“UNDER MY THUMB…AIN’T IT THE TRUTH BABY…” Down the hall at the Fed, you could almost hear Alan Greenspan humming along to the Rolling Stones “Forty Licks” album. While Chairman Greenspan has been in charge, inflation has certainly been “under his thumb”, but now it appears that “change has come” in the economy, causing inflation to perk up a bit. Greenspan may now be thinking, “it’s down to me” to get inflation back in check, and is probably contemplating a rate hike as soon as next month.

It’s hard to believe that just a year ago, all the buzz was about deflation, but with Thursday’s hotter than expected Producer Price Index (PPI, which measures inflation on a wholesale level) and Friday’s move up in the Consumer Price Index (CPI, which measures inflation on a retail level), the inflation genie may be out of the bottle. But interestingly enough, in spite of the inflation news, Bonds had a very healthy rally on Friday – their best day since March 5th. Finally, mortgage rates found some stability, and improved by about .125% on Friday.

But wait a minute – if inflation is supposed to be bad for Bonds, why did they rally on Friday? Traders are thinking that the latest figures will send a clear message to the Fed to hike rates. Believe it or not, Bond Traders want the Fed to hike rates. Why? The rate hikes help keep inflation in check. If inflation “gets away” from the economy and runs to significantly higher levels, the value of Bonds will be hurt badly. A move by the Fed to keep inflation under its thumb will be good over the long run for Bonds, although it may sting in the short run. Much like a person who is sick and receives medicine from the doctor to get well – the medicine may taste bad, but without it, the condition gets much worse.

RECENTLY, THE SHARP MOVE HIGHER IN RATES HAVE SENT MANY BORROWERS SCRAMBLING TO SEE WHAT CREATIVE OPTIONS THEIR LENDERS MIGHT HAVE UP THEIR SLEEVES…AND MANY FIND AN APPEALING “ARM”! IS AN ADJUSTABLE RATE MORTGAGE OR “ARM” LOAN NOW THE WAY TO GO? DON’T MISS THIS WEEKS MORTGAGE MARKET VIEW FOR THE STRAIGHT SCOOP.

Finally, some good news! The candle chart below shows a pattern that indicates a strong reversal signal from “sell” to “buy”. This suggests that Bond price improvement will follow, resulting in lower interest rates. You can also see a strong ceiling of resistance at $98.48 looming just overhead Friday’s green “candle” on the far right…and Bonds will have to power through this level before gaining an opportunity to test the next higher ceiling of resistance at $99.09.

Bond Traders are now expecting a 25 basis point interest rate hike by the Federal Reserve at their next FOMC meeting scheduled for June 29-30. Using the Fed Funds Futures as a predictor…it indicates that the financial markets are currently pricing in a 92% probability for the hike to take place at the June meeting. Interestingly enough – this strong belief makes it even more likely that the Federal Reserve will make the rate change. Since the expectations are so high, if the Fed takes any other action than what is now expected, their actions could really “upset the apple cart.” Bonds could actually sell off hard – causing mortgage rates to worsen significantly – if the Fed doesn’t raise short-term interest rates. They could also sell off if the Fed surprises the financial markets by increasing rates much higher than the 25 basis point increase expected. The Fed will be walking a tightrope between now and the June 29-30th FOMC meeting.

Bottom Line: Mortgage interest rates should move a little lower this week.

The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails…William Ward.

If you have been in the market for a mortgage during the past three years, you may have gotten a bit spoiled. Historically low rates that seemed to keep getting lower have offered an incredible opportunity to purchase a home or save significant money by refinancing an existing mortgage.

Lately, rates have risen to their highest level in over two-years, as the economy appears to be firing on all cylinders. While mortgage rates are still attractive, taking a fixed rate loan is not the “no-brainer” it was just a couple of months ago when they hovered around 5%.

So what can we do now to keep our payments low, without elevating risk beyond our tolerance? Adjustable Rate Mortgages or “ARM’s” may be a terrific alternative. Let's look at a 5-year ARM as an example. Many 5-year ARM rates are almost a full 1% below fixed rate programs, which can make for a significant savings. But what about the downside risks of ARM loans? What happens after the initial 5-year honeymoon? Sure, the rate can move higher, but there are a few additional factors that should be taken into account.

Let’s first look at the time frame a family anticipates being in that home. Some think that a 5-year ARM only fits if the intention is to remain in the residence for a matching 5-year period. While this appears to be logical, it begs further consideration. Even if rates moved to their worst possible levels, the savings that had been gained in the initial 5-years would last into the 6th and 7th years when balanced out against the higher rate of a 30 year fixed. Better yet, if the savings during the first 5-years were used to pay down the mortgage, then it would likely take 8 or 9 years for a fixed rate to have been more advantageous. This gives the homeowner much more of a cushion then they may have first thought.

Certainly, there are no guarantees as to the time that someone will remain in a home, and ARM rates are not for everyone. But they do offer a way to lower payments with a reasonable period of safety.

However you decide to adjust your sails…it’s always important to consider risk tolerance levels and pure emotion. Even if an ARM loan appears almost assuredly to be a better financial option – if the worry over possible higher rates down the road will cause years of restless sleep – it may not be worth it.

To evaluate all of your options or learn more about ARM loans, please contact me for assistance. I am always here to help!

We have a reduced economic calendar scheduled this week with most of the action happening on Thursday. The report having the greatest potential for impacting the way the mortgage bond market trades this week is the Philly Fed manufacturing index on Thursday. Bond traders will also be interested in today’s New York Empire State manufacturing index, but as the “youngest” of the regional manufacturing indices, more emphasis will be on the Philly Fed report. Analysts are anticipating both of these manufacturing indices will continue to show strong economic recovery and growth this week.

Remember, as a general rule, weaker than expected economic data would indicate the economy is not improving as quickly as expected, and could cause mortgage rates to improve. Positive data would indicate a strengthening economic climate, and could cause mortgage rates to gradually climb higher.

For the week of May 17 – May 21, 2004