Federal Reserve & Interest Rates

Trade closed on Friday rather mixed after less than impressive economic reports on manufacturing.

The Dow Jones slipped slightly, by .23%, which is a loss of almost 29 points.  The S&P 500 index was up .08%, or 1.13 points.  The Nasdaq composite index lost .46%, or 10.74 points.

Reports indicated that manufacturing in New York contracted severely.  Consumer confidence is at record lows, and business spending is also contracting.  These reports were less than satisfying for traders.

Import costs rose by 1.7% and export costs fell short of balancing it, rising only 1.2%.  Investors are interested in further incoming data on inflationary conditions and the most current data on the housing market.  The next report on the CPI (consumer price index) is due mid week next week.  Mixed markets indicate some fears and uncertainty about the economic outlook among investors.

Oil prices still remain high, still a few dollars below $100 per barrel.

Consumers are very hesitant to spend under the current economic conditions.  Traders are very tense about the lack of spending.  About 70% of economic performance relies on consumer spending.  With everyone reluctant to buy, individuals and businesses alike, the economy continues to suffer.  Consumer confidence is down to 69.6%, from 78.4 in January. The new economic stimulus plan can give a temporary boost to consumer spending, hopefully, eventually, the money will circulate quickly through spending.

The 30 day freeze on foreclosure activity should perhaps reduce the number of foreclosures in the coming months as delinquent borrowers negotiate better terms with lenders.  Credit conditions are continuing to tighten and more and more fall behind in their mortgages.  Further collapse in the housing market is still possible, however.  Hopefully the pause will keep the market from sinking too sharply in the coming months.

Recession continues to be a strong possibility to those that still believe that recession is not yet official.  Economic reports show consistently negative data, mixed with occasional hopeful news.  Fears of recession seem to be slowing the economy down even further since risks are not as appealing for investing or spending.  Perhaps by mid-year we will see some changes in a positive direction as monetary policy takes effect.

Federal Reserve Chairman Ben S. Bernanke gave testimony today on the economy and financial markets before the Committee on Banking, Housing, and Urban Affairs, and well as the U.S. Senate.

Chairman Bernanke expressed that downside risks remain in the areas of the credit, housing and employment markets, which will probably lead to further interest rate reductions.  Bernanke expects sluggish growth to continue for a period, until the new fiscal stimulus policy takes effect.

He expressed concerns that the housing and labor markets may continue to weaken more than expected.  Credit is also expected to tighten even more so.

Bernanke signaled further cuts when he said, “The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.” Recent actions indicate that the timely response to extreme downside risk information is usually a call for further rate cuts.  Rates have been cut by 2.25% since September.

Monetary policy changes take effect after time passes.  It’s effects are seldom immediate.  Bernanke expects the outlook to improve once recent actions combined with the fiscal stimulus policy start to take effect later in the year.  For now economic uncertainty and downside risks remain, and sluggish growth is expected to last for at least a short while.

Bernanke expects business and consumer spending to improve for the third and fourth quarters into the first quarter of 2009.  He is also expecting inflation issues to moderate later this year.

Other economic data indicates that the U.S. trade deficit has narrowed.  This unexpected narrowing of the trade deficit was a drop of about 6.9% for December.  The trade deficit is the gap between U.S. imports and exports.  It now totals $58.8 billion, which is down from $63.1 in November.  This information may cause an adjustment in the poor GDP reports that showed minimal growth at 0.6% earlier this year.  The weakness of the dollar has given a slight boost to the demand of United States exports.  This demand is slightly offsetting the higher cost of imports for the U.S.

The Bush Administration is instituting a new plan to help homeowners who are facing foreclosures. The new plan, called Project Life Line, will affect a great deal of borrowers that are in danger of losing their homes.

The plan specifically addresses every homeowner who has been delinquent 90 days or more. The Treasury Department, and the Department of Housing and Urban Development are announcing this morning. Serious delinquencies headed for foreclosure will be paused for 30 days so that borrowers can communicate with lenders to work out more affordable payment terms. All foreclosure activity for these homeowners will be suspended for a month, including all stages of foreclosure.

Mortgages held by six major chain banks are already a part of Project Life Line. These are Bank of America Corp., Citigroup Inc., Countrywide Financial Corp., JPMorgan Chase & Co., Washington Mutual Inc. and Wells Fargo & Co. Other lenders will hopefully become involved in the plan as well.

This plan will affect a broader base of home owners that last year’s Hope Now plan. There was a series of criterion that had to be met to qualify for the assistance program. With the new Project Life Line plan, anyone who has defaulted 90 days or more qualifies.

Home prices have been falling and those who borrowed against their equity expecting to sell or refinance now owe more than the worth of their homes. Even those individuals will excellent credit ratings are struggling with high payments. Many adjustable-rate mortgages set up low payment plans for the beginning of repayment, but require higher payments down the line. Since home values have gone down, refinancing would come up short of what borrowers in these situations now owe, and payments still tend to be unmanageable.

With this foreclosure freeze, many borrowers that are in trouble will hopefully be able to work out affordable plans or refinance their mortgages so that they can keep their homes. The six major lenders will be very busy for the next month, as the Project Life Line plan appeals to a broad base of homeowners at this point. Combined with rate cuts and the new fiscal stimulus plan, the rapid increase in the number of foreclosures may slow down. The combination of these positive moves is a step in the right direction.