the visible hand

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Fed rate cuts can’t stop long-term rates from rising

Posted by ecoshift on February 25, 2008

Interest rates: The new conundrum
By Chris Isidore, CNNMoney.com senior writer
February 25 2008: 8:25 AM EST

NEW YORK (CNNMoney.com) — The Fed has lowered short-term interest rates this year but longer-term bond yields have risen. Call it the new conundrum. And it’s adding to the confusion on Wall Street about the economy.

In his final year as chairman of the Federal Reserve, Alan Greenspan repeatedly talked about a “conundrum” in the markets. He was referring to the fact that rates for the 10-year U.S. Treasury and 30-year mortgages remained low even as the Fed jacked its key short-term federal funds rate from 1% to 4.5%.

This conundrum didn’t go away after the Maestro retired either.

By the time Greenspan’s successor Ben Bernanke was done raising rates in June 2006, the yield on the 10-year Treasury stood at 5.22% while the federal funds rate was at 5.25%

What’s more, the 10-year yield was only 0.6 percentage points higher than where it was when the rate hikes began two years earlier. The average 30-year fixed rate mortgage had risen by less than a half-point.

These low long-term rates helped fuel the home building boom and the credit market’s appetite for securities backed by increasingly riskier mortgage loans. And it arguably put the economy into the trouble the Fed finds itself dealing with today.

So starting last September, the Fed started trimming rates. And last month, it slashed rates, with two cuts totaling 1.25 percentage points in a little more than a week.

But long-term rates are once again moving in the opposite direction of the Fed: the yields on the benchmark 10-year Treasury note and fixed-rate mortgages are higher now than where they were in late January. This could add to pain in the housing market…or be cause for optimism. It depends on who you ask.

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One Response to “Fed rate cuts can’t stop long-term rates from rising”

  1. Mason said

    It’s been quite a late to say that “the Fed is cutting the interest rate.” we might be considering a refinance, and we’re waiting to move forward till the Fed takes action again. But we need to be smart about waiting and watching. A Fed cut doesn’t directly affect long term rates (for instance a 30 year fixed mortgage), but it does impact long term mortgages rates. The problem is the impact might not have the result we’ve been waiting for.

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