January 30, 2006

After 6749 days (8-11-1987 until 2-01-2006) Fed Chairman Greenspan (he will be 80 years old in March) has just 24 hours remaining before he goes back to where it all started….head of an economic consulting firm. His new firm, Greenspan Associates will be different from his last in more than name (Townsend-Greenspan & Co.) I’m not sure what his consulting rates were in the late 70’s and early 80’s but I am sure they were NOT the $500,000 per hour (yes per hour) that he will reportedly be charging clients after he leaves the Fed. As most of my readers are aware I have followed the Federal Reserve, interest rates and world economics for over 40 years but memories of Fed Chairman are special because there have been so few that have risen to the 2nd most powerful position in the world. (US president is #1). Much has been written over the past few months about what is expected from new Fed Chairman Ben Bernanke (Senate confirmation Tuesday) and what Mr. Greenspan has accomplished so I will try and give you just a few of my personal highlights.

The most important point is that when Mr. Greenspan took office in August 1987 (due to Paul Volcker’s retirement) it was very similar to today’s situation in that Mr. Volcker was a legend that no one believed could ever be replaced at the top of the Fed. Mr. Volcker had spent many years conquering the inflation giant that had begun in the late 1970’s. When Mr. Greenspan took office the 30 yr. mortgage rate was 10.25%, oil was trading for $21 a barrel the US economy had seen almost 5 years of low inflation and steady economic growth. Unfortunately the US dollar went into a dive shortly after Mr. Greenspan took office and in one of his few poor moves the Fed raised short term interest rates in an effort to support the dollar but instead caused a “flight of confidence” and the stock market crash in October 1987. But he recovered quickly by lowering short term rates and went on to govern over 18+ years with only short recessions in 1990/91 and 2001 that lasted a total of 16 months. And for stock market players the Dow rose from 2,680 (8-11-1987) to just under 11,000 today. He also showed his leadership under pressure after the 9-11 tragedy keeping money flowing until the US economy could get back on its feet. Finally he was a master of history as he knew that the average Fed tightening lasted 19 months and on 6-30-04 he began the first of 14 Fed Funds increases from 1.00% that should end at 11:17am Tuesday with a FINAL increase to 4.50%. These increases were even more incredible when one considers that long term interest rates have FALLEN since 6-30-04 showing how inflationary expectations remain subdued at a time when many expected them to rise due to budget deficits, weak dollar and rising commodity prices. When Paul Volcker retired the press hailed him as the greatest Fed Chairman ever and I am sure that historians will place Mr. Greenspan as the “greatest ever”, it is fitting that the Super Bowl is Sunday as two champions will be crowned in the same week. Mr. Greenspan never let public opinion sway his decisions even when his was a lonely voice of dissent many times at the Fed…..For those that believe he made too many mistakes I offer just one question: Can you think of one person who would have done a better job of managing the US economy through a very difficult terrain over the past 18+ years??? The legend of Alan Greenspan will live for decades to come and historians will give him the highest of marks for a career of public service that we may not see for many a year to come……..

And now we head back to the daily reality show called the US economy with its ever changing weather forecasts of sunny today (business conditions) but cloudy tomorrow (housing). Tuesday the FOMC (with Greenspan) will raise the Fed Funds rate 25 basis points to 4.50%. This move will be accompanied by a short statement by the Fed at 11:17am that will enable Mr. Greenspan to pass the baton to Mr. Bernanke at a place where upcoming economic conditions will likely determine future Fed rate moves……just where Mr. Greenspan believed he would leave the Fed… with the Fed Funds rate at 4.50%. This probably represents “neutral” to the Fed and with the next meeting not until March 28th it gives the new Fed Chairman 55 days to study the US economy, inflationary expectations, housing, etc. and determine the proper rate for the Funds rate. Everyone is guessing what will be his first move (not changing the rate is considered a move) but we must remember that this is a job that really has no manual or training period. It’s jumping into the deep end of a dark body of water and learning how to survive and prosper and Mr. Bernanke’s initiation will be no different….although he was a Fed Governor and attended many FOMC meetings until you are the “man” you really don’t know what it feels like……

I’m sure many are beginning to worry that the price of oil is going to rise over $70 a barrel and that we are soon going to run out of this precious commodity….But as I have written so often, when the price of a commodity rises and rises and rises supply mysteriously shows up just at the right time to save the day. (just like Superman)…..There was an excellent article last week in CNN/Money.com entitled “How to Beat the High Cost of Gasoline. Forever!” Ethanol is a fuel we are going to being reading about more and more in 2006. Whether it be from corn (it could be starting my long awaited bull market) or sugar (it should be starting to decline) or other agricultural waste this is the fuel of the future. More than a few investors are going to make big $$$ from this fuel source and it may be one of the reasons that the price of oil does NOT reach $100++ over the next few years. We’ll see….http://www.cnnmoney.com

This is a HUGE week for news….Tuesday evening is the President’s State of the Union speech, Wednesday the US treasury announces almost $50 Billion of auctions including a 30 year bond ($13 Billion??) and on Friday is the jobs report with expectations of a 300M increase that if true would send long term interest rates soaring……the good news for real estate professionals is that the “experts” have been wrong for so long that many don’t even make predictions about the jobs report anymore…..

Did you read that Sen John McCain cut the asking price of his house (nine bedrooms, eight baths) in Phoenix to just $3.75 million but still has no bids in a softening housing market. It seems the high end of the market has more offers than bids and that should not change until the Fed ends its tightening mode…http://www.azcentral/news/articles/0127biz-talker28.html

Although last Friday’s GDP report showed a dramatic slowing (1.1%) it is almost a certainty that this number will be revised upward in the coming weeks. Somehow federal government spending on national defense FELL 13% which must be a fluke or a timing problem because this number has to be increasing so let’s just say that the 1st quarter GDP will stage a quick rebound to something over 3%. The good news is that inflation as measured by the PCE deflator (Greenspan’s favorite indicator) continues to grow at a very tame 2.2%. I will reveal Mr. Bernanke’s favorite inflation indicator in a few weeks…

Did you know that the interest rate on the 30 yr. British government bond is 3.89%??? It could easily happen in the US and certainly will if the Fed tightens further than the 4.5% we will arrive at on Tuesday……

It was probably a fluke but real estate loans outstanding FELL $10.6 Billion last week according to the Fed’s weekly H.8 report that is released every Friday at 1:15pm. With the HELOC category not showing any growth for the last 7 months if (and it’s a BIG if) this sector slows down it would be 2 out of 3 for the Fed with only the commercial and industrial loan category needing to slow down for the Fed to consider a lowering of the Fed Funds rate. It normally takes 6 months for the Fed to switch gears from tightening to easing so I have gone way out on a limb (there are only a few left on my tree as I have fallen off most of them) and predicted a Fed easing on August 8th and that day will also see the exact low in long term rates for 2006. The Fed cannot even think about easing until speculation in the residential housing market cools as the fact that 43% of first time home buyers last year put ZERO down keeps many Fed Governors up at night worried about a _ _ _ _ _ (rhymes with bash)

Finally I have to go back to something I wrote about two weeks ago….the good news is that it only really relates to real estate professionals. The bad news is that 39 out of the last 40 years long term interest rates have RISEN an average of 100 basis points in the first half of each year. The average start date has been 2-03 and the average end date has been 4-22 with the only year not seeing a rise of at least 34 basis points being 1995. If history repeats it could be a rocky spring for mortgage borrowers but the good news is that I still see much lower long term rates in the fall but remember my Greenspan crystal ball is being retired and my brand new 2006 Bernanke crystal ball is not guaranteed to be as prescient…

Wednesday brings a new chapter in Fed history..it’s been a great ride with Mr. Greenspan at the helm with world financial markets becoming very accustomed to smooth rides…It will take more than a couple of months before we know how the Bernanke train navigates the world economy….

January 17, 2006

Good morning!

The clock is ticking on the remaining days in Fed Chairman Greenspan’s term in office. We have exactly 15 days before the new Fed Chairman Ben Bernanke takes office (Senate confirmation vote is scheduled for 1-31) and ends the current Fed tightening cycle.

Since June 30, 2004 the Fed Funds Rate (short term) is UP 325 basis points from 1.00% to its current 4.25%. The US Treasury 30 yr. interest rate is DOWN 105 basis points from 5.59% to its current 4.54%.

In just two weeks the long reign of Fed Chairman Greenspan (1987-2006) will conclude and with it a remarkable period of financial history that began with Fed policy cloaked in secrecy and ending with transparency that has taken much of the volatility out of financial markets. As many of you know I read at least 15 daily newspapers, monitor 5 different financial new services, watch Bloomberg and CNBC TV (sometimes at the same time) and watch most world financial markets for 18 hours a day (6am-midnight) and am constantly amazed at how the markets are able to digest so much news each day and just yawn and act like it’s no big deal…..since the Fed began increasing the Fed Funds rate on 6-30-03 the long term US bond market has not only risen (interest rates down) but done so without the gyrations that we so often saw in the late 70’s and early 80’s. As an example just look at the last 2.5 months where the 10 year interest rate peaked at 4.66% on November 4th and has stayed in a 31 basis point range (4.66-4.35) despite a very uncertain oil market and most importantly the BIG unknown….a New Fed Chairman beginning February 1st. One of the items that bothers me is a feeling in the financial community that the FOMC will not change with a new Fed Chairman and that other FOMC members will have an impact on future Fed policy. I would put this probability at less than 5%…it will soon be Bernanke’s world and everyone else will guessing his first move in office and that could cause more volatility than we have seen for many years.

A month ago the Comptroller of the Currency sent banks a strongly worded memo urging them to tighten their underwriting guidelines for home loans and last week another memo was sent to commercial real estate lenders with many of the same requests….slowly but surely the Fed will make it more difficult for lenders to give credit to the riskiest borrowers who have found it so easy to buy, borrow and watch as prices soar…..2006 will NOT bring a crash but it will bring a flattening in prices.

Much has been written about the yield curve (interest rates plotted against time) and after the Fed increases the Funds rate on 1-31-06 to 4.5% we will officially have short term rates above long term (10 yr.) rates. But patience is in order as history has shown that inversions last much longer than desired by Wall Street. Over the past 37 years (yes I remember every detail) the longest inversion occurred from April 1968 to June 1970 (26 months) with the shortest from February 1982 to June 1982. The average time of inversion has been just over one year but as I have said over and over and over again since June 2004 history does repeat itself…just not when it is expected….normally an inversion occurs when short term interest rates rise faster than long term interest rates but in the last 19 months long rates have fallen……as a result if long rates continue to decline it will make this new inversion more severe without any action from the Fed…..in many ways the NEW Fed (Bernanke) will be watching long rates to see if it can ease (lower short term rates)….so if you want to know when (not if) the Fed will drop short rates just watch long rates…they always lead a Fed easing and this time will be no exception……

With oil stubbornly trading above $60 it is no surprise that we are seeing an increase in oil drilling. In California it is estimated that over 3,000 abandoned wells will begin production in 2006. The longer that oil stays above $60 the more likely that oil drilling will increase bringing more supply into the market and that will help cap the price at 2005 highs of $70 per barrel. The major change between the oil price surge in the mid-70’s and the 2005 price increase is in the way OPEC has invested the proceeds of its oil sales. 30 years ago 52% of oil revenues were spent on imports from trading partners with the other half being used to find more oil….today OPEC recycles almost 90% into imports as it comes to the realization that they are closer to the end of its ability to find “cheap” oil and that new exploration would be prohibitively expensive…..this is good for global commerce but not a good sign for future oil supplies from the Middle East….

When digging into the jobs number from Friday January 6th I found it interesting that the payroll diffusion index (number of industries showing “net” job growth fell to 54.9% from 66% in the previous month. With real estate and construction fueling most of the growth in the US economy in 2005 the winter months are not the best time to judge job growth so we will have to wait a few more months to see if we again see a pickup in these areas. The other statistic that caught my eye was the “quit rate” (those who involuntarily lose their jobs) which fell to 11.4% from 12% the previous month. This is a key statistic for the Fed (Greenspan) and is one of the reasons why I believe it is much to early for the Fed to consider easing monetary policy and will just sit at “4.5%” for at least six months. The other key stat comes from the lending sector as we saw that last week’s h8 report showed unabated growth in commercial and industrial loans. It will take at least six months for the inverted yield curve to have an effect on demand for credit

Monday’s (1-09-06) London Financial Times had two interesting articles about demand for global real estate. The first on page 18 said that 44 different private equity-style property funds were launched in 2005 with over $100 Billion in assets. In 2004 funds raised just $20 Billion in these real estate funds. The 2nd article on page 20 was about how property funds are finding it difficult to find any properties to buy and as a result they are investing in real estate with higher risk and less return. Why don’t they just wait for prices to pull back??? The managers of these funds only get paid if they put the money to work in real estate and are afraid that if they don’t invest quickly that investors will demand their money back……this is what happens at the top of a bull market…..$$$ chases assets that have already risen in value…..many of these investors will soon learn a painful lesson…”never confuse a bull market with brains”….

GM announced last week that the generous discounts and rebates it has offered for the past many months weren’t achieving the results expected, so they have decided to do what most of us do when we have a product that isn’t selling….lower prices ….it is reducing 57 of its 76 North American models by an average of $1300….that’s is not inflationary and one of the many reasons the US inflation rate is hovering under 2%…

Every week I receive dozens of calls and e-mails from readers asking where is the best place to buy real estate….let me remind everyone I am NOT an investment advisor…but an article in last weeks Wall Street Journal entitled “Stagnant Market Rocks Lake City” was unusual because I can’t remember the last time I read something about real estate prices declining….I am not one to chase rising prices and running a full time charity puts me in a position where I couldn’t afford to buy an outhouse in Southern California but if I did have investable funds I would be looking at the fine city of Cleveland. The best quote in the article came from the CEO of a real estate investment trust who said that after entering Cleveland 10 years ago it was now going to close its office and sell its approximately 4.5 million square feet of office and industrial properties. He said that he just doesn’t see the opportunity going forward in the Cleveland market…..Sounds like a good buy to me…but obviously due diligence is needed….

Finally some good news for the hundreds (thousands??) of mortgage brokers and real estate professionals that read this newsletter……What is the one thing that everyone would love to happen to make their business soar in 2006???? of course…lower long term interest rates….refinancing of houses, more home buyers, etc. making RE people jump for joy….while the media watches the Fed my readers will be watching the bond market and long term interest rates (The Treasury will begin issuing 30 yr. bonds again in 2006)….with the holiday on Monday I had a couple of extra hours to do a little research ( I can’t remember everything from the past) and found that in the last 43 years the longest period (in days) between interest rate peaks was 2037 days. Using the 5 yr. US Treasury which peaked (rate) on 3-26-71 and then peaked again on 12-03-76 it gives us another reason to believe that long term rates will decline to NEW lows in 2006. The 5 year peaked on 11-11-05 at 4.52% and the previous peak was 2-11-00 at 6.76% and that is a difference of 2100 calendar days. It’s just one of many reasons I believe that the summer of 2006 will see another (and maybe the last) opportunity to lock in low long term mortgage rates. I repeat my prediction from earlier this month that when the Fed finally begins easing later this year (August 8th??) it will be the best time to lock in low financing rates. Just like June 30, 2003 when the Fed began to tighten and everyone predicted long term rates would rise (and were wrong!!!) when the Fed begins to ease they same “experts” will predict that long rates will fall and fall and fall….but they will be wrong again…..this time it will the signal to lock as long rates will begin an advance in the face of Fed easing…….don’t worry about missing the opportunity of a lifetime as we have at least six months to prepare…..

the bad news is that for 42 out of the last 43 years (1995 the only exception) long term rates have risen in the first half of the year at least 25 basis points with the average of 100 basis points. The average advance has taken about 81 calendar days…..

The bottom line is that long term rates may rise in the first half of 2006 and then fall dramatically toward summer giving us the opportunity I wrote about above……

January 4, 2006

The clock is ticking on the remaining days in Fed Chairman Greenspan’s term in office. We have exactly 27 days before the new Fed Chairman Ben Bernanke takes office and ends the current Fed tightening cycle.

Since June 30, 2004 the Fed Funds Rate (short term) is UP 325 basis points from 1.00% to its current 4.25%. The US Treasury 30 yr. interest rate is DOWN 105 basis points from 5.59% to its current 4.54%.

Before we begin with my 2006 predictions let’s revisit the past and start with the e-mail from 7-21-05 when I wrote:” 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.” This comes after my 1st e-mail of 2005 (1-04-05) where I wrote that the big surprise of 2005 would be that long term rates would NOT rise while short term rates (Fed Funds) would rise all year….There it was the perfect road map of interest rates and we hit a bulls-eye….

That’s nice but as they say that’s now history and now everyone wants to know what will happen in 2006……

Let’s start with the Fed where the minutes (http://www.federalreserve.gov/fomc/minutes/20051213.htm) of the last FOMC meeting that was held on December 13th has caused the press to jump on every little word that might give an indication that the Fed will stop tightening soon and then ease…..My first question is why does anything that happened under Mr. Greenspan matter to Mr. Bernanke??? The FOMC is a committee only in spirit, it has and always be run by the Chairman and what he wants will be what he gets for monetary policy. I warn everyone to be very careful of what you read over the next few months as the so called “experts” try to guess when the Fed will begin easing again….I wrote for much of 2005 that the average Fed Funds rate increase was 19 months and that if you added 19 months to the first Fed tightening on 6-30-04 you would have 1-31-06 as the last Fed rate increase and that is exactly what we will see when the FOMC meets for one final time under the Greenspan regime. Mr. Greenspan will ride off into the sunset with the Funds rate at 4.50%, the 10 yr. Treasury at approx. 4.35% and a yield curve that is slightly inverted with short rates just a few basis points above long rates.

History does repeat itself just not when everyone is expecting…..and somehow many forgot how long a Fed tightening cycle can last and the same will be true about an easing cycle…on average it takes at least 6 months between the last Fed increase and the first Fed ease so if the Fed does increase the Funds rate on 1-31-06 to 4.75% then I will go out on a limb (sometimes I think I live on that limb) and predict the first Fed easing on 8-08-06 (FOMC meeting) and my biggest prediction for 2006 will be the following (if I hit this one I really hope that someone makes millions and writes a check to FOF) ……..
long term interest rates will hit their low of the year on the exact day that the Fed drops the Fed Funds rate for the first time since June 25, 2003 when they dropped the Funds rate to 1.00% from 1.25%.

On 6-30-04 when the Fed first began its tightening phase the “experts” predicted that long term rates would follow and rise step by step with short term rates….the “experts” were wrong and they will be just as wrong when the Fed begins to ease as long rates again will NOT follow the Fed because the interest rate market will spend the next six months anticipating (discounting) the Fed’s moves and long rates will decline until the Fed actually begins the easing cycle….

I know I have hundreds of real estate professionals as readers and others who have adjustable rate mortgage loans so get those loan applications ready as the opportunity of a lifetime to lock in the lowest long term rates for this decade will coming in approximately 7 months…..it will seem like forever to many as the bond market starts and stops as it tries to anticipate what is inevitable but the timing just won’t be right until August.

The key to 2006 will be “timing”….being ready before it happens….those with adjustable rate mortgage loans want the Fed to ease and quickly but this year will require patience and even more patience. Long term rates (30 yr. mortgages) should drop into the low 5%/high 4% range by the summer as the economy begins to slow and the housing market flattens (no crash) and begins its long slow decent back into a normal atmosphere….

a few thoughts…

Mr. Bernanke’s first FOMC meeting will be held on Tuesday March 28th and I expect it to show a “NEW” Fed and one that does NOT take action in regards to the Fed Funds rate. This will immediately change perceptions in the bond market and begin a drive towards much lower long rates as market players begin to guess the exact date of the first Fed ease of the Bernanke era….

Not sure where this fits but did you know that in 2004 $27 million worth of Wal-Mart gift cards expired UNUSED???

Back to reality…one of the reasons the Fed won’t ease just yet is the demand for commercial and industrial loans continues at high growth rates…until we see short rates take hold for a few months this number will act like a wall that prevents the Fed from changing direction completely.

Even though the yield curve is flat and somewhat negative (2’s versus 5’s) I expect the curve to invert further and the average inversion (2’s versus 10’s) is usually around 60 basis points and it normally takes almost 6 months for the curve to reach its maximum inversion (July 2006??)

Did you know that a 2005 investment in long term US treasury bonds returned 7.4% versus 4.9% for the S&P 500???

The jobs number will be released on Friday morning at 5:30am and the payroll number has been weaker than expected for the last three years so this year the seasonal adjustment may catch up and give the market a jolt for a few days…….

Every six months the Wall Street Journal surveys 56 economists for interest rate predictions and for the 8th consecutive time these “experts” are predicting an increase of 50 basis points in the US Treasury note over the next 6 months. They have been wrong for 7 straight surveys so there is no reason to believe they won’t be wrong for an 8th time……Only 4 out of 56 (92%) see lower rates……the beat goes on…when you are NOT held accountable for bad forecasts you just keep repeating your predictions figuring one day like a broken clock you will be right….it’s the best job in the world…you are paid a high salary with no expectations of ever being right…..if you get lucky and hit one out of the park you receive a bonus…if you are wrong and wrong and wrong there is no suffering except for your readers (followers)…..when I am wrong I write about it as I have with my prediction on the rise in the price of corn (better late than never as corn has risen 20 cents in the last month)

next time…the dollar continues its rally as the bears will be doubling up their losing bets and telling us that the trade deficit really matters…..not even close…ask the bruised and battered bears why the dollar rose dramatically in 2005 despite an exploding deficit….oh well….as long as Mr. Warren Buffett stays short the dollar….I’ll stay bullish..it’s like David and Goliath…hopefully we will have the same result…

Happy New Year……if you have any comments please don’t hesitate to write……