed’s tightening mode over the past year has not only NOT increased long term rates but actually helped them decline to new lows. (see above). So the best way to make sure that long term rates continue to decline is for the Fed to continue to raise short term rates.

Do I believe the Fed is finished??? Doubtful…….Unless they woke up yesterday and decided their inflation worries had gone away I fully expect Mr. Greenspan to continue his march toward retirement (01/06) by “sealing the deal” against inflation and raising the Fed Funds rate until it is higher than long term rates thus creating an inverted yield curve (short rates higher than long rates). Mr. Greenspan has one solid goal in mind before retirement and that is to “pop” the housing bubble before he leaves so that the next Fed Chairman is not left in the same position he was in 1987 when he replaced Paul Volcker. The good news is that it has become obvious to Mr. Greenspan that long term rates don’t always follow short term rates and that if he continues too much further he could do major harm to the US economy. But this does NOT mean he will “ease” and lower short term rates in his remaining 8 months in office. So we are still headed for a inverted yield curve and it could stay that way for many months (2006). England, New Zealand and many other countries have inverted yield curves and show no signs of major economic weakness.

So what is the answer to the really, really, really BIG question??? Most of you have followed my advice over the past many years and have one month Libor (fully adjustable) loans on your homes and want to know when will be the best time to convert to 30 year fixed rate loans. The answer is……………..The interest rate cycle is upside down……a year ago I wrote that Mr. Greenspan’s increase in the Fed Funds rate would have the opposite effect on long term interest rates driving them lower NOT higher as the Fed tried to prevent an increase in a low inflation rate. When the Fed finally begins lowering the Funds rate in 2006 and everyone is jumping on board the train to lower long term rates the trap door will be shut…..The low in long term rates and the time to lock your 30 year fixed rate loans will be the EXACT day the Fed eases (lowers short term rates) in 2006. That will be a celebration day for everyone who out smarted the Fed and stayed in fully adjustable one month LIBOR loans and then just when everyone figures out what happened they switch to fixed rate loans. Remember adjustable loans are not the 3yr.& 5yr. fixed rate loans that are sold heavily by mortgage brokers because of their big rebates they are the truly fully adjustable loans (not pay option arms, etc.). The good news about this reverse interest rate cycle is that there will be a MAJOR shake out in the mortgage business where only the strong, honest and client first people will survive…….Until then, sit back and watch because the next 8 months will be anything but a smooth ride for many who have leveraged themselves to the max…….

June 1, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 200 basis points from 1.00% to its current 3.00%. The US Treasury 30 yr. interest rate is DOWN 135 basis points from 5.59% to its current 4.24%.

Trees do grow to the sky, right??? Interest rates can go to zero, right??? Less than 4 weeks ago on Friday May 6th the monthly jobs number was announced to be higher than any expert had predicted and immediately thoughts of more Fed tightening entered the interest rate markets. The US Treasury 10 yr. yield was 4.26% and the 30 yr. was 4.63% with no upside target in sight, fear ruled the market. Amazingly in less than a month the 10 year interest rate has dropped 37 basis points to 3.89% and the 30 year has fallen 41 basis points to 4.24%. If this trend continues for just another few months we will hit 0.00% and then the only question will be: “Can interest rates go negative??” When you have been studying interest rates on a daily basis for over 40 years (1965) there are no surprises and you learn quickly that trees don’t grow to the sky.

Of course I am happy that long term rates are lower as I have written for the last year despite everyone in the world telling me that long term rates always follow the Fed…..But last week Mr. Greenspan spoke of “froth” in the real estate market and now I am starting to see the same “froth” in the interest rate market. Has anything changed??? Not really, the dollar is strong (my continued prediction for the big winner in 2005) and this is causing massive amounts of money to pour into US Treasuries as dollar shorts are covered and new longs created (they have to invest in something safe) and I wonder how much pain Mr. Gates and Mr. Buffett can stand in their losing dollar positions. Just because you make money in your business doesn’t mean you will have the same result when speculating in foreign currencies. One of my favorite expressions continues to be: “Never confuse a bull market with brains” It appears that even Mr. Buffett and Mr. Gates are learning this powerful lesson.

Back to the froth: This morning on CNBC Dallas Fed President Fisher stated that we are in the 8th inning of Fed rate hikes and that then 9th inning would occur on June 30th (next Fed meeting). This caused short term rates (2yrs., 5yrs.) to fall even faster than 10 yr. and 30 yr,.rates. Did Mr. Greenspan tell Mr. Fisher to say this??? Is Mr. Fisher going to be taken to the wood shed (Ronald Reagan) and told never to say something like this without prior Fed approval?? Does Mr. Fisher have the Friday jobs number and know something we don’t??? (Only Mr. Greenspan and Pres. Bush are given the number 48 hours ahead) We won’t have to wait long for Mr. Greenspan’s reaction to plummeting long term rates as he will be testifying before Congress on the US economics outlook on Thursday June 9th at 7am (CNBC will have Super Bowl type ratings that morning). I wonder if he will still be as confused as he was a couple of months ago when he said interest rate declines were a “conundrum”. Remember the jobs report is just two days away and I have a strong dislike for a bond market that rallies like a runaway locomotive into a dark tunnel (jobs number)…..

The BIG question is: When do I lock in a 30 year mortgage??? When will be the low in long term interest rates?? Tune in tomorrow as I will reveal the answer to the BIG question……