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May 021, 2011

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"SLOW AND LOW, THAT IS THE TEMPO..." Just like these lyrics from the "Beasties Boys" song, slow and low have been the tune for the Bond market recently, as we’ve seen our slow economy cause home loan rates to move lower recently. What’s been happening, and where are the economy and rates headed? Read on to learn more.

The search for answers begins with last week’s regularly scheduled meeting of the Federal Open Market Committee (FOMC), which was followed on Wednesday by the historic, first-ever Fed Chairman's Press Conference. Here’s a summary of the main points that Fed Chairman Ben Bernanke shared:

Bernanke said the downtick expected in Gross Domestic Product (GDP) is "transitory," and that the economy's temporary sluggishness is somewhat a result of high Oil prices, which he believes is also temporary in nature. Inflation has picked up in recent months but long-term inflation remains subdued. Bernanke was also crystal clear in saying the Fed will complete the $600 Billion of Quantitative Easing 2 (QE2) purchases through June, as originally planned.

So what does all of this mean for home loan rates in the short and long term?

An important factor to keep in mind is the US Dollar, which continues to decline. With QE2 and the dollar printing presses going full steam through the end of June - we should expect the "greenback" to erode further, and how the US Dollar performs after QE2 may have a meaningful effect on the Bond market and home loan rates. A persistent weak US Dollar is ultimately not good for Bonds or home loan rates, as a continued decline would make US dollar denominated assets like Treasuries and Mortgage Bonds (to which home loan rates are tied) less attractive. A weak Dollar is also inflationary, as it makes our exports more expensive.

The bottom line is this: In the short term, Bond prices are close to a position to break out higher, which would lower home loan rates further still. However, in order for this to happen, the Bond must break above a tough level of technical resistance. Longer-term, how the economy performs post-QE2 will determine which way Bonds and rates are headed at that point, but it’s most likely they’ll trend higher.

If the economy, which still has stubbornly high unemployment and millions out of work, doesn't pick up on its own post-QE2, then the Fed will continue its accommodative monetary policy as much as it can to avoid inflation. This is to support the economy and push Stocks higher still...but this would have a further negative effect on the US Dollar, as well as Bonds and home loan rates.