by marko » Tue 09 Aug 2005, 19:22:00
$this->bbcode_second_pass_quote('jimmydean', 'A')lso continued FED tightening (today and proposed future hikes) means we are nearing the end of cheap money. Those house prices are going to head lower in the new 1-2 years and our supply of credit which fueled the market the past 2 years is also drying up.
Maybe, but this is not yet clear. Probably most of you know this, but the Fed does not set long-term interest rates, such as mortgage rates. Those are set by the market (buyers and sellers), with the 10-year Treasury bill as a benchmark.
Until very recently (the past couple of weeks), long-term interest rates have been drifting down, probably mainly because Asian central banks have been using the dollars that they earn from exports to buy Treasury bills. (They do this rather than convert the dollars into local currency, which would drive the dollar down and make their exports more expensive in the US. They have probably also been doing this to keep US long-term interest rates low because they know that their exports to the US depend on Americans taking on more debt.)
In the past couple of weeks, 10-year T-bills and mortgage interest rates have edged slightly higher. It is unclear whether this a temporary blip or the beginning of a new trend. It is too soon to tell. But it is interesting that this change coincided with China's announcement that it was ending its dollar peg. It may be that China has reduced (or eliminated) its purchases of US T-bills, which would increase the likelihood of a steady rise in long-term rates, but this remains to be seen.
It is also entirely possible that long-term rates could continue to drop, due to purchases by Asian central banks (and Japan spends more dollars on T-bills than China), even as the Fed raises short-term rates. This is called an inverted yield curve. I think that this is what the Fed is hoping. This would bring a modest drop in consumer spending, as people begin to have trouble servicing their credit card debt. (Credit card interest rates are keyed to the short-term rate controlled by the Fed.) The Fed would like to slow the economy down and stop the housing bubble from inflating without bursting it.
My belief is that long-term rates will resume their gradual descent even as the Fed raises short-term rates. There is evidence that the Fed is coordinating policy with Asian central banks, especially the Bank of Japan (BOJ).
I suspect that the BOJ will print yen in order to buy dollars if needed in order to buy enough 10-year T-bills to keep long-term interest rates from rising. The BOJ will act alone if the Bank of China has decided to stop buying because a) they know that Japan's economy is totally dependent on the US current account deficit continuing to expand so that Japan can increase sales to its biggest customers: the US and China (which is also dependent on the US); and b) Japan is counting on the US to protect it militarily from China if things start to get nasty and is therefore committed to doing everything possible to prop up the US economy.
Of course, there is a point beyond which the Fed and the BOJ will be unable to prevent a collapse of the credit bubble (and the global economy). But I think that this is still 2-4 years away. We shall see.
