Curve Watchers Anonymous is watching the yield curve, LIBOR, mortgage rates, and the Fed Funds Rate probability curve. Here’s what’s cookin’.

January FOMC Fed Fund Probabilities

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Chart courtesy of the Cleveland Fed.

The odds of at least a 50 basis point cut by the Fed later this month are all but certain. Odds of a 75 basis point cut to 3.50% have soared to 45%.

Yield Curve January 14th 2008

Click on chart for sharper image.

The above yield curve looks steep. But appearances are deceptive. In relation to the current FF rate at 4.25%, nearly every part of the curve is inverted. That will change on January 30 after the January two day meeting (29th-30th). Assuming the Fed cuts 50 basis points, the yield curve from 10 years out will no longer be inverted in theory, practice, or appearance if it stays where it is.

Steepening Yield Curve Good For Gold

As the Fed slashes rates, the yield curve steepens. This is traditionally a good environment for gold. As noted in Trends in Inflation and Deflation gold is not signaling inflation. Rather gold is signaling a destruction of fiat currency and the Fed’s effort to combat that problem.

Favorable seasonality for gold is typically through January. With that in mind, the upcoming cut, especially a “surprise” cut to 3.5% could mark an intermediate top in gold.

Tossing aside seasonality, there is every reason for gold to continue running. When it come to destruction of credit, problems are severe. Bernanke has finally reached a point of recognition.

LIBOR Is Acting Close To Normal

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With the Fed on hold, and no expectations of hikes or cuts, LIBOR would tend to trade within 10+- basis points above the FF rate. With rate cuts priced in and virtually everyone knowing still more are coming, LIBOR should be below the FF Rate.

Indeed, LIBOR dropped 20 basis points yesterday and is now trading below the FF Rate for the first time since June 2003.

Mortgage Watch

Click on chart for sharper image.
Prior three charts courtesy of the Bloomberg.

15 year mortgages trading 30+- basis points below 1 year arms is rather interesting. This almost looks like “reverse herding”. ARMs rates are clearly very stubborn here.

Anyone remember Greenspan herding people into ARMs at exactly the worst time? Are the same folks being herded into fixed rate mortgages now?

Certainly, every incentive (push?) is being given to those who qualify, to get a fixed rate mortgage. This might sound devious, and perhaps it is. However, the other side of the coin is gun shy lenders just might be scared to death about people taking on more risk than they can afford if interest rates head back the other way.

For the record, interest rates are not headed back the other way any time soon, but lenders are pricing in increased default risk just in case.

Many stuck in ARMs will not be able to refinance. Those in ARMs seem poised to benefit anyway. However for the “truly stuck” it is all a mirage. Mortgage lending standards, fees, down payments, etc, are much different than a year ago. On a comparable basis, mortgage rates are way higher for most than they were a year ago.

Treasury yields will have to drop much further for those in ARMs with rates tied to treasuries to benefit much. More than likely it will be too little, too late for most struggling homeowners. Rising unemployment will exacerbate this problem.

Heaven help us if it becomes socially acceptable for those severely under water on their mortgage, yet still able to make payments, to simply hand over the keys and say goodbye. With that in mind, I am wondering: How long will it take for a book to come out, advocating just that strategy?

Mike “Mish” Shedlock
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