Newspaper article The Christian Science Monitor

Signals Mixed on US Interest Rates ; the Fed Is Tightening, but Long-Term Rates Aren't Keeping Up. Some Worry It Means That Economic Growth Will Slow

Newspaper article The Christian Science Monitor

Signals Mixed on US Interest Rates ; the Fed Is Tightening, but Long-Term Rates Aren't Keeping Up. Some Worry It Means That Economic Growth Will Slow

Article excerpt

Interest rate forecasting has now become almost as difficult as predicting the path of a hurricane.

Even after the Federal Reserve raised interest rates 0.25 percentage points last week, there is now a wide disagreement over whether rates will be rising or falling next year, reflecting a split over the pace of future economic activity.

The pessimists expect economic growth to slow in 2005, although they don't project a recession. The overall bond market now seems to be in this pessimistic camp. Professional bond traders haven't pushed long-term interest rates up on pace with the Fed's tightening of short-term rates. In effect, the bond market seems to signal a slowing economy that will put a damper on the Fed's rate hikes.

The optimists, however, foresee the economy skipping along at a relatively brisk pace that would be powerful enough to cause the Fed to continue raising rates through the year.

"The forecasts are all over the map," says Jose Rasco, an economist with Merrill Lynch & Co.

The difference in terms of the future direction of rates is fairly wide. Economists in the glum camp see 10-year treasuries paying less than 4 percent interest next year - down from 4.25 percent currently. The optimists foresee those same rates rising close to 6 percent.

"The spread is as wide as I can remember in the last 25 years," says Sung Won Sohn, chief economist at Wells Fargo Banks in Minneapolis. "That's because we're at a turning point where interest rates that have been declining are now beginning to rise in what could be a major trend."

Impact on housing market

There are widespread implications for either forecast. For example, the housing market is one of the most interest-rate sensitive areas of the economy. As interest rates rise, fewer consumers qualify for loans or even bother applying for them. If the economy does not improve as rates are being raised, it could mean as many as 250,000 new homes would not get built, says Michael Carliner, an economist at the National Association of Home Builders.

And in a growing economy, rising rates may make it harder for some people to afford a mortgage. Consider a $200,000 loan. A monthly payment that is $1,412 at a 7.6 percent mortgage rate would be $1,136 if the mortgage rate is 5.6 percent.

"It might disqualify some and others might be unwilling to pay it," says Mr. Carliner. "However, interest rates are less sensitive than in the past because the awareness and cost of refinancing has changed so people are willing to buy now and if the rates fall, get a new mortgage. …

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