Why the Fed's not done cutting rates---What is happening with a market?

The market is past its panic phase, but a grinding slowdown may soon put Bernanke back into easing mode.
By Colin Barr, senior writer

The market is eager to see Ben Bernanke heading for the sidelines. But with the U.S. economy softening, he may not stay there for long.

The Federal Open Market Committee is due to conclude a two-day policy meeting Wednesday afternoon. Trading in futures markets predicts the Fed will cut its key fed funds overnight lending target by a quarter-point, to 2%, and hold the line there in coming months. If the markets are right, the Fed is ready to go on hold for the first time since it began cutting rates last summer in response to troubles in the credit markets. The shift wouldn't come a moment too soon for some observers.

"Lower fed funds?" wrote Bill Gross, managing director at bond investor Pimco in Newport Beach, Calif., in his May investment outlook. "They would, in Pimco's opinion, likely do more damage than good from this point forward." Gross wrote Tuesday it's imperative that the Fed hold rates steady because "foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result."

But while surging food and energy prices have stolen the headlines this month, some observers believe falling house prices will force a substantial consumer retrenchment that could turn the Fed's attention back to economic growth. So while the Fed will surely be eager to show Wednesday that it hasn't forgotten that inflation is a concern, it could find itself cutting rates again later this year.

"The Fed is very likely going to find a way to signal a wait-and-see approach," Merrill Lynch economist David Rosenberg wrote this week. "That should not, by the way, be confused with an end-of-the-cycle approach."

For now, a pause in Fed action would be a welcome development after months of unrest. In addition to cutting the fed funds rate from 5.25% back in September, the Fed has expanded the scope of emergency loan programs to keep financial institutions lending to consumers and businesses. Since last month's Fed-brokered rescue of Bear Stearns (BSC, Fortune 500), fears of a default at rival brokerages such as Merrill Lynch (MER, Fortune 500) and Lehman Brothers (LEH, Fortune 500) have fallen sharply, judging by trading in the firms' credit default swaps.

But if Bernanke's policies have succeeded in easing the market's liquidity problems, signs of a slowdown in the United States economy have only become more pronounced. Rosenberg points to steep declines in home sales, retail sales and consumer confidence over the past three months. Merrill Lynch now expects second-quarter gross domestic product to fall 2.3% from a year ago, in the first quarterly contraction of U.S. economic output since the 1990 recession.

Rosenberg, who has been saying the Fed will cut its target rate as low as 1% during this cycle, isn't the only one talking about a prolonged slowdown. Merrill chief John Thain made a similar point in the firm's first-quarter earnings call two weeks ago. He said the firm believes the worst of the capital markets dislocation is past, but that related problems could just be coming to light.

"I think the real risk going forward here is how much do all of the problems in the financial and credit markets seep into the real economy," Thain said. "What is the impact of higher energy prices, higher food prices, higher unemployment, and falling home prices on the consumer and what's the impact of that in terms of the U.S. economy and ultimately the global economy?"

More bad news on the home-price front came this week, when Standard & Poor's said prices in 20 major markets dropped an average of almost 13% from a year ago in February. "There is no sign of a bottom in the numbers," said David M. Blitzer, chairman of the Index Committee at S&P. "Prices of single family homes continue to drop across the nation."

Falling house prices are likely to weigh on consumer spending, by preventing homeowners from funding consumption by tapping their home equity. That slowdown makes Dan Libby, a senior portfolio manager of the Sands Brothers Select Access Management fund, skeptical of the prospect that the economy will bounce back fast enough to permit the Fed to hold rates steady for long.

Libby said he believes Bernanke has staved off a deep recession and a market panic by acting as quickly as he did. But he said that he sees little sign that a strong recovery is at hand. While Libby said the Fed doesn't want to repeat its mistakes of the last cycle, when it left interest rates at very low levels even as economic growth picked up, he believes rates could fall to 1.5% before Bernanke & Co. are forced to confront a possible monetary tightening.

"I expect to see a slow, grinding muddling-through type of economy" for the next year or two, Libby said. He added that the Fed must "be careful about sounding too hawkish" when it issues its statement Wednesday laying out how it sees the risks confronting the economy.

That statement is what investors expect to be focusing on at 2:15 p.m. EST, when the Fed announces the results of today's meeting. "What is critical is what signal the Fed provides in the press statement," Rosenberg wrote this week, "and how much emphasis they put on inflation."

First Published: April 30, 2008: 3:42 AM EDT

Choosing a mortgage

Mortgage rates have stayed relatively low, but they are still considerably above rock-bottom levels reached two years ago, and many worry that they will ultimately head higher. It is one of the reasons why Realtors think it is a great time to buy or move now.

Still, that's not the only consideration when choosing a mortgage. Here's how to make the decision.

1. 15-year versus 30-year debate

The first question you should ask is, "How much can I afford to pay on a monthly basis?"
Keep in mind, your mortgage payment is only part of what you'll pay to live in your home. You also should budget for furniture, your house's upkeep and the general expenses of life (like, say, food).

A 30-year mortgage will have a lower monthly payment and a higher interest rate than a 15-year mortgage.

So you'll have a smaller monthly obligation but you'll pay more for your house over time because you're paying it off with interest for a longer period.
Conversely, a 15-year mortgage will have a higher monthly payment and a lower interest rate so you'll pay less for your house because you're paying it off in a shorter period.

"For most home buyers, especially first-time buyers, taking a 15-year (or 20-year) mortgage is out of the question," said Keith Gumbinger, vice president for mortgage tracker HSH Associates. The higher monthly payments are often too much to handle for these types of buyers.
But for home buyers with sufficient income and a desire to be mortgage-free in a short time, a 15-year loan might be a good bet.

If you do not feel comfortable commiting to 15-year loan, do yourself a favor at least and every time you save some moeny put them toward priciple of the mortgage, it will reduce the amount of moeny your own, and therefore, it will reduce how long it will take to pay it off and some interest money.

2. Fixed versus adjustable-rate conundrum

The second question you should ask is, "How long will you be in the house?" You probably can't answer with absolute certainty, but you can play the odds.

Say, for example, you're single and buying a small condo but you can easily envision yourself married; or you've just started a family and plan to expand it at some point. Chances are good you'll want to trade up to a new home in five to seven years. On the other hand, maybe you've had your family and want to settle into a place with a good school system, which your kids will be using for the next 12 years.

My experience says that most people stay in the house/condo longer than they though they would originally. So keep that in mind.

Whatever the answer, it will help you decide whether it makes sense to get a fixed-rate or an adjustable-rate mortgage (ARM).

A fixed-rate mortgage locks in a rate for the length of your loan.

ARMs, meanwhile, are short-term fixed-rate loans: After the fixed rate term is up, the rate adjusts at regular intervals in accordance with current interest rate conditions at that time.

A 5/1 ARM, for example, has a fixed rate for five years and then adjusts every year for the next 25 years. (ARMs typically run on a 30-year schedule.)

The length of the fixed-rate term on an ARM typically can range anywhere from one month to 10 years. The longer the rate is fixed, the higher the interest rate you'll get.

But generally speaking -- and there have been exceptions in the past -- ARMs will cost you less in the short-term. With the ARM, both your monthly payments and interest rates should be lower than either a fixed rate 15-year or 30-year mortgage.

The risk with an ARM is that when interest rates rise, you could end up paying much more than you bargained for. "You're subject to the vagaries of the market," Gumbinger said. That's why in today's low-rate environment, he noted, "You want to maximize the fixed-rate picture to match your time frame."

If you know you'll be in a home for 12 years or more, a 30-year fixed rate mortgage might work better for you than, say, a 5/1 ARM, where you fix a rate for five years and then it adjusts every year after that. But if you think you won't be in the home longer than five or six years, a 5/1 ARM might make more sense.

3. A dollars-and-sense exercise

Say you need a $200,000 loan to buy a home and you can get the current average rates for a 30-year fixed, a 15-year fixed, or a 5/1 adjustable rate mortgage.

If the 30-year fixed rate mortgage is at 6.62 percent - a level it was at just a few months ago - your monthly payment would be $1,280. The interest you pay over the life of your loan would total $260,786.

With a 15-year fixed rate at 5.94 percent, your monthly payment would be $1,681. The interest you pay over the life of your loan would total $102,623, or about $158,163 less than the 30-year fixed.

With a 5/1 ARM at 4.20 percent, your monthly payment would be $978 for the first five years. The total interest you pay over the life of the loan if you stayed in your home past five years is anyone's guess because your rate would then adjust annually. But if you move after five years, that won't be an issue.

So, to say the least it is only few things to consider...And, always compare at least 2-3 mortgage companies, you will be surprise how different they charge you so called "closing costs"

End of the Week Market Projection

The “second” reading of GDP growth in the 4th quarter of last year was unchanged – a basically flat 0.6 percent growth rate. As we go forward, economic growth in the first half of this year will be essentially non-existent. But there is some light at the end of what many pundits view as a dark tunnel. By the second half of the year, the economy will expand at slightly higher than 2 percent. The 2008 fiscal stimulus package contains over $100 billion in tax rebates. Those checks should be in taxpayers’ mailboxes in early summer. This tax cut is more than twice as high as a similar rebate passed in 2001. Past research suggests that consumers’ propensity to spend out of those tax rebates is about 40 cents to 50 cents on the dollar. That translates into additional consumer spending of $60 to $80 billion in the second half of the year. Make no mistake – this stimulus is the key factor in helping move the economy in the second half of the year. Other Factors than Housing Involved in Economic Doldrums Seems like most people blame the housing downturn for our economic doldrums. But there are other factors. This tax rebate is needed to compensate for outrageously high oil prices and from falling stock market values. A $104 dollar per barrel oil price is a major drag on consumer spending – and something that virtually every consumer feels. Europeans are not paying as much because of their stronger currencies. The higher oil price, which is priced in U.S. dollars, is partly driven by the very weak dollar. The weaker dollar is caused in part by a higher inflation rate in the U.S. vis-à-vis the rest of the world’s advanced economies. If a currency is losing its purchasing power, why hold that currency? Recall, the oil price was under $20 per barrel just 10 years ago. When the price of oil rises, it is essentially a tax placed on consumers with less money available to spend on more enjoyable items and activities. This “oil tax” unfortunately does not even go into the U.S. Treasury. Rather it fills the coffers of the governments of Russia, Venezuela, Saudi Arabia, Nigeria, and Iran. In today’s world, it is a transfer of money from a democratic country to a non-democratic country. The housing market will also get some relief. A higher loan limit – up to $729,000 from $417,000 – in several local areas, including Los Angeles, Orange, and San Francisco counties, will have a big impact in bringing out the buyers. As a result, home sales in the second half of 2008 will no doubt be much stronger than in the first half. Look for existing-home sales to rise to a 5.7 million-unit pace in the second half versus 4.9 million in the first half.Pent-Up Demand Rising sales will also bring down inventory and help strengthen home prices. The national median price of an existing home will fall in the first half of the year and then rise in the second half. For the year as a whole, the median price will have fallen by 1 percent – after having fallen 1.4 percent last year. Of course, there will be tremendous local market variations. The Northeast region is likely to be first region to show signs of stabilizing and then strengthening housing market conditions. The West region will likely trail behind. The West region could, nonetheless, surprise us on the upside. What is unique about the current housing cycle is the pace of price declines in some local markets, which can significantly improve affordability conditions in a short time. Home prices are falling at or near a double-digit pace in California, Nevada, and Arizona. A sudden quick home price adjustment may be just the thing to quickly induce buyers back into these marketplaces. After all, as is the case in many parts of the country, jobs have been created in those Western states over the past two years even against the backdrop of a housing market slump, and hence, there exists significant pent-up demand. New home sales will take much longer to turn around. That is simply due to the fact that there are far fewer new homes being built. Single-family housing starts have fallen by more than 50 percent in the past two years. Based on housing permits – generally a reliable indicator of upcoming housing starts – new home construction will fall further for the remainder of the year. New home inventory has been trending down but more cutbacks are needed. Therefore, homebuilders need to further bite the bullet and hold back construction. Loan modifications and other foreclosure mitigation programs are all well intended and good, but the best policy assistance in our current market condition is to unleash the pent-up demand. Any measures that violate the sanctity of private contracts – such as permitting judges to reset interest rates – should be avoided as those can greatly harm home sales by raising the cost of borrowing on new loan originations. There is some discussion of a possible tax credit for first-time home buyers. Such a policy will be a great stabilizer for the housing market and the economy.