Thursday, May 1, 2008

Implications Of The Fed's Rate Cut

The Federal Reserve decided to cut rates yet again by a 1/4 point yesterday while signalling that a pause in rate cuts is a probability. While historically any rate cut is significant, the significance of this rate cut is not as much financial as it was a signal that both the financial and credit markets have stabilized to an extent that drastic measures no longer seem to be required (for the time being, at least). It is remarkable that just 7 weeks removed from the collapse of Bear Stearns and near panic in the markets that things have calmed to such an extent. It is early yet, but it appears as if Ben Bernanke has done a remarkable job of steering the Fed through some very perilous straits. As much as a rate cut is significant, the real challenge as far as real estate is concerned, is mortgage rates. Rate cuts do have an impact on mortgage rates, however the larger determinant of late has been the large spread between Mortgage rates and the 10 year treasury. In early 2007 that spread stood around 1.25%. In the middle of the Bear debacle it spiked to 3.5%, and has since gradually decreased to just over 2%. Should we see the spread fade back to historical levels, we could expect mortgage rates drop another point. The spread between the Jumbo mortgage and the 10 year is even larger and has farther to fall.
In sum, the Fed has done a great job of stabilizing the markets and it is starting to be reflected in the spreads. Hopefully this is a trend that will continue, as the real stimulus will come from lower real rates.

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