Feeling Out The Fed: Two Analysts Expect Rates To Again Decline

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At least one economist is suggesting that new Fed Chairman Ben Bernanke may be wondering why he ever agreed to accept the job.

WesCorp's Dwight Johnston, vice president of economic and market research, and Ron Araujo, vice president of investment strategy and education, noted a Bloomberg poll of 70 economists' expectations for yearend 2006 included a median prediction of a Fed Funds Rate at 5%-precisely where it is today. The reason: worries over inflation are being balanced by concerns on the growth side.

"Poor old (Fed Chairman Ben) Bernanke. He's off to a rough start, to say the least," said Johnston. "It has nothing to do with policy, it's been the way he's communicated with the markets. To be fair, the last Fed message on May 10 was remarkably clear. The markets just didn't like the message. The markets have been spoiled over the last one-and-a-half years by the measured pace of rate increases. Now, there is uncertainty."

Added Araujo: "The entire point of raising rates is to get to a neutral point."

The Fed will "let the markets set the pace," Johnston said, and might not respond as swiftly to inflationary signals. He said the speculative fervor in commodities is something to keep an eye on. WesCorp does expect higher inflation numbers going forward, but only temporarily, he added.

As for housing, Johnston said there are more homes for sale in the U.S. market than any time before.

Stocks of the major home builders are down significantly since July 2005, and a sharp rise in inventories in formerly red-hot markets such as Phoenix, Miami, Washington, Los Angeles and San Diego raises concerns.

"The overvaluation numbers in these markets dispute the notion there are no signs of a bubble," said Johnston. "Sustainability is a huge concern for people who just bought one year ago. Many people who were late to the party have zero or negative equity."

The Fed could continue to raise short-term rates (or not), depending on factors such as the direction of the consumer price index, the housing market and payroll growth, the two said. Johnston said WesCorp expects the Federal Funds Rate will fall in the second half of 2006, "or it certainly will in 2007."

Araujo's advice for credit unions: "At least a plausible scenario can be made rates will fall even lower than the slow scenarios. Look for investments that will supply income and safety. Buy extendable securities where the credit union has the right to extend the maturity date some time in the future. This controls interest rate risk."

Johnston counseled credit unions to watch for an increase in delinquencies, especially in mortgage loans.

Johnston said the yield curve will keep the heat on margins, although he foresees the possibility of an influx of liquidity in late 2006.

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