The Federal Open Market Committee (FOMC) will leave the fed-funds rate target unchanged at 5.25% at their next meeting on September 20, 2006. The combination of such factors as the decline in the housing market, the Federal Reserve staff estimate of GDP running below potential over the next six quarters, and the easing of inflation that should accompany those expectations would ordinarily point to a decrease in the rate target. However, the fact that inflation remains above the 1% to 2% target is worrisome. As evidenced by the hawkish discussion found in the minutes of the last meeting, suggesting a reduction in the rate target is unlikely at this time.
Since the last meeting, we have seen declines in the new and existing housing markets nationwide. The home sales results for July show a decline of 4.1% from June and a troubling 11.2% from the year earlier period nationwide. However, the Northeast, Midwest, and West were the primary drivers of the decline. The South fared better overall with just a 7% decline from the year earlier period (Conkey). Troubling indications that mortgages, especially sub-prime mortgages, are falling past due is compounding the decline. The prevalent use of adjustable rate and other, more exotic loan types by all credit quality customers during the most recent housing expansion could exacerbate the potential problems (Eisinger). Significant rate increases, especially in the 10-year Treasury note that provides the basis for most mortgage rates, could result in significant defaults from customers unable to service their new payment at the higher rate. Going forward, banks have to increase loan/loss reserves and face a reduced appetite for these risky loans in the secondary market.& ...