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Greenspan's cheer could push mortgage rates higher

Fed Alert Alan Greenspan says the economic slowdown appears to be over. Treasury yields jumped higher as soon as the words were out of the Federal Reserve chairman's mouth, and long-term mortgage rates are likely to follow.

Greenspan's statement Thursday morning before a U.S. Senate committee marked a change in his opinion about the economy from last week. On Feb. 27, he spoke to the House of an "anticipated recovery" and said the business cycle appeared to be "prompting a firming in economic activity."

On Thursday, just eight days later, Greenspan told the Senate Banking Committee that the "recent evidence increasingly suggests that an economic expansion is already well under way."

An economic recovery implies inflation sometime in the future, and therefore higher interest rates. Traders, prompted by Greenspan's optimism, caused Treasury yields to shoot up abruptly. Fixed rates for 15-year and 30-year mortgages tend to move along with 10-year Treasury yields. So Greenspan's statement to the Senate was expected to indirectly cause a rise in mortgage rates.

Specifically, the yield on the 10-year Treasury note rose from 5.05 percent before Greenspan's speech to 5.17 percent an hour after the speech. That's roughly the same as a one-eighth of a percent increase in mortgage rates.

The rise in Treasury yields doesn't guarantee that every mortgage lender will raise rates immediately. But lenders pay attention to Treasury yields, making it likely that a lot of them would raise rates in response. About 2 1/2 hours after Greenspan started speaking, one prominent lender raised some of its 30-year fixed rates by one-eighth of a percentage point.

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Greenspan's speech to the Senate was almost the same address he gave to the House last week, with a few small, but significant, changes. On Feb. 27 he said "a subdued recovery beginning soon would constitute a truly memorable performance" for the economy. Thursday, he took out the words, "beginning soon."

On Feb. 27 he said the economy "is close to a turning point," and on Thursday he said the economy "is moving through a turning point."

Greenspan became more optimistic after seeing the results of the economic reports of the last week. Auto sales, personal spending and initial jobless claims posted improved numbers. Most important was the manufacturing index compiled by the Institute for Supply Management, which showed the first sign of manufacturing expansion in 19 months. That's important because last year's recession was led by a long-term decline in manufacturing. Consumer spending wasn't affected nearly as much, which made it an unusual recession.

In both speeches, Greenspan declared optimism about the long-term health of the economy, but said that the recovery in the near term probably will be sluggish because consumers already have been spending a lot. Responding to a senator's question Thursday, he said consumer demand "never went down and so there's little room to move back up."

The Fed's Open Market Committee, which sets short-term rate policy, next meets March 19. Right now the overnight lending rate is 1.75 percent. Futures traders at the Chicago Board of Trade regard an interest-rate increase unlikely at that meeting. The real question is whether the Fed will change its bias to reflect a belief that the economic outlook is balanced. Currently, the committee says the risks are toward economic weakness.

The Chicago Board of Trade has priced in a 50-percent chance that the Fed will raise the overnight lending rate to 2 percent by the beginning of June, and traders believe the overnight will be 3 percent in December.

The Open Market Committee's next three meetings are March 19, May 7 and June 25-26."

See Also
How does the Fed Funds rate affect mortgages and should you ...
Graph the fed funds rate, other economic rates
Fed Alert Home
Federal Reserve Board definitions
Federal Reserve Board story archives

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