54 words cause mortgage rates to spike
By Holden Lewis • Bankrate.com

It took 54 words for Alan Greenspan to send mortgage rates skyward.

When Greenspan, chairman of the Federal Reserve, went to Congress Tuesday to deliver his semiannual economic report, mortgage rates had been tranquil for a week, edging downward slightly. Minutes after Greenspan opened his mouth, long-term rates blasted off the launch pad.

The benchmark 30-year fixed-rate mortgage rose 22 basis points to 5.83 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.34 discount and origination points. One year ago, the mortgage index was 6.54 percent.

The rate on the average 30-year mortgage has climbed more than a half-point in three weeks. The Bankrate.com index on the 30-year fixed-rate mortgage was 5.31 percent the week of June 25. The last time mortgage rates were higher was the week of April 23, when the average 30-year clocked in at 5.84 percent.

The benchmark 15-year fixed-rate mortgage rose 23 basis points to 5.20 percent. The benchmark 1-year adjustable-rate mortgage rose 9 basis points to 3.86 percent.

You are welcome to skip this paragraph, but if you're trying to fall asleep, here are the 54 words that Greenspan uttered, and which sent markets into a tizzy:

"Indeed, the FOMC devoted considerable attention to this subject at its June meeting, examining potentially feasible policy alternatives. However, given the now highly stimulative stance of monetary and fiscal policy and well-anchored inflation expectations, the Committee concluded that economic fundamentals are such that situations requiring special policy actions are most unlikely to arise."

Bond traders translate the chairman's words as he speaks them. When he says "FOMC," they know he means the rate-setting Federal Open Market Committee. For old hands in the Greenspan-watching trade, it's like viewing a poorly dubbed Godzilla movie, in which the Japanese actor's lips keep moving long after the dubbed line in English has ended. Here's what holders of U.S. Treasuries heard as Greenspan spoke: "The Fed's not going to buy Treasuries to hold down long-term interest rates. You might as well sell them now."

So they did. Supply exceeded demand, so Treasuries prices cratered. Yields move in the opposite direction of prices, so yields shot up. And that caused long-term mortgage rates to rise, too.

Speculators had been hanging onto Treasuries, hoping that the Fed would buy them at a high price, because the Fed had raised the possibility a few months ago. Early this year, the Fed floated the notion of buying up Treasuries to drive down interest rates even further. The Fed would deploy such a tactic only in an emergency, and some investors bought Treasuries in case such a crisis came to pass.

When Greenspan pronounced that possibility "most unlikely," Tuesday's sell-off began.

There's another big reason for Tuesday's rate jump, says Steve East, chief economist for Friedman, Billings, Ramsey Group near Washington, D.C.: The Fed predicts rapid economic growth in 2004.

Tuesday morning, as Greenspan began addressing the House Financial Services Committee, the Fed released its semiannual monetary policy report to Congress. In the report, the Fed predicted that the U.S. economy will grow 3.75 to 4.75 percent in 2004. That's really strong, East says, "especially that four-and-three-quarter percent. That's exceptionally strong."

And exceptionally strong economic growth, along with low interest rates, lower taxes, increased government spending and huge federal budget deficits, pave the way for a return to inflation. Add those expectations together and you get higher long-term interest rates.