Interest Rates Have No Where to Go But Up

The New York Times - Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion program to buy mortgage debt, placing even more upward pressure on rates.

“Mortgage rates are unlikely to go lower than they are now, and if they go higher, we’re likely to see a reversal of the gains in the housing market,” said Christopher J. Mayer, a professor of finance and economics at Columbia Business School. “It’s a really big risk.”

Each increase of 1 percentage point in rates adds as much as 19 percent to the total cost of a home, according to Mr. Mayer.

The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5 percent by late summer and as high as 6 percent by the end of the year.

Another area in which higher rates are likely to affect consumers is credit card use.

And last week, the Federal Reserve reported that the average interest rate on credit cards reached 14.26 percent in February, the highest since 2001. That is up from 12.03 percent when rates bottomed in the fourth quarter of 2008 — a jump that amounts to about $200 a year in additional interest payments for the typical American household.

With losses from credit card defaults rising and with capital to back credit cards harder to come by, issuers are likely to increase rates to 16 or 17 percent by the fall, according to Dennis Moroney, a research director at the TowerGroup, a financial research company.

Fed Mortgage Efforts Prove Costly

The Wall Street Journal - The U.S. Federal Reserve's program to keep mortgage rates low by buying securities and Treasury bonds so far has been costly and seems to be having a fleeting impact.

An analysis of the timing of the Fed's purchases of mortgage-backed securities by J.P. Morgan Chase & Co. shows the Fed is "under water" on its portfolio by about 10%, and it would have to take about $5 billion in losses if it were to mark its portfolio to the market.
Since last autumn, the Fed has purchased more than $480 billion, out of an allowance of $1.25 trillion, in mortgage-backed securities and more than $130 billion, of $300 billion, in Treasury bonds to help keep mortgage rates low. Keeping rates low lets people refinance their mortgages to reduce payments and stay in their homes. It also encourages them to consider snapping up bargains in the still-ailing housing market. Many analysts believe the Fed plans to hold these securities until they mature in 10 years or so, with no plans to sell them into the market, so the losses will probably never be realized.

The central bank owns the majority of securities sold in 2009, with interest payments of 4%, 4.5% and 5%, according to J.P. Morgan's research. As interest rates rise, the value of these securities falls because new bonds are backed with higher-interest mortgage loans and thus pay higher coupons.

The Fed has spent about $2,500 per borrower, by J.P. Morgan's analysis -- more than it costs a typical mortgage borrower to refinance their debt. Higher fees and adjustments based on a borrower's credit score or home's value have been an impediment to borrowers looking to refinance a mortgage, damping the refinancing wave the Fed hoped for, analysts sayhttp://online.wsj.com/article/SB124380834210470271.html#mod=testMod

Jittery Bond Market Threatens President's Agenda

The Wall Street Journal - WASHINGTON -- Senior Obama administration officials said Friday that policy adjustments necessary to contain soaring budget deficits would be made once an economic recovery takes hold, in response to growing concerns about a run-up in long-term interest rates.

Treasury Secretary Timothy Geithner, National Economic Council chief Lawrence Summers and Office of Management and Budget director Peter Orszag said in separate interviews that the administration was acutely aware that rising interest rates pose a threat to the improving U.S. economy.
[chart]

Yields on 10-year Treasury notes have risen 1.5 percentage points this year as bond traders pull back amid worries about rising federal debt. Higher yields will leave the government with higher interest costs and still higher deficits. They could also push up other forms of interest rates, making borrowing more expensive for many people.

On Thursday, the Treasury Department is expected to announce an auction of roughly $65 billion in three-year, 10-year and 30-year notes and bonds, and the result will be closely watched.

"We're going to do what's necessary," Mr. Geithner said. "That's the only way you're going to get a strong, sustainable recovery." As soon as a recovery takes hold, the administration will reduce the deficit to a sustainable level, he said, adding, "That's difficult, but critically important."

Mr. Orszag said the administration's commitment to fiscal rectitude would become clear in coming weeks when President Barack Obama demands that any health-care plan drafted in Congress be fully paid for. That pledge, he said, "is ironclad, no ambiguity, not up for negotiation."

Additional steps on the deficit may become necessary, he added, and the administration is committed to turning to Social Security next.

"There is not a day that goes by that the president and the economic team do not focus on the long-term commitment to decrease the deficit," Mr. Summers said.

The comments by the administration officials were aimed at calming worries on Wall Street, and indicated concern that rising interest rates might imperil the president's domestic agenda, as they have done to the plans of previous Democratic administrations.

Some officials tried to play down market fears about federal borrowing. The jump in long-term interest rates, both in Treasurys and mortgages, is more a product of technical factors, they argue, than a reaction to Washington's borrowing.http://online.wsj.com/article/SB124364263595268139.html

Bond Yields May Signal a Recovery

The gap between short- and long-term Treasury rates is approaching a record as the U.S. economy shows signs of recovery and the government floods the market with new debt.

The gap between two- and 10-year Treasury yields was as wide as 2.360 percentage points at one point Tuesday, the most since the 2.619 points hit in November and nearing the August 2003 peak of 2.747 points. The gap ended Tuesday at 2.352 points, as the 10-year note fell 9/32 point, or $2.8125 for every $1,000 invested, to 99 to yield 3.243%, while the two-year note rose 1/32 point to 99 31/32, lowering its yield to 0.891%. Prices and yields move inversely.
[Treasury Yields]

Strategists said the gap could exceed three points. Two-year yield is expected to remain anchored by the Federal Reserve's interest-rate target of 0% to 0.25%. But the yield on the 10-year note is expected to rise amid a surge of new government debt and as investors sell existing government debt as they look to move out of these safe investments. Until the Fed starts to reverse its stimulative monetary policies and starts raising interest rates, the curve is likely to remain steep.

Investors profit from a steepening yield curve by buying two-year notes and selling 10-year notes. The steeper the curve, the bigger the profit potential. Banks benefit as they can borrow funds at cheap short-term rates and invest in higher-yielding long-term assets.http://online.wsj.com/article/SB124274038273134537.html

Yield curve explained: http://en.wikipedia.org/wiki/Yield_curve

It May Be Time for the Fed to Go Negative

By N. GREGORY MANKIW

WITH unemployment rising and the financial system in shambles, it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I’m not talking about attitude. I‘m talking about numbers.

Let’s start with the basics: What is the best way for an economy to escape a recession?

Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them.

In many ways today, the Fed is in uncharted waters.

So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent?

At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.http://www.nytimes.com/2009/04/19/business/economy/19view.html

Fed Gets a Test on Treasurys

The Wall Street Journal - Treasurys slumped Tuesday, and the 10-year note's yield rose above 3%, as the market tested the Federal Reserve ahead of the end of its monetary-policy-setting meeting on Wednesday after a so-so five-year note auction and stronger data.

The 10-year yield rose as high as 3.03% following the auction as losses picked up speed. Treasurys had started to weaken midmorning after data that showed a surprise jump in consumer confidence this month. That figure erased early gains spurred by continued worries about the health of the banking sector.

The 10-year yield has bounced around 3% for most of the month, but had failed to close above that level since mid-March, before the Fed began its Treasury-buying program. Late Tuesday, the 10-year note was yielding 3.002%.

Strategists are focusing on 3.04% as the next key level if supply concerns continue to push yields higher, followed by 3.10% and then 3.25%.

Reaching 3.25% would likely concern policy makers, said Carl Lantz, interest-rate strategist at Credit Suisse in New York, as it could force mortgage rates to rise above 5%. The Fed may then decide to increase its purchases of Treasurys, a program it kicked off March 25 to help drive down consumer borrowing rates.

"There's more of a sense we could see the market break now and test the Fed's resolve to be more aggressive" in its buying, Mr. Lantz said, adding he doesn't believe the Fed will refer to any added buying in its policy-meeting statement Wednesday.

Instead, the Fed is likely to stress that it will work to keep long-term borrowing rates low. If it words the statement correctly, Treasurys could rally.

The Fed, though, could choose to surprise market participants Thursday when it buys Treasurys in 10- to 17-year maturities. Its previous foray into buying longer-term Treasurys was relatively small, at $2.5 billion. The Fed could decide to purchase more than it has in the past and send a message to the bond market that it wants to keep long-term yields in check, Mr. Lantz said.

Bernanke's PR Push Rewrites Fed Script

The Wall Street Journal - WASHINGTON -- Ben Bernanke became Federal Reserve chairman intent on making the central bank less personality-driven than it was under Alan Greenspan and Paul Volcker. But as he confronts an economic crisis that has pushed the Fed to shatter precedent and lend trillions of dollars, Mr. Bernanke is waging a public-relations offensive that casts him in the starring role.

The latest example came Tuesday at Atlanta's Morehouse College, where Mr. Bernanke delivered what amounted to an Economics 101 lecture on the crisis. On a day when the government said U.S. retail sales had fallen a worse-than-expected 1.1% in March, Mr. Bernanke told students he's "fundamentally optimistic" about the economy's prospects. After his speech, he sat with undergraduates at a table and took questions with television cameras rolling.

The Fed chief's efforts to speak plainly to Americans come on the heels of a March interview with CBS television's "60 Minutes" and a February appearance at the National Press Club in Washington, where he took questions from a crowd of journalists.http://online.wsj.com/article/SB123975237751018765.html

Rates: When Zero Is Way Too High

Post Courtesy of Emily Mullin

BusinessWeek - Can an interest rate of zero be too high? Unfortunately, yes. A new analysis by Goldman Sachs (GS) concludes that the Federal Reserve's cut in the federal funds rate to a record low of zero to 0.25% on Dec. 16 isn't going to be nearly enough to get the economy going again. The report says the Fed would need to reduce the federal funds rate to negative 6% by the end of 2010 to supply the needed amount of monetary stimulus.

The problem: It's literally impossible to cut interest rates below zero. As a result, "we are entering a world with interest rates that are far too high for the economy's good," Goldman Chief U.S. Economist Jan Hatzius wrote in a Jan. 16 research note.

That's a big negative for a U.S. economy that's already in a deep slump, with retail sales, industrial production, and exports all plummeting. Citigroup (C), Bank of America (BAC), General Motors (GM), and Chrysler, among others, are struggling to keep their heads above water. Circuit City, the second-biggest U.S. electronics retailer, announced on Jan. 16 that it was going out of business and closing all its stores by the end of March. Meanwhile, homebuilders like Lennar (LEN) and D.R. Horton (DHI) are getting squeezed by a record decline in home prices.

Ordinarily when the economy slows, the Federal Reserve can juice it up by cutting short-term interest rates to below the rate of inflation, meaning that in inflation-adjusted terms, rates are actually negative. For example, if inflation is running at 6% per year and interest rates are at 4%, the "real" rate is negative 2%. Negative real rates entice people to borrow money for consumption or investment, which gets the economy going again and soaks up unemployed workers and equipment.http://www.businessweek.com/bwdaily/dnflash/content/jan2009/db20090119_561565.htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis

Mortgage Rates Near a Year High

Home-mortgage rates are nearing their highest levels in a year, adding to pressures on the already weak housing market.

Rates on conforming 30-year fixed-rate mortgages rose by nearly 0.40 percentage point in the past week to an average of 6.71%, according to HSH Associates in Pompton Plains, N.J. Rates on jumbo loans, which are too big to be eligible for purchase by Fannie Mae or Freddie Mac, currently average 7.84%.

The higher rates are making it more difficult for borrowers to refinance and putting another crimp on weak home sales. "It's a tough market and rates going up isn't helping it," said Steve Walsh, a mortgage broker in Scottsdale, Ariz.

Mortgage rates typically move in line with rates on 10-year Treasurys. Treasury rates have risen, but so has the spread between rates on 30-year mortgages and 10-year Treasurys, said Nicholas Strand, a mortgage strategist at Barclays Capital. http://online.wsj.com/article/SB121677010658575383.html?mod=todays_us_money_and_investing