LAST WEEK - Fed Chairman Ben Bernanke and his Federal Open Market Committee cut to the Fed Funds Rate 0.50%. Here's what the Fed had to say as they announced the cut: "Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time." It is pretty clear that they will take whatever steps are necessary in terms of rate cuts to try and prevent a possible recession, as long as the beast (a.k.a. inflation) remains in check.
At first, both Stocks and Bonds rallied on the warm words from the Fed - but as Bond Traders analyzed the potential future impact of the Fed cut over the following days, they started selling off Bonds with both hands, causing fixed home loan rates in Raleigh ans Cary to rise by .125 to .25%, actually higher than where they stood before the Fed Rate Cut. So what happened?
The reduction of the Fed Funds Rate may encourage increased spending by consumers and businesses, borrowing costs will now be cheaper for Home Equity Lines of Credit, consumer loans like car loans and credit cards, and even business loans as well. Now if there is increased spending this will translate into inflation in the long run - inflation is the enemy for Bonds. Bonds deliver a fixed rate of return, and the value of that return is eroded by inflation. So Bond Traders sold, the price of Bonds moved lower, and home loan rates moved higher as a result. This is counterintuitive to many...but its reality!
THIS WEEK - Fastener your seat belt...we have an action packed economic calendar this week. (Consumer Confidence and Sentiment, New and Existing Home Sales, GDP, Manufacturing) Simply name the report and this week will have it. On Friday we will have the Big Dog" of reports that will lmake all other look small: the highly anticipated Personal Consumption Expenditure (PCE) Index. Why is it so important? This is what the Fed watches most carefully to gauge consumer inflation.
We all know that the Fed feels inflation is presently under control, if not they would have never cut to the Fed Funds Rate. So will this important report show a tame read on inflation, and confirm the Fed's move to cut? Fed Chairman Bernanke and his fellow inflation-fighters at the Fed certainly hope so. Inflation-hating Bonds would also appreciate news of soft inflation, and home loan rates her in the Triangle could improve as well. But what if the report shows stronger than expected consumer inflation? If it does, inflation-hating Bonds will react negatively, and home loan rates Raleigh and Cary will move higher in response.