Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve System, told congressional leaders in a letter yesterday that the Fed will seek to renegotiate mortgages it owns that might otherwise enter foreclosure.

It is unclear how many homeowners stand to benefit. Under the program, the Fed can reduce what a homeowner owes on a mortgage, lower the interest rate, lengthen the term of a loan or take other steps to keep a loan from defaulting, if doing so would offer taxpayers a better long-term payoff than foreclosure.

The interesting thing is that this has been going on now for almost a year through reputable loan modification companies.

Scott Jenkins, a homeowner in Irvine CA, worked with Mortgage Modification Legal Network located in California and says. I felt like my mortgage company was giving me the run around and I needed help now. I contacted the Mortgage Modification Legal Network and my mortgage modification was done in 10 days. I truly believe that waiting on the government or federal programs would of landed me in a shelter or even worse.

This latest attempt to help homeowners should be taken with caution. The new policy applies only to mortgages the Fed controls through three companies formed to hold mortgage-related assets it acquired last year from the collapse of investment house Bear Stearns and insurer AIG. Those three companies hold roughly $74 billion in assets. That is only a fraction of the total troubled mortgages and mortgage-backed securities

As in the past government announcements seem to be the lifeline homeowners need to rescue them from foreclosure. Then you look at the fine print. Individual borrowers are unlikely to know whether their mortgages are owned by the Fed, but if they qualify for Loan Modification, they would deal only with their mortgage servicing company.

Trying to figure out if you mortgage is owned by the Fed is more than likely going to be a timely task, something homeowners facing foreclosure can not afford. A loan modification can stop foreclosure and is usually the best option for homeowners. It is recommended that you contact a loan modification attorney for assistance.

The Federal Reserve also announced it will use new tools to stimulate the economy and curb foreclosures. The Federal Reserve on Wednesday kept its benchmark lending rate near zero and said it’s likely to stay that way for some time, while also signaling new efforts to lower home mortgage rates.

The Fed left its target for the fed funds rate unchanged at a range of zero to a quarter-point. This ensures that most consumer lending rates will remain unchanged, too. The Fed promised new steps to boost lending to consumers. It also suggested that it would soon purchase Treasury bonds to decrease other lending rates notably, home mortgage rates and long-term corporate loans.

The Fed has also accepted collateral spurned by private lenders, expanded the kinds of institutions that can borrow from the Fed and extended repayment periods.

All this being said the probability of this having a big impact on the economy and foreclosures is low. A report on Friday is expected to show the economy contracted at a 5.4 percent annual rate in the final three months of last year, which would be the steepest falloff in activity for any quarter since 1982.

Testifying before the Senate Banking Committee, Bernanke acknowledged that European debt problems are slowing U.S. growth, as is the protracted slump in the U.S. housing sector. He said mounting federal budget deficits must be addressed, but added that government spending is warranted given the lack of private-sector demand for goods and services.

Bernanke shot down suggestions that his Fed is out of bullets should the economy slide back toward contraction.

“If the recovery seems to be faltering, then we at least need to review our options. We need to think about possibilities. But, broadly speaking, there are a number of things we could consider” he said.

The Fed’s benchmark interest rates, a main lever of the central bank to spur economic activity, have been near zero for the past two years. That’s led some economists to worry that the Fed is running out of options to spark a slumping economy.

Bernanke countered that there are a number of unconventional steps the Fed still could take to stimulate the economy, ranging from resuming purchases of mortgages to reinvesting in securities to issuing a statement that interest rates will remain at zero for a fixed period to provide certainty to investors.

“We have not come to the point where we can tell you precisely what the leading options are” he said, adding that “policy is already quite stimulative. I think we still do have options, but they are not going to be the conventional options.”

Bernanke was blunt about the challenges, and he acknowledged that some government stimulus that powered the expansion in the first half of 2010 is likely to fade.

“Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth” Bernanke said in opening remarks.

He later discounted, when asked directly, the chances of sliding back into recession.

“Our expectation is still for a moderate recovery which will over time bring down the unemployment rate. That’s still our main scenario, that the economy will continue to grow and that private demand will take over as the driver of growth” he said.

Financial markets slumped shortly after Bernanke’s testimony was made public, in part because of his acknowledgement that “the economic outlook remains unusually uncertain” but the thrust of what he said was positive.

Real consumer spending appears to have expanded at about a 2.5% annual rate in the first half of 2010, Bernanke said, with purchases of durable goods “such as large appliances” increasing especially rapidly.

The economic forecast of the Fed’s Open Market Committee (FOMC), which sets the benchmark lending rate that influences borrowing costs across the economy, remains mostly unchanged, he said. Most FOMC members expect the economy to grow at a rate of 3-3.5% this year and 3.5-4.5% in 2011 and 2012, and they anticipate a jobless rate of 7-7.5% by late 2012.

Not everyone agrees with the Fed’s assessment

“This forecast looks a bit optimistic. Our own outlook calls for growth of 2.4% in 2010 and 2.5% growth next year” Mark Vitner, senior economist with Wells Fargo Securities in Charlotte, N.C., wrote in a research note to investors after Bernanke’s testimony.

What Bernanke didn’t say was also noteworthy. There was no mention of the threat of deflation, a fall in prices across the economy.

Deflation leads businesses and consumers to hoard cash on the assumption that prices will be lower soon, and growth skids. The word deflation doesn’t appear anywhere in Bernanke’s 56-page Monetary Policy Report to Congress, either.

Yet some prominent economists fear that the United States is nearing a deflationary cycle like the one now in Japan. They point to core inflation, which strips out volatile food and energy prices. Through June, it was running at a year-over-year rate of 0.9%, the lowest increase since 1966. That’s below the Fed’s target rate of 1-2%.

“Bernanke has thought long and hard about how to avoid a Japanese-style economic trap, and the Fed’s researchers have been obsessed for years with the same question. But here we are, visibly sliding toward deflation and the “Fed is standing pat” columnist Paul Krugman, a Nobel Prize-winning liberal economist, wrote recently.

Krugman’s concerns are shared by John Makin, a highly-regarded analyst at the conservative American Enterprise Institute, a research center. Makin fears that consumers and businesses may begin sitting on cash because it gains purchasing power as prices fall.

“The desire to hold cash is a dangerous part of the deflation psychology” he warned, noting that deflation often accompanies a financial crisis.

Near the end of his lengthy testimony, Bernanke was asked directly about deflation and he discounted the threat.

“Forecasts are very uncertain, but I don’t view deflation as a near-term risk for the United States” he said, noting that the Fed would be “assiduous” should deflation emerge. As the economy picks up steam, inflation will start ticking back toward the 2% range, Bernanke said.

The forecast for higher interest rates has been extended as the Federal Reserve remains committed to maintain a policy of ultra-low interest rates. The released minutes from the last meeting of the FOMC suggest that the majority of Fed policy-makers are weighing the risks of economic slowdown as greater than those of inflation. Until economic activity picks up again in the US, it appears the Fed is satisfied keeping the federal funds rate set at 0.25% and the discount rate set at 3.25%. Mortgage rates remain low for home buyers and home owners according to the most recent survey of American lenders from Freddie Mac. The weekly survey released last Thursday indicated that many mortgage rate averages once again are at record lows. The national average on the 30-year fixed rate mortgage was unchanged from the previous week’s level of 4.57%. The national average on the 15-year fixed mortgage decreased slightly, dropping one basis point from 4.07% to 4.06%. Adjustable-rate mortgages indexed to US Treasury yields were mixed this week according to the Freddie Mac survey. The 5-year Treasury-indexed hybrid adjustable-rate mortgage (ARM) increased to 3.85 percent and the 1-year Treasury-indexed ARM averaged fell to 3.74 percent. Adjustable rate mortgages tied to the LIBOR index, a common interest rate benchmark, were also slightly higher this week. The biggest catalyst for the record low mortgage rates in the US has been the continued support of the Federal Reserve of the housing market and the strong demand from investors for US Treasuries. Mortgage rates have been attractive enough to homeowners keep lenders busy with refinancings. Homeowners with fixed mortgages over 5.25% or variable-rate mortgages tied to interest-rate indexes have been advised to compare refinancing rates before interest rates increase again from today’s present levels. Check MoneyRates.com for the best mortgage rates and deals.

Short-term US Treasury yields have stayed in a very narrow range for the first half of July. The 90-day T-Bill is currently yielding 0.16% and the one-year T-Bill is yielding 0.27%, nearly unchanged from the yields that they ended with in June. The benchmark 10-year Treasury note yield can react strongly with economic news and releases. Today, the 10-year Treasury note is yielding 3.00%, but in the last 90 days it has ranged from 3.35% to 2.94%. Economists are forecasting that as the US economy picks up steam, that yields on Treasury notes and bonds could increase back over 4.5%. If the yields increase too quickly, investors who own government bond funds could see some loss in value.

Americans with home equity loans and credit cards that are indexed to Treasury yield averages should also be careful to follow the Treasury yield trend. This scenaraio is not likely before 2011, so savers may have a long wait before they see the +3% savings rates that they crave for their CDs, money market accounts, and savings accounts. Check MoneyRates.com daily for the latest interest rate news and forecasts.

Foreign Prime Rates

Central Bank Rates

Global Interest Rate Report
The European Central Bank has kept their benchmark rate unchanged, following the path set earlier this month by the Bank of England who kept the benchmark lending rate in the UK set at 0.5%. Inflation in both Europe and England is higher than the price inflation recorded recently in the United States, making the decisions of central bankers in Europe more difficult than their counterparts in the United States. The most recent report from England pegged the inflation rate at 3.4%, much higher than the 2% target rate set by the Bank of England. Concerns about economic growth continue to weigh heavy enough on monetary officials to persuade them to keep rates at historic lows despite the risks of inflation.

The Bank of Japan is poised to keep their benchmark interest rate at 0.1 percent, but is facing increasing pressure to take more action to encourage lending and support the Yen. Companies in Japan can have their profitability decrease when the Yen appreciates against major currencies. The central bank in Russia also kept interest rates unchanged at a meeting last month, ending a long period of consecutive interest rate decreases. The improving economy in Russia, coupled with growing price inflation, prompted the Bank of Rossii to keep the benchmark Russian refinancing rate at 7.75% and keep their repurchase rate at 6.75%. Acceptable levels of inflation in Russia have traditionally been higher than the inflation rate found in many major economies because the Russians have traditionally struggled with foreign investment and economic stability. Another foreign central bank, The Reserve Bank of New Zealand, raised their benchmark interest rate a quarter point from 2.50% to 2.75% this month due to inflationary pressures in the New Zealand economy. Forecasts for inflation of over 5% spurred the first rate increase in New Zealand since 2008. Earlier this summer, the Bank of Canada became the first Group of Seven central bank to increase domestic interest rates since the credit crisis began in the summer of 2008. The Canadian central bank lifted the benchmark Canadian overnight lending rate a quarter point to 0.50%. The widely anticipated move was in response to a growing economy in Canada and increased domestic spending. The prime lending rate used by banks in Canada is now 2.50%.

The respite in the euro’s recent falls came as Asian bourses strengthened, bucking expectations for weakness after the Dow Jones Industrial Average closed down 1.2%. In early afternoon trade, Japan’s benchmark Nikkei Stock Average was up 0.34%.

The euro was also helped after U.S. Federal Reserve Chairman Ben Bernanke said that consumer spending and investment are showing “good momentum.” The cautious assessment that the U.S. economy is likely to continue recovering reassured investors anxious that European debt woes could rock the global economy, dealers said.

“Bernanke’s remarks basically fueled a bit more risk appetite,” said Osao Iizuka, head of foreign exchange trading at Sumitomo Trust & Banking. “Together with the stronger stocks, that has put more investors back in ‘risk-on’ mode, and that has helped the euro.”

At 0450 GMT, the euro stood at Y109.58 up from Y109.04 late Monday in New York, and at $1.1959 from $1.1917. If European and U.S. share markets also bounce back, the euro could extend its gains slightly, dealers said.

But in the coming weeks, lingering concerns over further contagion of euro-zone debt problems is likely to keep strong downward pressure on the common currency. Moreover, investors would likely refrain from buying back the euro aggressively given how sharply it has moved recently, traders said.

“We’re in a very volatile market now where it’s possible for the euro to drop suddenly by 100 points or more” against the dollar or yen, said Sumitomo Trust & Banking’s Iizuka. “While stock rallies like today’s can help, the flip-side is that if stocks fall again the euro could be sold off quickly.”

Elsewhere, the dollar traded hands at Y91.64, little changed from Y91.60 late Monday in New York. The ICE Dollar Index, which tracks the greenback against a trade-weighted basket of currencies including the yen and euro, was at 88.273 compared with 88.500.

But while Treasury prices hit record highs, concerns surfaced among analysts about how much farther the rally can go considering the implied message in the Fed’s statement that the economy is in worse shape than we thought and policy makers will do anything they can to keep it from completely tanking.

“Everyone originally was very enthused yesterday because the Fed made it known they were going to stand and do anything that is necessary, no matter what, to get this economy back on track” said Sal Arnuk, co-manager of trading at Themis Trading in Chatham, New Jersey. “This morning we awaken with a hangover and the realization of how many bullets do they have left”

Long term Treasuries with 10- and 30-year maturities were favored by investors after the Fed said it would keep long-term interest rates suppressed for “some time.” In its statement the central bank vowed to buy agency and mortgage-backed securities and said it will consider purchasing government debt.

Yields on the 10- and 30-year notes tumbled in New York trading, touching their all time lows, according to BGCantor Market Data, as investors continued to bid up prices.

And for the second straight day, investors in the shortest government securities were willing to accept a negative return for the safety of U.S. government debt, as yields on one-month T-bills reached minus 0.02%.

But the Fed’s latest statement has raised doubts about its real intentions with some analysts. Even though the central bank promised to purchase treasuries to keep interest rates from rising, policy makers will likely avoid purchasing government debt, according to RDQ Economics LLC.

“This step is still an unlikely one for the Fed to take, since it is trying to narrow the spread between mortgage-backed securities and Treasuries,” John Ryding and Conrad DeQuadros, founders of New York-based RDQ, wrote in a note yesterday.

30-year mortgage bonds issued by Fannie Mae (FNM) currently yield 1.49 percentage points more than the benchmark 10-year Treasury note, down from 1.62 percentage points Tuesday. The Fed wants to drive those yields down to encourage borrowers and lenders.

More skepticism comes from the rates themselves. After all, how many investors can tolerate a negative return on their money, when the very nature of investing says they will eventually demand a respectable return?

History is another factor leading some investors to conclude that the Treasury rally is overdone because yields simply can’t fall much further. For instance, the 10-year Treasury currently yields around 2.5%, despite an average of 6.91% since 1962.

Then there are those who see the Fed’s move to cut rates to virtually zero as validation of the market’s valuation of short-term credit. Treasury markets had already breached the Fed’s previous Federal Funds target of 1% before Tuesday’s move to cut that target to 0% to 0.25%

“Short-term interest rates have been falling sharply since the financial markets went into a tailspin in September. With Tuesday’s announcement the Fed was essentially acknowledging that it can’t control interest rates any more,” said John Schoen a Senior Producer at MSNBC.

That may be speculation, but the Fed was indeed conspicuous by its absence in the open markets early Wednesday.

According to Reuters, the Federal Reserve of New York said the U.S. central bank had refrained from any open market operations on Wednesday. Typically the New York Fed conducts open market operations at 9:30 a.m.

The regional Fed conducts open market operations for the central bank system. The Fed normally supports its monetary policy by executing short-term purchase and reverse repurchase agreements to influence day-to-day trading in the Federal Funds market.

Federal funds, the benchmark overnight lending rate to banks, last traded at 0.0625%, within the Fed’s new target range of zero to 0.25%

The Fed’s quarterly Senior Loan Officer Survey found that while banks were tightening their lending standards, the number doing so declined in a number of categories. At the same time, some banks eased lending standards in certain areas.

Banks easing lending policies were big institutions with assets above $20 billion.

“Demand for, and supply of, credit remains soft, but this survey suggests that conditions are gradually improving” said Peter Newland of Barclays Capital.

The Fed surveys 56 domestic banks and the U.S. branches of 23 foreign-based banks for the report.

Large banks eased standards for home mortgage and home equity lines of credit, while smaller banks tightened standards for those two categories of lending.

The report, which Fed policymakers reviewed before they left unchanged their pledge to keep benchmark interest rates exceptionally low for an extended period last week, found slight improvements in commercial lending, with some banks easing standards and some terms on loans to large and medium firms.

Standards nevertheless remain quite stringent after the severe restriction of credit during the financial crisis, the Fed said.

Also, standards on commercial loans to small firms were roughly unchanged, and terms on such loans were tightened further over the past three months, the Fed said.

Banks said their standards for approving business credit cards are tighter than before the crisis. Many banks had tightened terms on business credit card loans to small firms in the past six months.

While a large number of banks continued to have tightened standards for commercial real estate loans in the quarter, the number is smaller than in the previous survey, the Fed said.

The program has been credited with holding mortgage interest rates at near-record lows and slowing the nationwide decline in home prices that threatened to send the economy into an extended slump.

When the central bank announced the program two days before Thanksgiving 2008, the spread, or difference, between the rates for a 30-year fixed-rate mortgage and a 10-year Treasury note exceeded 2.5 percentage points, or 250 basis points, nearly twice the typical spread.

Demand for mortgage bonds had been frozen since the federal takeover of Fannie Mae and Freddie Mac, the giant mortgage-finance companies, in September 2008. “We were in a deflationary spiral, causing mortgages to go underwater, more foreclosures and a further decline in housing prices,” said Susan M. Wachter, professor of real estate and finance at the Wharton School of the University of Pennsylvania. “The potential maelstrom of destruction was out there, bringing down not only the housing market but the overall economy. That’s what was stopped.”

She called the Fed’s mortgage purchases “the single most important move to stabilize the economy and to prevent a debacle.”

The program was initially for $500 billion. The purchases began in January 2009, and in March, the Fed raised the goal to $1.25 trillion. The purchases were to end by Dec. 31, but in September, the Fed said the purchases would taper off more slowly, ending on March 31.

The purchases caused rates for 30-year mortgages, which exceeded 6 percent in late 2008, to fall to below 5 percent by March 2009. They are hovering slightly above 5 percent today.

Economists had feared that mortgage interest rates would climb sharply after the 15-month program, but those fears have abated in recent weeks. Fed policy makers have suggested that they would consider resuming the purchases if conditions warranted it, but only as a last resort.

“Financial markets have improved considerably over the last year, and I am hopeful that mortgages will remain highly affordable even after our purchases cease,” Janet L. Yellen, the president of the Federal Reserve Bank of San Francisco, said in a speech on March 23. “Any significant run-up in mortgage rates would create risks for a housing recovery.”

Ms. Yellen is President Obama’s choice to be the next vice chairwoman of the Fed, after Donald L. Kohn retires in June, but she has not been formally nominated.

Lawrence Yun, chief economist at the National Association of Realtors, said the private market for mortgage-backed securities had sufficiently recovered for the Fed program to end without a hiccup.

“Just as the Fed is stepping out, private investors appear to be stepping in,” Mr. Yun said. “As long as there are buyers on Wall Street for mortgages, it should have no impact on consumers. Having said that, it’s possible that the mortgage rate could be higher later in the year, but that would be due to macroeconomic forces unrelated to the Fed purchase program.”

A major factor in that recovery was the government’s announcement last December that it would guarantee debts owed by and securities issued by Fannie and Freddie, according to David Crowe, chief economist at the National Association of Home Builders.

While the future of the two mortgage-finance entities remains uncertain, the government backing has been particularly reassuring for foreign investors, including the Chinese and Japanese central banks, that hold securities based on mortgages originated in the United States, Mr. Crowe said.

Another reason mortgage interest rates are not expected to rise sharply is that the supply of the securities has not increased substantially, said Michael Fratantoni, vice president for single-family research at the Mortgage Bankers Association.

“Home sales really are running at quite a slow pace, and we haven’t seen much of a spring buying season yet, so there haven’t been a lot of mortgages originated or securities issued,” Mr. Fratantoni said. He projected that as the job market recovered, mortgage rates for 30-year mortgages would rise to 5.8 percent or so by the end of the year.

For consumers, the biggest impact of the Fed purchases was to encourage mortgage refinancing, Mr. Fratantoni said. “Although they did induce some additional sales, more importantly, the Fed enabled a lot of homeowners to have lower monthly payments,” he said.

The loonie might be pushing parity with the U.S. dollar, but if you’re looking for the cheapest double-double, you’re still better off south of the border.

At the Tim Hortons on Victoria Avenue in Niagara Falls, Ont., a large coffee will set you back $1.52 before tax. But at the Tim Hortons on Pine Avenue in Niagara Falls, N.Y. – just an 11-minute drive across the Rainbow Bridge – a medium coffee (equivalent in size to a Canadian large) costs only $1.34 U.S..

The loonie continued its surge against the greenback Wednesday, after strong wholesale trade numbers underscored the strength of the Canadian economy and the U.S. central bank said it would keep interests near zero for the foreseeable future. A rise in crude oil prices also lifted the loonie. It rose as high as 99.31 cents U.S. in trading before easing to close at 98.98, up .36 for the day.

The dollar has risen almost five per cent over the past two and a half weeks as various economic indicators – housing sales and a recovery in employment among them – show the Canadian economy quickly recovering from recession. It has gained almost 30 per cent over the past year against the U.S. dollar.

The latest data on the economy, released Wednesday by Statistics Canada, showed wholesale sales in Canada surging three per cent in January to $44.4 billion, the biggest increase in three years, with autos leading gains in every major category.

On Tuesday, the federal agency released similarly strong data showing manufacturing sales rose for the fifth straight month in January, while productivity rose the most in 12 years in the most recent quarter.

Despite the loonie’s rise, Canadian consumers shouldn’t expect prices on either side of the border to magically even out any time soon. A variety of factors keep prices of certain goods higher in Canada, including the volume discounts that many big U.S. retailers enjoy and higher labour costs and taxes in Canada, said Mark Beazley, a spokesman for the Retail Council of Canada.

“It also needs to be understood that the adjustment is slowed by the fact that retailers have a lot of fixed costs (payroll, property rental costs), and those costs are in Canadian dollars. They don’t come down just because the Canadian dollar has gone up,” Beazley said in an e-mail.

The loonie last hit parity in July 2008, before crashing back to earth as commodity prices collapsed with the global financial crisis. This time, however, some economists say the loonie could be here to stay.

“It seems fair to say that the Canadian dollar is perhaps fairly valued at its current level,” said Millan Mulraine, senior Canadian macro strategist at TD Securities. “We think over time it will probably be around this range, or just below it.”

Economists point to a number of factors that could fuel the loonie’s continued rise through the summer. It is widely expected that the Bank of Canada will raise interest rates before the U.S. Federal Reserve, thus making the loonie more attractive to investors. The ongoing recovery in global demand for commodities and the relative fiscal health of Canada’s finances should also give the dollar a boost, CIBC World Markets analysts noted in a recent report.

A strong loonie tends to be hard on Canadian exporters, making their products more expensive in the U.S., their biggest market. But Industry Minister Tony Clement said Wednesday that Canadian companies are adjusting to the reality of a higher dollar by improving their productivity.

“What we’re seeing now with the higher dollar . . . is an increase in labour factor productivity in our country, the fact that companies are adjusting to a higher dollar and are looking at other means to increase their productivity and their competitive edge,” the minister said after a meeting of the Conservative caucus.

“I think the new normal is that you don’t just rely on a low Canadian dollar for your productivity edge,” Clement said, following similar remarks Tuesday from Finance Minister Jim Flaherty.

Mounting foreclosures are making it harder to clear inventories, keeping pressure on prices and discouraging new construction. The economy has yet to create the sustained job growth that could invigorate housing demand and is one reason Federal Reserve policy makers will keep interest rates near zero after their meeting today.

“There are still a lot of headwinds for builders,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm. “There’s enormous competition from distressed homes that’s weighing on demand for new housing. It’s going to be a very, very grudging recovery.”

The Commerce Department will report starts at 8:30 a.m. in Washington. Estimates in the survey ranged from 510,000 to 610,000, after a 591,000 pace in January.

At the same time, the Labor Department will release the import price gauge. Estimates ranged from a decline of 1 percent to a gain of 0.7 percent, following an increase of 1.4 percent in January, according to the Bloomberg survey median. Compared with a year earlier, the index probably rose.

Building Permits

The housing report may also show building permits, a sign of future construction, dropped for a second consecutive month, a sign the extension and expansion in November of a homebuyer tax credit is doing little to stoke demand. Permits fell 3.4 percent to a 601,000 annual pace, a three-month low, according to the survey.

A report yesterday showed builder confidence unexpectedly declined in March as prospective-buyer traffic fell to a one- year low. The National Association of Home Builders/Wells Fargo’s index of builder confidence dropped for the third time in four months.

The Standard & Poor’s supercomposite index of 12 builders, including D.R. Horton Inc. and Pulte Homes Inc., fell 0.9 percent yesterday. The broader S&P 500 rose less than 0.1 percent to 1,150.51.

Fed Meeting

Fed policy makers will leave the benchmark lending rate unchanged at zero to 0.25 percent, where it’s been since December 2008, according to the median forecast in a Bloomberg survey. They’re also likely to stick to their timetable of completing their plan to purchase $1.25 trillion in mortgage- backed securities at the end of this month that was part of an effort to drive down borrowing costs and revive the housing market.

President Barack Obama in November extended a tax credit of as much as $8,000 for first-time homebuyers, and expanded it to some current owners. The extension covers closings through June as long as contracts are signed by the end of April.

Bigger gains in housing sales ultimately require a pickup in job creation. Unemployment may end the year at 9.5 percent, according to a Bloomberg monthly survey.

Executives at Hovnanian Enterprises Inc., New Jersey’s largest homebuilder, are among those watching if demand will hold up after the incentive fades. The Red Bank, New Jersey- based company this month reported its first quarterly profit since 2006.

“With the tax credit for first time and repeat buyers expiring at the end of the second quarter, we too are interested to see if the positive momentum that we established can be sustained,” Chief Executive Officer Ara Hovnanian said on a conference call with investors on March 3. “We’re keeping a close eye on this as we head into the summer months.”

Fed funds futures are often used as a window into when institutional investors expect the Federal Reserve to hike rates. But this little-understood market has weaknesses as a predictive tool, say traders.

While huge at $440 billion, trading volume has declined since the Fed last cut rates in December 2008, bringing its benchmark lending cost to near 0%. Plus, many institutions use these contracts as hedges against other positions, says George van Schaick, a mortgage repo trader at Barclays Capital.

Both factors can cloud the interest rates priced into the contracts.

Then there’s the time element. Uncertainty about what may happen in the economy between now and December, the point at which the market is pricing in a 68% chance of a rate hike, raises questions about reading too much into these contracts. See MarketWatch’s full coverage of the Federal Reserve.

“December is so far away and there will be so much volatility between now and then,” said Mary Sirois, an independent trader and market maker in fed funds futures.

When the Fed will start raising interest rates is important to everyone from bond traders to credit-card borrowers, from individual stock pickers to investors in commodities. That’s because the rate the Fed sets for short-term loans between banks is used as a benchmark for many types of corporate and consumer loans, and higher loan rates are expected to temper a company’s ability to expand and a household’s ability to buy.

So even while flawed, fed funds futures can be helpful as a barometer for what the market is expecting about rates, some analysts and investors say. Read how to invest in fed funds futures.

“I look at probabilities and find them useful to see what traders are thinking,” said Jack Ablin, chief investment officer at Harris Bank, who says he doesn’t trade them. “I use it as consensus against which I gauge whether I’m more aggressive or bullish or bearish.”
Fast money

Trading of fed fund futures is driven mostly by hedge funds and short-term money- market traders, according to bond, foreign-exchange and equity traders. The CME Group /quotes/comstock/15*!cme/quotes/nls/cme (CME 314.88, +0.73, +0.23%) says fixed-income portfolio managers and bank treasurers also participate.

They use these contracts, which trade over the CME Group’s Chicago Board of Trade, to offset other investments that are sensitive to changing interest rates, or simply to engage in short-term trades.

“I use them as a hedging tool versus my overall position in the market and when I disagree with market expectations,” said Ray Remy, head of fixed income at Daiwa Securities America Inc., one of the 18 primary government security dealers that trade directly with the Fed.

As a type of interest-rate future, the contracts are part of the broader and vitally important money market. Seizures two years ago in this vast market, which includes money-market funds and commercial paper, were at the heart of the U.S. financial crisis.

Traders buy them for a certain month. Their value is based on the buyer’s expectation of where the federal funds rate will be that month.

One factor that may hamper the accuracy of fed funds futures is that volume has dropped since the Fed last changed its target overnight interest rate.

And while trading activity has picked up in the last couple months, volume is still pretty low for contracts six to nine months in the future, according to the CME.

These thin trading conditions several months out matter because that’s the time period in which many economists and analysts predict the Fed will start raising rates.

The most active fed funds futures contract right now is the one maturing in April. The December contract has about a quarter of that volume.

Sirois, the fed funds futures trader, said she tends to trade the futures between contracts maturing in upcoming months versus later contracts, attempting to profit on whether the spread between the two will grow or shrink.

Researchers at the Federal Reserve Bank of Cleveland said, in 2006, the fed funds futures market isn’t terribly good at predicting actual rate moves more than a few months into the future, even when the Fed is actively adjusting its target.

Volume dwindles

Fed fund futures track the effective overnight lending rate between banks, set by the Federal Reserve Bank of New York every business day. When the Federal Open Market Committee announces its target lending rate, the New York Fed conducts operations in money markets to get the actual, or effective, rate as close to the target as possible.

In December 2008, the Fed lowered the target rate to a range of zero to 0.25%. The effective rate has sat between 0.1% and 0.17% this year, according to the Fed. See fed funds effective data.

When the Fed is in the process of raising or lowering the target rate, fed fund futures trading is more active.

It reached a multi-year high of more than 76,000 contracts on average each day in 2008, according to CME Group. That amounts to about $380 billion in daily trades on average that year.

But in 2009, volume dropped off to about 41,000 contracts a day.

This year, volume is picking up again.

In March, volume has jumped to more than 88,000 contracts daily on average, or to $440 billion a day. That volume is on par with the average trading volume for Treasurys in January, says the Securities Industry and Financial Markets Association.
Realm of repo traders

So-called repo dealers make up another group of users of fed funds contracts. These dealers are part of the way banks arrange intraday funding, though they’ve been less active in fed funds futures trading since the target became a range and the central banks let excess reserves balloon.

In repurchase agreements, one party?? like the Fed?? agrees to buy securities from a dealer for a specific period of time and a set price before returning that security. The Fed used to conduct billions in repo transactions almost every day, mostly just overnight, to get the effective fed funds rate as close as possible to policy makers’ target.

Whether the effective rate was above or below the target rate was an indication of the availability of cash, said Barclays Capital’s van Schaick.

So fed funds futures were used by banks as a hedge that their funding costs would be different than the Fed’s target rate, he said.

While under-the-radar, these trading arrangements belie the importance of this market. Disruptions in the repo market two years cut off a major source of short-term funding for the investment banks using this market.

Around that time, the Fed moved away from repo transactions to other liquidity measures and encouraged banks to keep massive reserves. The shift changed the utility of fed funds, van Schaick said.

“In this environment, it’s less meaningful because the target is a range and the market has more than $1 trillion in excess reserves,” he said.

Still, what’s being indicated by the fed funds futures remains relevant because market participants need to hedge their rate risks, he said. But with so much in their coffers already, they don’t need to borrow much from each other to hedge those transactions.

Another big user of fed funds futures are Fannie Mae /quotes/comstock/13*!fnm/quotes/nls/fnm (FNM 1.06, +0.02, +2.02%) , Freddie Mac /quotes/comstock/13*!fre/quotes/nls/fre (FRE 1.27, -0.01, -0.78%) and the other government-sponsored enterprises that finance the vast majority or mortgages in the country, he said.