Last month, YOU Magazine shared Part 1 of our 2011 Forecast, focusing on the economy and employment. But what's ahead for inflation, the housing market, and home loan rates this year? Read on to find out.

Inflation
One of the major topics that we need to watch in the coming months is inflation. The Fed and the markets keep a close eye on inflation because it impacts so many aspects of the economy, including home loan rates. In fact, inflation is considered the archenemy of home loan rates!

Why is this the case? It's because home loan rates are tied to Mortgage Backed Securities, which are a type of Bond - which means home loan rates improve when Bond prices do. But when inflation - or even just fear of inflation - grows, Bond prices fall, meaning home loan rates rise. That's because lower Bond prices are needed to give Bond investors juicier yields that will help outpace inflation.

Here's an analogy to help illustrate this point further. Think of inflation as the ocean and interest rates as a boat. As inflation (or the ocean's tide) rises, interest rates (or the boat floating atop the ocean) have to rise as well. In other words, interest rates (or boats) must always be higher than inflation (or the ocean) in order to compensate investors.

With that in mind, let's take a look at what's going on with inflation and what you should keep an eye on in the coming months.

At the end of 2010, the Fed initiated its second round of Quantitative Easing (QE2), which is the concept of the Fed becoming a buyer of Treasuries and Bonds. They took this step in a bid to stimulate the economy by: creating inflation, lowering the unemployment rate, and raising Stock prices. While those goals may be good for the overall economy, remember that inflation is very unfriendly to Mortgage Bonds and home loan rates.

In the end, as a result of the Fed's QE2 and other stimulative actions, we predict a 1.5% increase in consumer inflation by the end of 2011. That should still be within the Fed's comfort zone of 1 - 2%, so inflation should not be too much of a threat this year. However, the unprecedented amount of debt accumulation on the part of the U.S. could spark significant inflation down the road.

Housing Industry
Home prices began to stabilize during 2010, and homes sales showed some signs of encouragement. We expect more of the same in 2011, although there will be some additional headwinds.

After a modestly good start to the year, home prices could actually decline slightly in some areas, particularly depending on the health of the local job market. Another headwind that could weigh on home prices is the overhang of several million distressed properties. The moratorium on foreclosures has ended and all of the major lenders have resumed foreclosure procedures.

At the end of last year, three million homes were in foreclosure activity, with over one million repossessions. Overall, we expect to see accelerated rates of foreclosures in the first quarter until things settle to normal during the second quarter and rest of the year. This could extend the housing downturn a couple of months longer.

That being said, we still expect to see home prices move higher in the year ahead, especially in the latter half of the year.

Home Loan Rate Outlook
Now for the big questions: Where will home loan rates go in 2011? And why?

Let's start by looking at where we are right now. Although rates are still near historic lows, they have trended higher since early November, and indications are that those unbelievably low home loan rates seen during 2010 may be behind us. In fact, there are only a couple things that would bring back the lows that we saw in early November 2010:

1. If the Fed's recent round of Quantitative Easing falls on its face and doesn't meet its mission of creating inflation, boosting Stock prices, lowering unemployment and creating consumer demand. If that happens, Bond prices could make some gains as the threat of deflation reemerges. But this is a long shot. As the saying goes: "Don't fight the Fed." This means that if the Fed wants to raise inflation, it most likely will.
   
   
2. If the financial problems and uncertainties in Europe that we saw in 2010 worsen significantly in 2011. This would drive investors into the safe haven of the U.S. Bond market, which would help Bond prices and therefore home loan rates, but probably only modestly.

Realistically, the economy is improving, and as it does home loan rates will gradually increase over time. We expect rates to stay relatively low during the beginning of the year, but gradually rise higher.

The good news is that historically speaking, 2011 should still offer exceptionally low rates. If you want to learn more about how you can benefit, contact the professional who supplied you with this copy of YOU Magazine.