by John M. Curtis
(310) 204-8700

Copyright January 25, 2006
All Rights Reserved.

atching the bond market's inverted yield curve raises red flags for fund managers, doubtful about corporate growth in 2006. With earnings uncertain, investors are betting short-term rates might head back down as the economy loses steam. Global events, like rising oil prices and the prospects of more terrorism, also don't bode well for the stock market, or, for that matter, today's real estate boom. No matter how rosy the picture, economic forecasters don't like to see the yield on short-term treasuries exceed long-term rates, raising concerns about an economic downturn and possible recession. Following the same trend as last year, 2006 has watched the 6-month T-bill rise to 4.26% while the 10-year T-bond has dropped to 4.37%, leaving a gap of only 11 basis points. While not inverted yet, the gap between long short-term rates send chills through Wall Street.

      Federal Reserve Board Chairman Alan Greenspan has been relentless, hiking the Federal Funds Rate 14 times since June 30, 2004, now at 4.25%. More rate hikes are on the way, anticipating higher yields in short-term notes, including the 6-month T-Bills. With many real estate investors relying on adjustable rate mortgages, negative amortization loans and interest only options to stay solvent, further rates-hikes could lead to late-pays, defaults, foreclosures and bankruptcies. “As a borrower, you have nowhere to hide,” said Greg McBride, financial analyst at Bankrate.com. Like the inverted yield curve, gaps between adjustable and fixed- rate loans have been narrowing since 2004, when Greenspan began increasing short-term rates. Instead of fighting inflation, Greenspan raised short-term rates to make U.S. treasuries more attractive to foreign investors, already taking a beating on currency exchange.

      Gold prices have been steadily rising along with short-term interest rates. Gold typically increases while stocks steadily decline. Yet so far, equity values haven't taken the kind of hit expected with rising precious metal prices. With Ford Motor Company announcing downsizing and massive layoffs in its North American Automotive Operation, jitters ran through the stock market, causing today's sideways movement. Fund managers take short-term strategies, trying to capitalize on buying low and selling high. Private investors can only sit back and watch investments gyrate. Rushing to commodities, like gold and sliver, reflect growing uncertainty, stemming from the unsustainable of corporate earnings growth. Many businesses have earnings tied to the auto industry, shaking investor confidence when corporate icons announce layoffs and downsizing.

      Inverted yield curves spell trouble for real estate speculators currently in a six-year feeding frenzy, driving prices into outer space. Investors relying on meeting obligations with cheap short-term interest rates are beginning to sweat, as payments increase on adjustable mortgages. As investors get squeezed, they're forced to refinance, liquidate holdings or default on current obligations. In either case, inventories swell and prices begin to fall. Rising rates have already taken a toll on inflated markets, causing prices to deflate. With many speculators paying little or nothing down, falling prices leave some investors upside down, owning more than current market value. When home equity lines dry up, investors have no choice but to get out, leaving markets with too much inventory, further depressing prices. Rising rates, deflated real estate values and empty home equity lines anticipate economic problems.

      Higher short-term rates eventually take a toll on real estate speculators. When real estate prices drop, equity dries up, leaving investors unable to convert costly adjustable rate loans into fixed rate mortgages. Even with the current inverted yield curve, fix rates would dramatically boost monthly payments, assuming borrowers could qualify for new loans. Adjustable rate mortgages typically have more liberal qualification guidelines, both in terms of monthly income and loan-to-value ratios. “It reinforces a soft-landing scenario,” said Richard DeKaser, chief strategist at Nation City Corp. in Cleveland, believing that an inverted yield curve will push speculators to convert adjustable rates to fixed. There's no soft landing when investors are stretched to the breaking point, can't meet current obligations and panic about their next moves to stay financially afloat.

      Today's inverted yield curve spells trouble for real estate speculators, the real estate market and overall economy. Rising short-term rates hurt real estate investors, hopelessly dependent on artificially diminished payments from adjustable rate mortgages. It's tempting to ignore the inverted yield curve, attributing it to zealous foreign investors locking in long-term yields. Yesterday's dot-com bubble or tech-wreck suggests that most wild speculation ends in market crashes. Today's inverted yield cure suggests that six-consecutive years of inflated real estate values may be coming to an end. While real estate differs from the stock market, speculation usually leads to a day of reckoning. Rising short-term rates make real estate speculation a dangerous game, tempting speculators to rely heavily on adjustable rate loans. Sooner or later, the inverted yield cure catches up with zealous investors.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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