"For many people, the single biggest financial shock and surprise over the next decade will be the revelation that the Fed has never really known what on earth it was doing."
The Federal Reserve's second round of quantitative easing (QE2) was supposed to keep interest rates low, spur economic activity and halt deflation. But in fact, mortgage rates have been rapidly rising.
"The average 30-year mortgage rate rose to 4.61 percent from 4.46 percent last week. It hit 4.17 percent a month ago, the lowest in 40 years of record-keeping."
Associated Press (12/10)
Ironically, this rise in mortgage rates came shortly after QE2 was announced. Mortgage rates generally follow 10-year Treasuries, and as Reuters reports (12/13):
"The benchmark U.S. 10-year Treasury note yield briefly pushed above 3.375 percent. That constituted a nearly two-thirds retracement of its May-to-December move...
"Benchmark U.S. yields are now at six-month highs."
Investors have been selling bonds -- driving prices lower. Yields rise as bond prices fall. This is the opposite of what the Fed intended with its $600 billion Treasuries purchase. The rising rates are being chalked up to tax cut extensions, which contribute to an increasing deficit and a perceived lack of fiscal discipline.
And these rising rates are coming at a time when U.S. home values will decline by an estimated $1.7 trillion in 2010 (exceeding the $1.05 trillion loss in 2009, according to the real estate website Zillow). The Mortgage Banker's Association says the rise in rates is already discouraging refinancing, now down four weeks in a row.
The deflationary trend was already in place well before "QE2" and the tax cut extensions were announced. QE2 is simply another Fed reaction:
"In setting interest rate policy and monetary policy, the Fed reacts to trends; it doesn’t lead anything."
Elliott Wave Theorist, November 2010
The evidence so far shows that the Fed's attempts to stop the deflationary trend will fail, including home values.
"When it hits full force, deflation will take almost everyone by surprise, even though the buildup has been long and deep. It includes a four-year, 25% drop in home prices..."
Elliott Wave Financial Forecast, December 2010
Twenty-five percent of homeowners are underwater with their mortgages. In turn, many tend to treat their residences like renters. They spend less on home improvement, which in itself is deflationary.
Where is the residential real estate market headed? Let's return to EWI's Robert Prechter's second edition of his New York Times bestseller
Conquer the Crash, p. 157:
"At the bottom, buy the home...of your dreams for ten cents or less per dollar of its peak value."