Yield Curve Likely to Keep Hedging Costs High: January pointed toward continued growth, with both wages and job creation showing strength.

A bevy of year-end economic outlooks suggest that mortgage hedging managers are heading into another challenging year. Most economists expect the yield curve between long-term and short-term interest rates to remain relatively flat - and perhaps even inverted at times - at least in the early part of 2007.

And so far, the prognosticators appear to be right. In early January, 30-year mortgages were running at about a 6.20% average, according to Freddie Mac's weekly rate survey. The 10-year Treasury, meanwhile, stood at about 4.65%.

Even more tellingly, the two-year Treasury in early January was trading at yields that exceeded not only the yield on 10-year Treasuries but also on 30-year Treasuries. Economists are divided about what this means. In the past, an inverted yield curve was often seen as a sign of a nascent recession. But some economists are skeptical of the notion that this hypothesis still holds true, arguing that circumstances are different. For one thing, strong foreign demand for U.S. long-term debt has helped keep demand growing for U.S. treasuries (and mortgage-backed securities). And economic reports in early January pointed toward continued growth, with both wages and job creation showing strength. In fact, the job and wage numbers seemed to spark renewed fears about inflation, dousing any hope that the Federal Reserve Board might lower short-term interest rates any time soon.

What does that mean for those executives trying to hedge a mortgage servicing portfolio?

For one thing, it means the cost of hedging will remain relatively high and the results relatively unpredictable. Hedging strategies generally do not assume an inverted yield curve.

That does not make it ...