- The Washington Times - Thursday, January 5, 2006

It’s official. The yield curve flipped. I have been writing about the movement of short-term and long-term interest rates and speculating that short-term rates would exceed long-term rates, resulting in an inverted yield curve. I’m compelled to write at least one more column on the subject.

Such an occurrence is unusual and counterintuitive. Logically, investors demand a higher return for a longer commitment. This is why 30-year fixed-rate mortgages carry higher interest rates than one-year adjustable-rate mortgages (ARMs).

For several months, I have been noting in this column that certain short-term rates are higher than certain long-term rates. Take the prime rate, for example. The prime rate affects many consumer loans and most home equity lines of credit.

It is considered a short-term rate because it is directly affected by the monetary policy of the Federal Reserve Board. In fact, the Fed’s latest credit-tightening campaign over the past 18 months has pushed the prime rate up from 4 percent to the current rate of 7.25 percent.

Meanwhile, 30-year fixed-rate mortgages are hovering around 6 percent.

Though many short-term financial instruments are carrying higher rates than their longer-term counterparts, the media didn’t focus on the phenomenon until Dec. 27. On that date, the yield on the two-year Treasury bill edged up to 4.35 percent. On the same day, the yield on the 10-year Treasury bill fell to 4.34 percent.

Suddenly, the inverted yield curve became big news.

How does all this affect real estate and mortgages?

First, ARMs are no longer the bargains they once were. In fact, you’ll probably discover that the rate on a three-year ARM, which carries a fixed rate for the first three years, is higher than the rate on a seven-year ARM, which carries a fixed rate for the first seven years.

Let’s look at the big picture. The stock market fell sharply on Dec. 27 because an inverted yield curve historically has been followed by a recession. Some economic talking heads have insisted publicly that it won’t happen this time. Others are siding with history and predicting slower growth by mid-2006.

For homeowners and future homeowners, I can tell you that a weaker economy, whether it’s called a recession or not, tends to keep inflationary pressures in check. When inflation is kept at bay, interest rates often fall across the board.

If we are indeed headed for an economic slowdown in 2006, homeownership may become more affordable, not just as a result of slow or flat price increases, but because of lower mortgage rates as well.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail (henrysavage@pmcmortgage.com).

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