The Veridian Blog

Today's Fed cut was a classic example of how its correlation (or lack of) to mortgage rates is often misunderstood.  The 10-year note fell significantly today despite the Fed decision to cut the overnight rate to 4.50% and the Discount Rate to 5.00%.  Why?  It's because bond traders are looking into the future, and based their actions on the FOMC directive implying that they are reluctant to cut rates again. 

In particular, that understanding was driven by three items: (1) the committee judging the upside risks to inflation roughly balance the downside risks to growth - in fact the GDP number came in very strong today; (2) the acknowledgment that recent increases in energy and commodity prices may put renewed upward pressure on inflation (yikes!) and (3) the indication that Fed President Hoenig voted against a rate cut, saying he preferred no change in the fed funds rate

In our opinion, the most influential downside factor today was probably inflation worries but over the next few weeks will not outweigh the growing weight the subprime fallout is going to place on the economy.  GDP may be strong now, but it takes time for illiquid market to truly show its ugly colors.  The Jumbo loan markets, for instance, jumped significantly only as recent as August.  Once the dust settles, the Fed will move again.  To that end, we are in full support of the Fed cut today and another one by year end. 

Happy Halloween!