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We Wish You A Merry…And A Neutral New Year

In Jennifer Ablan’s article A Shift to Neutral in ’06 [Barrons] [1] “The real conundrum for investors and economists is to figure out when the Federal Reserve has reached a “neutral” interest rate. That is, a level that neither stimulates nor slows economic growth.”

Right now we seem to be firmly ensconced in a flat yield curve economy. I get worried this could lead to a recession if the Fed doesn’t stop soon.

Source: Barrons

“But among the eclectic group of 15 economists, strategists and traders Barron’s surveyed, more than half believe the Fed isn’t too far from reaching the magic level.”

“All our panelists say the Fed’s policy-setting Open Market Committee will boost its fed-funds target rate by 25 basis points (a quarter-percentage point), its 13th consecutive hike, to 4¼% when it meets on Tuesday. And according to the average estimate of those polled, the Fed will then raise short-term interest rates two more times, to 4¾%, by the end of June. But a majority of our group sees the monetary authorities cutting them once by 25 basis points in the second half, to 4½% by year’s end.”

“Last week, Greenspan wrote to Rep. Saxton that “a flattening of the yield curve is not a foolproof indicator of future economic weakness.” Earlier this year, Greenspan dismissed the argument that slowing growth was bringing down long-term interest rates. “I didn’t want to leave the implication with respect to the yield curve as though I’m concerned that the potential tilting of the yield curve is precursing a significant economic weakness,” he said, adding that low rates could be due to “new forces” in the international marketplace.”

It seems to me that the Fed during Greenspan’s tenure goes at least 2 rate increases too far and within the following year and a half returns to rate cuts…which could mean rising mortgage rates for the next year but not at a rapid clip. Possible mortgage rate reductions in 2007?