Futures Market 100% Certain Prime Rate Will Hold At 3.25% After The June 24 FOMC Meeting

Back in March of this year, the Fed began buying long-term U.S. Treasury securities with a two-fold objective: a) increased demand would produce lower yields, which would in turn cause the rates associated with 15- and 30-year fixed-rate mortgages to decline, and b) lower yields would also stem the flow of capital to the safety of government debt by souring the Treasury security milk (the government would rather have capital moving to riskier investments like stocks and corporate debt, which would be much better for the economy.)

For a while, it looked like the Fed got exactly what it wanted with regard to mortgage rates. According to the mortgage giant Freddie Mac, the average rate on a 30-year fixed-rate mortgage was 5.47% on December 11, 2008. The average rate dropped below 5% during the winter and spring of this year, declining to 4.78% twice during April.

But now rates may be starting to trend upward. Earlier today, Freddie announced that the average mortgage rate rose from 4.91% last week to 5.29% for the seven-day period that ended today.

So if you've been sitting on the fence waiting for mortgage rates to bottom out before diving into the housing game, you may want to consider jumping in now.

Then again, you may want to take your chances and bet that rates will head south again in the future. That's because the Fed plans to continue buying mortgage-backed securities during the rest of 2009, and long-term Treasury securities into the fall of this year, which will keep downward pressure on rates.

Why Did Mortgage Rates Spike?

The average mortgage rate jumped because investors reacted positively to the not-as-bad-as-expected May employment situation report released by the Labor Department Friday. Wall Street economists were expecting non-farm payrolls to decline by 530,000 last month, but the figure for May came in at 345,000. 345K is still a lots of pink slips, but it’s the softest monthly decline since September of 2008. Investors saw this as sign that an economic recovery may be in the offing, and moved enough capital from the safety of government debt to cause bond yields to spike. As demand for bonds wanes, the yields associated with bonds rises, and as long-term bond yields rise, so do the rates on 30-year FRM's.

Investors are also worried that excessive government spending, combined with the Fed's quantitative easing (a.k.a. printing money), will erode the value of the dollar; that inflation will surge at a pace the Federal Reserve won't be able to manage easily, when the U.S. economy returns to prosperity. Inflation and a weak dollar are both anathema to bond investors.

Here is how the yield on the benchmark 10-year Treasury Note looked over the past 16 days:

• 5 Jun 2009: 3.86%
• 4 Jun 2009: 3.72%
• 3 Jun 2009: 3.55%
• 2 Jun 2009: 3.64%
• 1 Jun 2009: 3.71%
• 29 May 2009: 3.46%
• 28 May 2009: 3.67%
• 27 May 2009: 3.69%
• 26 May 2009: 3.49%
• 22 May 2009: 3.45%
• 21 May 2009: 3.35%
• 20 May 2009: 3.20%
• 19 May 2009: 3.24%
• 18 May 2009: 3.21%
• 15 May 2009: 3.12%
• 14 May 2009: 3.11%

Recent economic news that managed to seduce the bull out of recession-weary investors may well have been the siren song of an economic false dawn. During the Great Depression, there were many instances where the economy looked like it was getting better, when in fact economic conditions were only to get worse.

Home values across much of the country probably won't improve in a significant way during 2009, so whether you choose to get a FRM now or wait a few months, you're probably going to get a deal that'll have you smiling for a while.

Here's an interesting calculation from the good folks at Bloomberg.com (referring to this week's rate spike that Freddie announced today) :

"...This week’s rate increase translates into an additional $31.79 a month for a buyer purchasing the median-priced U.S. home of $170,200 with a 20 percent down payment..."

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As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 100% (as implied by current pricing on contracts) that the FOMC will vote to leave the benchmark target range for the Federal Funds Rate at its current level at the June 24^TH, 2009 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will remain at the current 3.25% after the June 24^TH, 2009 FOMC monetary policy meeting is adjourned: 100% (certain)
  
• NB: U.S. Prime Rate = (The Federal Funds Target Rate + 3)

The odds related to federal-funds futures contracts -- widely accepted as the best predictor of where the FOMC will take the benchmark Fed Funds Target Rate -- are constantly changing, so stay tuned for the latest odds.

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