Thursday, November 11, 2004

Housing Bubble, like every bubble, won't pop on schedule

Housing Bubble, like every bubble, won't pop on schedule

Pity the Housing Bubble decline prognosticator. Like the tech stock bubble, on and on and on it goes.
Today, for example, the following article by Alexandra Marks appeared in The Christian Science Monitor:

Pessimists will have to wait, as housing boom rolls on

Remember that great real estate bubble? It appears almost as buoyant as ever, despite the Federal Reserve's decision to raise interest rates for the fourth time since June.

The piece echoes a common misunderstanding. The Fed does not control long term interest rates, the bond market does. Long rates indeed have generally tracked the short term rates that the Fed does influence. Problem is, unlike very other time the Fed has lowered short term rates, not only aren't long rates following along with them, long rates are actually falling.

The same day the CSM piece appeared, John Crudele of the New York Post Online Edition lays out the oddball rate dynamics in his article Fed has Made a Mess of Rates:

Back on June 30 the Federal Reserve attempted to increase borrowing costs for the first time in years. But what happened instead was this: the cost to borrow money actually declined while the rates paid to savers has risen. For instance, back in late June the average rate on a fixed 30-year mortgage was 5.98 percent. Now it's 5.46 percent. A 15-year mortgage averaged 5.47 percent then and it's 4.95 percent now, according to Bank Rate Monitor. A five-year adjustable rate mortgage: 4.89 percent on June 30 is now 4.80 percent. Home equity loans declined from 6.95 percent to 6.80 percent. Ostensibly the Fed was trying to raise interest rates to slow down the economy. Readers of this column know the real reason: even though the economy has been growing only moderately by historic standards, the Fed needed to get rates back up so it will be able to cut them later if business began to slow. But if the Fed wanted to slow the economy its moves have had a much different effect. Even as borrowing costs have confounded the policy makers by declining, savers are getting higher rates for stashing their money in the bank. One-year Certificates of Deposit have gone from paying 2.06 percent on June 30 to 2.41 percent now; three-month CDs from 1.17 percent to 1.54 percent; while the humble statement savings account jumped the most — from just 0.93 percent to 1.63 percent. At that rate, a statement savings account is outperforming the Dow right now.

What gives? For one thing, as long as long bonds yields and, thus, mortgage rates keep falling, the housing bubble will keep on keeping on. As for the cause of the unusual inverse relationship between the Fed's raising of short term rates and the decline in long term rates, it's all according to plan, according to bond fund contrarian Mike Pietronico. In a recent article for BondsOnline Advisor, Stephen Taub reports Mike's explanation for he anomaly.

When the Federal Reserve starts to raise rates, it's time to shorten your maturities, right?

Don't tell this to Mike Pietronico, who runs about $600 million in tax free assets for Evergreen Investments, including three municipal bond funds.

He says he's moving more of his dough to longer maturities, defined as 10 years or more. Why? "We will remain in a low interest rate environment," he asserts. "That's the story."

But wait. Didn't the Federal Reserve raise rates three times since the beginning of the summer as the economy showed signs of strengthening, and is likely to hike them some more before it is finished with its tightening mode?

And isn't it dangerous for investors to remain in bonds, especially long paper, when the Fed is in a tightening mode?

Not this time around. "That's fighting the last war," he asserts. "People want to continue to pull out the playbooks from 1994, or 1999."

This time, he insists, it's truly different. He says short-term maturities like two-year paper are most sensitive to the Fed increasing the overnight rate.

However, Pietronico asserts that when the Fed is raising rates to combat core inflation measuring a mere 1.8%, that is nothing but bullish for the long end of the market. He's figuring on a flattening of the yield curve. "They are setting up a big bond market rally," he insists.

Who's your Daddy? Greenspan.


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