rising long-rates as the Fed eases(ZT)

Easier Fed policy seems likely to do very little to change thetransmission of weakness from housing to broader consumer spending.



Remember,the key to the Fed easing monetary conditions for the household sectoris getting long rates down. Long rates have not come down: in fact,there's a hint that the Greenspan conundrum – the unexpected decline inlong rates in the face of tighter Fed policy – has been supplanted by aBernanke conundrum, rising long-rates as the Fed eases. Admittedly, Idon't expect this to last: if growth weakens as I expect then Treasuryyields will come down. But the simple point for now is that the Fedrate cut did not lead to an easing in what in this cycle is the mostimportant interest rate: the mortgage rate.



Takingthis a second step, it's important to understand the limitations of Fedpolicy in this cycle. A common view seems to be that the Fed has‘reloaded' the monetary policy shooter. Yes, the funds rate target,which was cut in the last cycle downswing from 6½% to 1%, was returnedto 5¼%. But from a household sector perspective, short rate bullets areblanks: what matters is the long rate. The average effective interestrate on the stock of mortgage debt is now 6.3%, only marginally abovethe 2004 low of 6.1%. That's in part because the wave of mortgagerefinancing that occurred in 2002-03 – as the long-end Treasury yieldfell towards 3% – has locked in mortgages at what are now well-belowmarket rates.



To stretch the metaphor, the Fed'sreloaded the pistol but its rifle is empty. Yes, those mortgages willbe able to be refinanced if Treasury yields head back towards 3% (or,more realistically, below 3% given the widening spread between mortgagerates and Treasury rates). But if we do see Treasury yields below 3%(and ultimately I do expect that) I'm sure that will be because the USis already in recession.







Gerard Minack

Morgan Stanley