June 10, 2005

...AND LOWER...:

Long-Term Interest Rates Buck Conventional Wisdom (Tom Petruno, June 10, 2005, LA Times)

[T]o the shock of most investment pros as well as the Fed — and to the relief of home buyers — long-term rates have tumbled, even as the Fed has raised its key rate eight times over the last year, from 1% to 3%.

While the housing market celebrates the good news of 30-year mortgage rates under 5.6%, down from 6.3% a year ago, a lot of financial professionals have egg on their faces.

"Basically, 100% of economists have gotten the direction of long-term interest rates wrong," said Steven Permut, a money manager at American Century Investments in Mountain View, Calif.

Now, a new school of thought is developing among market analysts. Some believe long-term rates could hold at current levels for years, or even fall further to low single digits. In a world awash in savings, investors' urgency to lock in returns on fixed-rate, long-term IOUs like bonds will help keep a lid on rates in general, they say.

Bill Gross, chief investment officer at Newport Beach-based Pacific Investment Management Co. and one of the world's top authorities on interest rates, says it's conceivable that the rate on the 10-year U.S. Treasury note, a benchmark for mortgages and other long-term interest rates, could drop to 3% in the next three to five years. Currently it's just under 4%.

If he's right, that could mean that far lower mortgage rates lie ahead — which could provide a bailout for people who have purchased homes with huge, interest-only loans and are hoping to eventually refinance with more favorable terms.

Consider too the influx of money that would be provided by privatizing SS and by universal HSA's.

Meanwhile, Sherman better tell Mr. Peabody to return from 1974, Fed Chief Warns on Mortgages: Easy loan terms may be driving home prices up but the economy is healthy, Greenspan says. (Joel Havemann, June 10, 2005, LA Times)

Federal Reserve Chairman Alan Greenspan warned Thursday that new, more liberal kinds of mortgages were helping to drive up home prices and fueling the danger of a sharp price decline, but said the economy overall was on "reasonably firm footing."

Greenspan said interest-only mortgages in particular were contributing to what he termed "froth in some local markets." He said he continued to be bewildered by the decline in mortgage rates and other long-term interest rates even as the Fed was beginning the second year of its campaign to raise short-term rates.

Posted by Orrin Judd at June 10, 2005 8:54 AM

I had lunch with two very smart economists yesterday, one of whom said that the inverted yield is a sign of a possible recession and the other of whom said that the bond market has lost its mind.

Posted by: David Cohen at June 10, 2005 9:02 AM

Another factor to fold into the mix is the massive transfer of wealth underway as boomer parents die.

Posted by: Luciferous at June 10, 2005 9:07 AM

Tyler Cowen has a good post up on the flattening yield curve (it's not inverted yet) at Marginal Revolution.

Posted by: joe shropshire at June 10, 2005 12:39 PM

Joe: Good catch.

Posted by: David Cohen at June 10, 2005 12:55 PM

Another possibility is that Fed has established such high credibility for fighting inflation that the market expects future nominal interest rates to be very low. That would be a scenario in which it actually would make sense that the more the Fed tightened, the lower long-term int. rates would go.

Posted by: Tom at June 10, 2005 11:05 PM


Not just credibility, but fighting inflation has become the Fed's sole purpose for being. That's not necessarily a bad thing, but does mean they'll periodically and needlessly tip us into slowdowns.

Posted by: oj at June 10, 2005 11:13 PM