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Investors' expectations shift, mortgage rates jump

The Federal Reserve is trying to talk mortgage rates higher. But the weather did a more-effective job.

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Rates rose this week because investors worried that the back-to-back hurricanes in the Gulf of Mexico could lead to inflation caused by higher fuel prices. That's a switch from just a couple of weeks ago, when investors and economists talked about higher fuel prices depressing economic growth, curbing inflation and keeping interest rates low.

Lately, there has been a shift; now investors and economists say they are concerned that higher fuel prices could lead to higher prices for everything. Mortgage rates went up because of these inflationary expectations.

The benchmark 30-year, fixed-rate mortgage rose 9 basis points, to 5.97 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 0.39 discount and origination points. One year ago, the mortgage index was 5.75 percent.

The 15-year fixed-rate mortgage rose 8 basis points, to 5.58 percent. The 5/1 adjustable-rate mortgage rose 13 basis points, to 5.59 percent.

Warnings from the Fed
Concerns have been building about the inflationary effects of high fuel prices. This week, Federal Reserve Governor Susan Bies told reporters that the longer energy prices stay high, the more likely will be the impact on prices in general.

Her colleague, Janet Yellen, delivered a similar message this week, while drawing the distinction between short-term and long-term inflation. Yellen, president of the San Francisco Federal Reserve Bank, spoke in London this week to members of the parliament, and said: "There is a chance that core inflation may be raised for a time, as a part of the rise in energy prices gets passed through to other goods and services. However, a more-persistent increase in inflation, such as was witnessed during the 1970s, seems unlikely as long as inflation expectations remain well-contained."

And how do the people at the Fed contain inflation expectations? By raising short-term interest rates, threatening to keep raising short-term rates, and complaining that long-term rates are too low.

In her speech in London, Yellen said she wouldn't be surprised to see inflation actually fall in the next two years. Why? Because the Fed "cannot take it for granted that inflation expectations will remain well-contained."

Read that again and savor the circularity of the argument: Inflation might fall because the Fed cannot assume that it will fall. It's the monetary version of the adage that the price of peace is eternal vigilance. As Yellen said, "it is the job of a central bank to earn, through its actions, the public's confidence in its commitment to price stability."

More rate increases coming
That's a strong hint by an alternate member of the rate-setting Federal Open Market Committee that the Fed intends to continue raising short-term rates to keep inflation away.

In the past, the Fed would raise short-term interest rates, and long-term rates would follow. Not so this time around, and it seems to frustrate Fed Chairman Alan Greenspan.

In a speech to the American Bankers Association this week, Greenspan noted that the 30-year mortgage rate has dropped about half a percentage point during the same time that the Fed has raised the federal funds rate from 1 percent to 3.75 percent. "This decline in mortgage rates and other long-term interest rates in the context of a concurrent rise in the federal funds rate is without precedent in recent U.S. experience," Greenspan said.

Translation: He expected long-term rates to rise. He wanted them to rise. But they didn't.

Warning: Infectious euphoria
Greenspan still wants long-term rates to rise. A day after his speech to the bankers, he spoke to a group of economists and lamented that the Fed's success at inflation-fighting carries its own risks -- namely, a reduction in "perceived credit risk and interest rate term premiums." That's another way of complaining that long-term rates are too low.

Greenspan added that periods of low rates have inevitable reversals, resulting from "the all-too-evident alternating and infectious bouts of human euphoria and distress, and the instability they engender."

Today's low interest rates are all in your head, Greenspan is saying. They're infectious euphoria. And someday you will be cured.

-- Posted: Sept. 29, 2005

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15 yr fixed mtg 2.94%
5/1 jumbo ARM 3.30%

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