July 28, 2005

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 119 basis points from 5.59% to its current 4.40%

It’s amazing what can happen in a week….a week ago today the Chinese government raised the value of the yuan (currency) by 2.1% sending shock waves through the US treasury market. 30 yr. interest rates rose 11 basis points in just one day (4.39% to 4.50%) and experts predicted that this was just the start of massive liquidation of US government bonds by the Chinese who have over $700 Billion of foreign currency reserves. One week ago (7/21) I wrote: “Unfortunately for market players a hard lesson is often learned that the first reaction to an event is usually the wrong reaction” and amazingly the bond market has NOT seen any more selling since that day and it is very doubtful that the Chinese would be selling their US securities for no other reason than “where else could they invest $750 Billion” The US dollar remains one of the strongest currencies in 2005 and our economy’s growth is stronger than everyone else other than China. Next time you read about a major economic event save the next day’s newspaper and compare what was predicted with what actually happened one, three and six months later……you might be surprised to see that these experts over reacted and the actual result was NOT what they expected….

Last week I gave my readers the “key” to the front gate at the Federal Reserve with my perspective that the yield curve (short rates compared to long rates) was the most important ingredient in Mr. Greenspan’s next monetary serving. Tonight the 2yr. is at 3.95%, the 5 yr. at 4.03% and the 10 yr. at 4.19% so we are getting closer and closer to a flat yield curve and then the inversion (short rates higher than long rates) that I feel will end the current Fed tightening and set the stage for the next Fed easing in 2006. It is at this point that long term rates will reach a MAJOR bottom and all homeowners will be urged to lock in 30 yr.fixed rate mortgages. We still have many more months to go before this episode of monetary history is written and a new Fed chairman is selected by President Bush in January 2006.

Every economic cycle brings its memorable stories and this morning’s Wall Street Journal has a keeper for at least the next 10 years. The article is titled “What Housing Bubble?” and it details one writers opinion of why this housing price advance will never stop….insatiable demand, limited space, etc. this article is definitely going on my bulletin board…

On Thursday August 4th the Bank of England will meet and decide the course of short term interest rates and may actually cut their overnight lending rate by 25 basis points (currently 4.75%). House prices have flattened in the UK, home repossessions are at a high not seen since 1991 and retail sales are slumping so this central bank may decide to stimulate demand thru lower short term rates. The BOE was one of the first banks to begin raising short term rates and England has had a flat yield curve for almost two years. Yes, Mr. Greenspan pays close attention to events across the pond…..

Back in the US I find it interesting that the American Trucking Association reports that freight shipments are down in 4 of the past 5 months at an annual rate of 8%. Higher fuel costs do affect the demand for transportation and I wonder if rail shipments will increase over the next few months. Autotrader.com has thousands more SUV’s listed for sale than it did in 7/04. Yes rising oil prices are slowly changing the way consumers spend their hard earned dollars.

In a survey taken last week of money managers that control $1.371 billion in assets it showed 82% do NOT expect the yield curve to invert this year so it appears that the BIG money that has missed the down leg in long term interest rates will also miss the move to higher short term rates.

For those that follow gold I was noticing that since 1976 the price of gold has had its strongest moves upward between mid-August and mid October. If this repeats the dollar may take a breather from it’s one way upward journey this year against the Euro and yen.

The Fed released it’s July edition of the Beige book which detail economic conditions on a regional basis. No surprises but it is interesting to note that commercial construction is increasing in many areas with builders noting that demand is almost exclusively coming from investors NOT tenants. I have written many times before that when all of the building permits are converted to structures there is going to be a glut of space unless new businesses are formed and we see a massive migration of people into this country who are wealthy enough to afford these high prices. And why has the price of lumber fallen over 20% in the last 4 months??? Do builders know something we don’t??? How about that construction demand is about to fall off a cliff???

Mr. Greenspan has spoken often about the recent rise in the price of oil noting that futures contracts for delivery in 2010 are now trading for higher prices than current delivery contracts. (contango) He has used this information to project that oil prices will stay high for many years to come BUT does he not remember that in 1999 when the spot price of oil was $20 that the price of a futures contract for delivery in August 2005 was selling for $18???? Sometimes futures markets are NOT good predictors of the future but only guesses by traders who can change their opinions/positions based on very little new information.

Finally a note to the hundreds of mortgage brokers/RE agents that read this e-mail on a regular basis. I did a little research this week when it was really quiet (midnight-4am when it was too hot to sleep) and uncovered a few nuggets from the interest rate archives. The decline in long term interest rates began its latest move on May 8, 2000 with the 10 year at 6.57%. Since then we have travelled a bumpy path downward to a low of 3.13% on June 13, 2003. This move qualifies as a true “bull” market in bonds and dissecting the move helps bring perspective to the current level of rates and where we might go from here….There have been 13 distinct moves down in rates (38 basis points or more) with the average change of 87 basis points and the average move lasting 105 days. The mean is 75 BP and 84 days. Bull markets move great distances and more slowly with counter moves (rates up) happening quickly and travelling a shorter distance. Since 5-08-00 there have been 14 moves upward in rates of 38 basis points or more and these have averaged only 70 basis points and IMPORTANTLY lasted only 41 days. The mean is 60 BP and 38 days. I only used calendar days. For those of you trying to time your moves in and out of the mortgage market to refinance or lock purchase loans using the calendar is an important part of the puzzle that seems to confuse many in the mortgage arena. Where are we now??? Today is day 56 in an upswing that began 6-02-05 with the 10 yr. at 3.89%. Knowing that the average number of days in an up cycle is 41 and the mean is 38 and the there have been only three out of the 14 instances that were greater than 56 days I would be watching closely for a new leg DOWN in long term rates that should last for 6-8 weeks.

July 21, 2008

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 109 basis points from 5.59% to its current 4.50%

The sleepy summer of economic events was jolted out of bed this morning at 4am by the news from the Peoples Bank of China that the yuan was revalued up by 2% against the US dollar. The new level of 8.11 will be allowed to adjust up to +/- 0.3 percent per day. I wrote just a few weeks ago that contrary to market opinion it was a certainty that the Chinese government would revalue its currency and now that they have taken the first step I believe the move to a market based currency market is but a few years away. The impact of this move was felt quickly and strongly in the US Treasury market as sellers overwhelmed buyers and drove long term interest rates higher on fears that the Chinese would soon begin liquidating their massive ($250 Billion) US Treasury portfolio. Unfortunately for market players a hard lesson is often learned that the first reaction to an event is usually the wrong reaction and although I see long rates going higher for the next few weeks this does NOT change my position that US long rates are a function of inflationary expectations which continue to remain low. (under 2%). Just a few short weeks ago the US Treasury announced that they would soon begin reissuance of the 30 yr. Bond which drove long rates higher for a few days/weeks but then market forces took over and these rates began another drop based on economic fundamentals (which have not changed). It’s so easy to get caught up in the euphoria/panic of the moment when news is released but when you have been around as long as I have (35+years) you gain a perspective that only old age can bring to the table……Many of the raw commodity markets (copper, aluminum, etc.) may see increased demand from China as these are priced in dollars and their yuan price is now 2% lower than yesterday. The actual announcement of the exchange rate change can be found at the People’s Bank of China website: http://www.pbc.gov.cn/english

Back to the good old USA and our favorite speaker was in front of the House yesterday and the Senate today talking about our favorite topic…..interest rates. Some people can’t wait to turn on the TV on a Sunday and watch NFL football, others like to watch golf and now poker has become a “hot” sport. To me the World Series is watching a Fed Chairman speak to Congress and most importantly answer questions in a way as to send messages about future Fed activity without being overly obvious to the investing public. It’s sort of like a BIG puzzle and the best part is when you find the missing part that fits just perfectly…..Over the past two weeks Mr. Greenspan has spoken about the yield curve (short rates vs long rates) and that he does not believe that by continuing to raise short term rates it will have an adverse effect on the US economy. Currently the spread between the 3 month Treasury bill (3.34%) and the 10 yr. Treasury note (4.27%) is 93 basis points. In a recent letter to Congressman Jim Saxton the Fed Chairman wrote that the yield curve narrowed sharply over the period 1992-1994 even as the economy was entering the longest sustained expansion of the postwar period. Mr. Greenspan knew his response to the Congressman would be publicized all over the world and analyzed word by word by word….So let’s dig deeper in an effort to determine what Mr. Greenspan’s plans are for the remainder of 2005 and his retirement in 2006. Back in 1995 Fed Chairman Greenspan asked some researchers at the Federal Reserve Bank of New York to research the yield curve and its predictive value of future economic activity. In January 1996 they published a paper based on data from 1960 until the Spring of 1995 and it showed the probability of recession was dependent upon the spread between the 3 month Treasury Bill and the 10 year Treasury Note. When the Fed Chairman spoke this week to Congress he referred many times to the yield curve and what he thought (no recession) it was saying and that research from the Fed was what he was relying on for his predictions and recent decisions. The next step in our search was to obtain a copy of this research paper and I just happened to have an old copy in my files. (I never throw away anything). The best news is that I was able to find a copy in the archives of the New York Federal Reserve website.http://www.newyorkfed.org/research/current_issues/ci2-7.html
I STRONGLY urge everyone to read and reread this article and then cut out the table from Page 2 that shows why Mr.Greenspan currently believes the risk of higher short term interest rates is low against the chance of a recession. With the current spread of 93 basis points using the Fed research the probability of a recession is less than 10%. Mr. Greenspan feels that he can raise short term rates at least 4 times more in 2005 which would put the Fed Funds rate at 4.25% and that would make the yield spread roughly zero versus the 10 yr. treasury Note. The chart then puts the recession probability at around 25% which would give the Fed reason to stop their tightening mode and by the amazing calendar there are just four more FOMC meetings in 2005. (8/09,9/20,11/01,12/13) This would be perfect synchronized timing for Mr. Greenspan’s retirement in 1/06.

Bottom Line: Everyone wants to know when the Fed will stop raising short term interest rates and when…having the answer to that question is like having the key to the vault….But even more important is knowing how the Chairman’s thought process evolves and what is he focused on….If you just watch the 3 month Treasury Bill rate and the 10 yr. Treasury note rate and compare the two to the table in the above mentioned research paper you will be sitting in a chair next to the Fed Chairman for the next six months and knowing what will happen to future Fed policy before 99.9% of the interest rate watchers of the world…

Tomorrow I will address the other side of the equation…long rates and how their movements over the next 6 months will affect Fed policy decisions.

July 18, 2005

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 112 basis points from 5.59% to its current 4.47%.

Dear Mr. Greenspan…..Many of us have wondered what it would be like to have a conversation with the Fed Chairman but unfortunately few of us ever get that opportunity, unless you are a US congressman. For Jim Saxton, Congressman from New Jersey’s 3rd district and Chairman of the Joint Economic Committee it became reality this week. This afternoon Mr. Saxton’s office released the transcript of Mr. Greenspan’s answers to the congressman’s questions and I urge you to read carefully and thoroughly: http://www.house.gov/jec/hearings/testimony/109/ag06-09-05questions.pdf . For those that want the highlights….1) Mr. Greenspan feels that the recent rise in the price of oil to just under $60 will only reduce GDP growth by 3/4 of 1%, 2) there is no national “housing bubble”, 3) he does NOT believe that the Fed can control the rate of advance of house prices by raising short term interest rates. Although long term US interest rates rose sharply today on this news one must remember that the Fed has a very poor (under 25%) success rate in predicting the future course of the US economy. BUT I do believe that Mr. Greenspan would be happy if long term rates continued their recent advance because of his feeling that low long term rates are a direct stimulant to the real estate sector. The final determinant of long term rates are expectations of future inflation and that is an area that shows no growth with inflation (CPI, PPI, PCE) staying at the 2.0% level for the remainder of 2005 and 2006. Mr. Greenspan will testify before Mr. Saxton’s committee on Wednesday at 7am and I expect the same message from the Fed Chairman…..the economy is strong, inflation is low and the Fed will continue to raise the Fed Funds rate until it receives economic information that shows something has changed….Bottom Line: Nothing has changed from my year long forecast of higher short term rates and an inverted yield curve (short rates higher than long rates) until 2006 when the Fed Chairman retires.

Staying with real estate (isn’t everyone tired of reading about the real estate bubble???) housing prices in England are softening and according to http://www.fightmove.co.uk house inflation has finally registered a decline (-1.0% in June) and that is the lowest level in 10 years. (But I thought house prices never decline…maybe it only happens in the UK)

In Lynwood, Washington (Yes I read the Seattle TImes every day) a land auction yesterday found 2,000 anxious buyers willing to part with their hard earned money for a chance to buy one of 220 parcels that totaled 2,000 acres in 12 states. The auction proceeds of $2Million is substantially more than this land (raw, raw, raw) will bring in resale transactions that speculative buyers hope and pray for over the next 5-10 years. But I am sure that the man who bought 640 acres of Nevada desert for $75,000 believes he got the purchase of a lifetime. For the full and somewhat sad story:http://archives.seattletimes.nwsource.com/cgi-bin/texis.cgi/web/vortex/display?slug=landauction18m&date=20050718&query=brian+alexander

There are literally dozens of these stories I read daily and it is actually a difficult decision as to what to share with my readers….Final RE story for the evening comes from today’s Newsweek about rental homes in Idaho which is not that unusual. What I found disturbing was a line about half way down the article where it was disclosed that two gentleman who run real estate seminars in Southern California are pointing students towards purchases where they are receiving 50% of the commissions on these sales from the local RE agents. It’s risky enough buying rental properties in Pocatello but not having FULL disclosure from the seminar teachers is a sign that the hurricane is coming and the loss of savings is soon to follow….http://www.msnbc.msn.com/id/8598955/site/newsweek/

FINAL,FINAL real estate note: Did you know that in Miami (bubble king) that 11,000 residential units are under construction, 23,000 more have been approved, and 27,000 are still in the planning stages. In the last 10 years a total of 7,343 units were built….I sure hope that everyone is planning on moving to Miami soon or else these builders/developers/speculators are going to be wondering how to find the exit door….Last week in Manhattan (43rd st.) a 180 square foot apartment (12×15) sold for $242,000…..that is over $1300 per sq. ft.

It’s late and I must leave for my real estate writers anonymous class (REWA) as I am trying to get to the place where I can write a interest rate column that does NOT mention RE….keep your fingers crossed….the next column could be the one…

July 12, 2005

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 121 basis points from 5.59% to its current 4.38%.

It’s truly summer as the markets become quiet for hours instead of minutes and news that would normally move prices/interest rates only draws a yawn or two from traders. There will be a few MAJOR events over the next 8 weeks (Greenpan speaks to Congress, FOMC meeting on 8/09, jobs report on 8/05) but for the most part many of the markets will be in a wide trading range until after Labor Day. (9/05).

This afternoon we begin in China where interest rates on long term (10 yrs.) government debt has fallen almost 1.5% in the past two months. This is extraordinary as the yield has fallen to 3.75% from 5.25%. This has been accompanied by a Chinese stock market that continues to set new lows (down 20% this year) and an economy that does NOT seem to growing as fast as many experts have predicted for 2005. Last night the Chinese government announced that they were increasing the ceiling on foreign investment in stocks and corporate bonds to $10 Billion from $4 Billion. This should give an immediate lift to many stocks and will be an excellent psychological boost to many domestic corporations.

Crude oil continues to hang around the $60 level as fears of a cutback in inventories (next report at 7:30am tomorrow) and more Gulf hurricanes has put a “buy on pullback” mentality into the market. Former President Clinton said on CNBC this morning that he sees oil “never” going below $45-$50 again….We’ll see…I’ve never known Presidents or even ex-Presidents to be good financial forecasters…

Amazingly the US government’s budget deficit is narrowing….Tomorrow morning the Office of Management and Budget (OMB) will announce that previously predicted deficits of $400 Billion or more are now being revised substantially lower to just over $300 Billion. Strong economic growth and higher real estate prices have created an increase in tax collections and many states are seeing their deficits decrease to low levels. When (not if) the real estate market softens the effects will be felt in many more ways than just by land/house owners.

The trade deficit will be announced tomorrow morning at 5:30am and a few months ago this would have produced headlines about a record of…….But now no one seems to care because the dollar has rebounded sharply and the focus is on oil, real estate and terrorism.

Last month I wrote about a new website called http://www.condoflip.com and now they have competition from http://www.uscondex.com. I wonder if condo flipping will soon be a reality event for television. Could we soon be watching the “World Series of Condo Flipping” on ESPN? Staying with real estate for those of you that believe that the real estate market is far from a bubble you will be happy to read a column from Kathleen Pender in Sunday’s San Francisco Chronicle: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/07/10/BUG8JDLA661.DTL&hw=kathleen+pender&sn=001&sc=1000

I haven’t written about India in many months but I am very curious about a dramatic increase in gold consumption (+63% in 2004) that has occurred over the past two years. India accounts for almost 18% of the world’s consumption and hoarding of gold has been way of life for hundreds of years. It also is used as a hedge against the depreciation of its currency (rupee) but the currency has been rising not falling and inflation is low…….If this continues I wonder about its effect on the Indian economy as a more productive (GDP) use would be for these funds to be invested into badly needed infrastructure so the Indian economy can continue its recent growth spurt. But obviously the average Indian household is worried about the future………

July 8, 2005

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 125 basis points from 5.59% to its current 4.34%.

The last 48 hours have been eventful for world markets and some of the messages sent by investors/traders may not be obvious to the casual observer. Thursday mornings (1am) tragedy received most of the headlines and for good reason. World markets initial reaction was to sell stocks, buy bonds, sell oil, buy the dollar. One of the keys to market watching is to always remember that the markets never react the same way to a repeat event. We all know that 9/11 caused a massive sell off in world equity markets that lasted for weeks and that interest rates plunged on a “flight to quality”. Then on 3/11/04 the bombing of a train in Madrid that killed 191 people caused a three day sell off in world equity markets. The world markets are no longer surprised by the terrorist strikes and as a result markets are quick to rebound as soon as the facts show that it is NOT a repeat of 9/11. The bad news for US long term interest rates is that the London bombing caused buying of US Treasury securities which drove rates lower for a few hours and then today’s jobs report showing only +146,000 (it was expected to be +200,000) caused another round of buying in Treasury bonds as many assumed this would cause the Fed to stop raising short term interest rates. Unfortunately for these buyers….BIG sellers were waiting on the sidelines ready to pounce on any bids and the long end of the bond market closed on its lows (on heavy volume) for the 2nd consecutive day. For many of you this is only noise and has no real bearing on your mortgage, real estate holdings, stock portfolio, etc. as I continue to believe that the Fed will increase short term rates until they are ABOVE long term rates and there is NO chance of a Fed easing until Mr. Greenspan retires. (01/06). But for those of you more short term oriented the next few weeks may be painful as long rates seem destined to rise………..

Today’s H8 report issued by the Fed may and I emphasize may be showing signs of reduced loan demand from commercial banks. It’s way too early to tell anything but consumer credit debt fell $3Billion last month and this is the largest drop since December/2004. Real estate loans dropped $6.5 Billion last week and the HELOC (credit lines) category continues to show a small amount of growth. It will be many weeks before we know if this is just a one week adjustment or the start of a trend but it is worth watching closely because the Fed is increasing the Fed Funds rate which has a direct impact on the Prime Rate which is used for most Heloc’s.

Kansas City Fed President Tom Hoening gave a speech this morning in which he said he sees a strong US economy, little inflation and no signs of a housing bubble….Luckily he is not a member of the FOMC and his opinions carry almost no weight with Fed Chairman Greenspan.

Important Dates: July 20 – 7:00am – Mr. Greenspan gives his semi-annual monetary report to Congress
August 9 -11:15am – next FOMC meeting and a 25 basis point increase in the Fed Funds rate is expected.

There will be many other economic indicators released over the next few weeks (CPI,PPI, Retail sales, etc.) but I am not sure the interest rate market is really focused on the economy. The center of attention is on the Fed and when they will feel they are at the end of their tightening cycle. This will cause more volatility than usual with the 10 yr. Treasury rising to 4.50% with a few drops of 5-10 basis points in between a generally rising interest rate trend over the remainder of the summer. I have NOT changed my opinion that the LOW in long term rates will occur in 2006 when the Fed begins a new easing cycle.

Finally, Freddie Mac announced that beginning in September it plans to disclose more information about its adjustable-rate mortgage securities to raise investor understanding of its products.

July 6, 2005

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 4.33%.

Most articles and stories I read have at most one or two sentences that I find of value…maybe someone has an opinion that has an interesting angle or basis that I had not seen before…..Last night I read something that is a “keeper” with many parts that are worth reviewing more than once….The title is: “Are Easy Liquidity and Razor-Thin Returns Driving Real Estate to Dangerous Highs?” and it comes from a recently held conference at the Wharton School of Business in Pennsylvania. The speakers were all heavyweights and there were many solid points but I found the best story about a man in jail that was seeking a loan for a commercial property. My guess is that he was going “stated income”, “stated assets” and “stated identity” since he is in jail. http://knowledge.wharton.upenn.edu/index.cfm?fa=viewArticle&id=1237

Oil rose to $61.28 today and this caused a sell off in the stock market of over 100 points in the Dow. Some days the stock market believes that rising oil prices are a sign of a strong economy and some days the stock market sees oil as only a sign of inflation which is bad for the economy. Eventually if oil continues to rise (most likely) the effect on consumer spending will be equivalent to an increase in tax rates.

Ford and Chrysler have announced that they will follow GM and allow the public to buy autos at employee discount prices. Yes this will increase auto sales for 2005 but at the expense of 2006 sales and the most important part is that this is DEFLATIONARY (lower sticker prices)!!! Auto price declines will help lower overall inflation numbers in the US and help keep long term interest rates DOWN!!!

We have the BIG jobs number on Friday morning at 5:30am and the consensus from the “experts” is for a gain of 200,000. These experts have been wrong for so long that they are actually due to be right this month but the last 6 years of June data has seen the number UNDER the consensus figure each time………

There was an interesting item in the Boston Herald earlier this week about the plight of apartment owners in the Boston area. It seems that property values have risen substantially (good) but rents have declined due to so many people moving from rentals to ownership of houses (bad) but the really bad news is that due to the increased property values taxes have risen so that the owners have less cash flow from their investment…..So what does everyone do when they have increased equity and less cash??? they borrow more against their property and that is one of the forces behind the increase in real estate loans in the US…..

Final thought: With Asia consuming 29% of oil production the yen has been hit hard (111-112) but with a stronger Japanese economy on the way the yen may soon be an undervalued asset to many portfolio managers…..and has anyone noticed that the price of live hogs (as opposed to dead hogs???) has RISEN 5% since I mentioned how cheap they were a couple of weeks ago???

July 5, 2008

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 4.36%.

Although for the US July 4th was a day of inactivity for the remainder of the world markets it was business as usual and that meant an increase in long term US rates. Three day US holiday’s are often accompanied by a change in direction for long term interest rates and this holiday weekend was no exception. (I am considering a special e-mail for mortgage & interest rate professionals only, it would be sent on an as needed basis, if you have interest let me know….)

One of the reason’s for the uptick in long rates is the news that GM saw June sales up by 47% which is the highest since 1986. Normally a pick up in auto sales signals a strong economy which frequently can translate into higher inflation, etc. At least that is the way the world used to work…but now higher GM auto sales are nothing more than than one auto dealer stealing sales from another auto dealer by lowering prices. The laws of economics still work and if a manufacturer lowers the prices of cars demand will increase but unfortunately from potential sales to other dealers. GM has a program that has now been extended to August where every consumer is able to purchase a vehicle at the same price as GM employees. That is great news for everyone except GM and its shareholders who will see higher summer sales and LOWER profits. The inflationary impact to the US economy is actually negative and will have a downward impact on CPI numbers released for July.

A couple of economist polls were released last week showing that 99.99% of experts (who is an expert??) believe that the US Treasury 10 yr. note will rise to 4.6% by December 31,2005. These are the same people who predicted six months ago that Treasury yields would be 4.8% today. The problem with economists is that are rarely held to the same employment standards as you and I…..if we don’t produce we get fired…if an economist doesn’t produce accurate predictions he/she is given another and another and another chance to succeed with eventual expectations that throwing darts brings better results.

There was a very interesting item in Saturday’s NY Times in a interview with PIMCO’s Bill Gross, known as the world’s bond market guru (sounds like more pressure than playing for the Yankees/Steinbrenner). The quote that I read more than once is: “One reason why interest rates are doing what they are doing has to be in part self-reinforcing behavior on the part of PIMCO. When PIMCO with $500 BILLION to invest turns from bearish to bullish, even if we move in a measured way, we probably move that market 10 basis points.” This is a very important part and I want all of my readers to think about this for more than just a minute. I have written for months about FNMA’s need to sell mortgages each month has helped widen the spread between mortgage and Treasury securities.but this was done in a declining rate environment where big sales don’t really affect the market or interest rates. BUT and it’s a big BUT when FNMA or PIMCO or anyone else that big attempts to liquidate a losing position and going against the trend then watchout below….if Mr. Gross feels that PIMCO affects the market by 10 basis points when they are entering a new position where they have all the time they need can you imagine how many basis points (50???) they affect the market when they are getting out of a bad position…. This is so important because it’s been a one way street for the bond/interest rate market over the past 14 months where every decline in bond prices/increase in long rates has been met with BIG, strong, deep pocketed buyers. BOTTOM LINE: When not IF PIMCO or FNMA needs to liquidate mortgage and or bond positions the result may not be pretty……in fact sometime in the next 12-18 months it’s almost a sure bet that a blood bath will hit the long end of the bond/mortgage market and although it won’t last long the losses will be in the BILLIONS…..

Let’s jump across the Pacific and we find that Japan is doing rather well after suffering through 10+ years of deflation, falling real estate prices (yes they have fallen 40%++) and weak consumer demand. One of the best ways to measure a country’s economic health is by watching tax collections and Japan is about to announce a second consecutive year of higher household incomes and corporate earnings. Tax collections are an excellent indicator because I have rarely found countries where individuals/corporations over reported their income so they could pay more taxes. This recent spurt of Asian activity should allow the Bank of Japan to finally raise short term interest rates to 0.25% from the current 0.00% (that’s correct). An interesting footnote to the Japanese economy: In 1989 the Japanese government collected taxes of 60 BILLION yen and spent 65 BILLION yen…in 2005 the Japanese will collect 45 BILLION yen and spend 82 BILLION….next time someone talks about a budget deficit in the US let them know about the bigger budget deficit in Japan.

Staying in Asia, it’s amazing what I find reading the Chinese daily newspapers….Very quietly last week the Chinese government announced that they will begin to fill their Strategic Petroleum Reserve that is located in Ningbo and has a capacity of 33 million barrels. It’s no surprise that the price of oil has risen to $59.60 in New York trading and isprobably headed higher……

The Fed, The Fed, The Fed….everyone is talking about the Fed and on July 20th at 7am Mr. Greenspan will address Congress with his semi-annual monetary policy testimony. I can’t emphasize enough that the Fed’s crystal ball is just as cloudy as every economist and that year after year I have witnessed the Fed turning on a dime and reversing course in monetary policy and interest rates. Yes I do believe the Fed will continue to raise short term rates and with long rates not rising this will create an inverted yield curve that will make it very difficult for the real estate industry (43% of the increase in US jobs comes from real estate) and the overall economy. But the good news that comes with the bad news is that Mr. Greenspan is well aware of the growing giant (RE) and understands that if he moves too quickly or too much the bubble won’t just deflate but burst and have a devastating effect on the US economy. The biggest problem the Fed faces today is how to stop the inflow of NEW speculative $$$ into the housing market as more and more money climbs aboard the runaway freight train. I continue to expect a brief pullback in prices before the ultimate ride to the top of the mountain where unfortunately most will be stranded and not rescued…….

BTW: With the yield curve coming so close to inversion the HELOC 2nds that so many lenders are pushing to their reps are about to become extremely expensive (Prime at 6.25%) and many borrowers may find that fixed rate loans are cheaper and less risky than variable rate credit lines. Many lenders will soon be caught with variable rate liabilities and fixed rate assets that create a negative spread for potential profitability……..The winds are blowing change in the economic weather forecast and this winter more than a few lenders may be left to freeze in the cold…..