Economic forecasts released last week point to a challenging year ahead for residential mortgage lenders - and for Wall Street firms that trade mortgage-backed securities.

The economic advisory committee of the Bond Market Association said in its yearend forecast that the Federal Reserve would tighten monetary policy twice next year, by 25 basis points each time, bringing the federal funds rate to 6% at yearend 2000.

It expects the unemployment rate to remain at or below the current 4.1% and inflation to dwindle to a 2.4% rate. Economic growth may decline, it said, partly because of year-2000-related computer problems in the first quarter.

The group also said it expects a "relatively flat yield curve," an indicator closely watched by bond traders and fixed-income investors; a fed funds rate of 6%; and a 6.7% yearend rate for the 30-year Treasury bond.

Ordinarily, a flat yield curve "has not been a friend of the mortgage-backed market," one trader said. The flatness causes less issuance of collateralized mortgage obligations, making it more difficult for investment firms to engage in arbitrage, he said.

Separately, Fannie Mae said it expects that a decline in refinancing activity and in home sales will reduce originations by 25%, to $993 billion, in2000. The company said refinancing activity will decline to 22.1% of originations, from 39.9% this year. Home sales will drop by about 7.5%, to 5.65 million units, it said.

Fannie also predicted that higher mortgage rates will keep the share of adjustable-rate mortgages at about 30% in the first half and that the average cost of fixed-rate mortgages will rise above 8% by the second quarter but decline to about 7.75% before yearend.

David Lereah, chief economist at the Mortgage Bankers Association, predicted a "cyclical downturn" similar to that of 1994, with 75,000 people - 20% of the mortgage industry's work force - losing their jobs as originations decline to $985 billion. His interest rate prediction was decidedly different from Fannie Mae's. Mr. Lereah said the average mortgage rate will rise to 8.3% in the fourth quarter. He said he expects the Federal Reserve to raise rates twice, for a total of half a percentage point.

Mr. Lereah predicted that adjustable-rate loans will make up "almost a third of the origination market." Housing starts will drop 10%, to 1.48 million; existing-home sales 8%, to 4.78 million; and new-home sales 7.7%, to 842,000, he said.

Mr. Lereah said home price appreciation will be the main cause of about a 4% drop in purchase originations. He also said refinancings would fall to 19% of total originations. Volume in the mortgage-backed securities market will drop, in line with the decline in 1999, he said.

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