The financial markets are becoming fixated on US interest rates, the Federal Reserve, inflation, Ben Bernanke and their impact on the US dollar, which is no longer the fall guy for the easy investment decisions for all those overpaid bankers and investment fund managers and punters.

As pointed out yesterday, the surprisingly encouraging employment report for November has turned sentiment, driving the US dollar higher as the market frets that rate rises will come earlier than expected from the Fed and end the easiest bonus-boosting play in the world. That happened again overnight with Wall Street weaker, oil and gold down, dragging other commodities lower as the greenback retained its stronger tone.

For most of this year the easy play has been to borrow heavily at the short tern, paying next to nothing for the funds, thanks to the Fed’s record low rates of 0% to 0.25% (For example, three-month US Treasury notes have been selling for close of zero an on in recent months) and then punting it into corporate bonds paying 7% to 10%, government 10-year bonds at 3.30% or better, gold, oil, other commodities, Aussie dollar assets, Kiwi dollars, Brazilian reals (where rates are 11%-12%) and looking like a hero.

This shell game is being played on both sides of the Atlantic, mostly in New York and London since they are in countries where the respective currencies have sunk and the economies and banking systems were the biggest disasters in the crunch with multibillion dollar bailouts of people who caused the crunch and crash in the first place.

But now the markets are extra sensitive to every twitch of a regulatory rate riser’s lips. And so it was overnight when Fed chairman Ben Bernanke spoke in Washington.

There was nothing really new in his comments, but those previously reported comments on the economy growing next year; his “best guess” that US unemployment will stay higher than desired for the foreseeable future and that the economy continues to face “formidable headwinds” that are likely to result in only a moderate recovery, were all suddenly new gold against the backdrop of the November employment report.

“The economy confronts some formidable headwinds that seem likely to keep the pace of expansion moderate. We still have some way to go before we can be assured that the recovery will be self-sustaining.

“My best guess at this point is that we will continue to see modest economic growth next year — sufficient to bring down the unemployment rate, but at a pace slower than we would like.”

“Household spending is unlikely to grow rapidly when people remain worried about job security and have limited access to credit,” he said. We will get more of the same a week next Thursday when the Fed ends its final meeting for 2009.

Now all of this sends a signal that interest rates will not rise any time soon in the US, and yet the market is now fixated on the timing of a rate rise and is preparing for one, much in the way traders been busily anticipated the rebound in the economy well before it happened, and financed their confidence (and their new bonuses) with cheapo money from the Fed.

But there were again a couple of unwelcome reminders of reality in the US economy overnight.

US consumers’ outstanding credit balance fell for a record ninth month in a row in October, but the decline wasn’t as steep as the market had been expecting. The Fed announced overnight that outstanding balances of consumer credit fell by $US3.51 billion, or 1.7% annualised, in October to $US2.482 trillion.

The market had been expecting a fall of more than $US9 billion. Consumer credit is now down 3.6% from a year ago. That’s down from a fall of 6.6% earlier this year and comes after previous monthly falls were cut by the Fed finding more up to date credit figures from banks and other lenders.

But there was a timely reminder that there’s still plenty of the muddy stuff to hit the fan with news that defaults on commercial real estate mortgages continue to worsen.

The US Mortgage Bankers Association said that arrears on commercial mortgage- backed securities at least 30 days past due rose to 4.06% in the September quarter, from 1.17% in the same quarter of 2008.

That’s the most since the MBA began tracking the loans in 1997. About 3.43% of bank-owned loans on offices, apartment buildings, shopping centres and other income-producing properties were at least 90 days past due, up from 1.38%. These souring mortgages are now the biggest cause of bank collapse in the US and account for a clear majority of the 130 failures so far.

They have overtaken home loan mortgages, especially subprime failures, as the leading cause of failure.

But mortgages on home loans and small multi-family dwellings remain more than double the CMBS rate. The MBA said last month that the delinquency rate for mortgage loans on one-to-four-unit residential properties rose to a seasonally adjusted rate of 9.64% of all loans outstanding as of the end of the third quarter of 2009, “up 40 basis points from the second quarter of 2009, and up 265 basis points from one year ago.” The non-seasonally adjusted delinquency rate “increased 108 basis points from 8.86% in the second quarter of 2009 to 9.94% this quarter.”

Many of these loans are now moving into foreclosure, something that has yet to hit the commercial real estate market in the US in a major way. That will happen in the first half of 2010.

That’s the dilemma for the Fed: stick rates up as the markets are starting to urge (for various reasons, including inflation, which is odd because it is not a worry) and watch commercial real estate losses soar and home loan losses and foreclosures escalate, and big banks again tremble.

Peter Fray

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