Rate hikes may be looming now in the U.S., but at least one economist thinks the Fed will be cutting rates again as soon as late 2005.

In a new report, HSBC Securities USA Inc. chief economist Ian Morrison argues that a bubble in housing prices will burst by mid-2005, causing the Fed to start slashing rates once again.

“Expectations of future house price appreciation are spectacularly, and unrealistically, high,” he says. “This partly reflects how the longest and strongest real house price boom in over five decades sailed through the plunge in equity values, the 2001 recession, terrorism, wars, corporate scandals and the 2002-03 jobless recovery. As a result, the perceived risk of buying a house has dropped to all-time lows, despite leverage at all-time highs.”

Morrison says that a bubble-psychology has set in on house prices, as evidenced by very rich valuations. House prices relative to income, rent, replacement-cost and home-equity have set new highs, he reports. As well, a huge boom in housing supply means that the vacancy rate is at its highest in over 40 years. “Prices look too high even if future incomes get a boost from stronger productivity,” he says. ”As a result, U.S. houses are bubbly. Prices are 10%-20% too high and can overshoot on the way down.”

That said, real house prices do not crash like stocks, he notes. “Instead, they deflate gradually over a few years. True, bubbles can inflate for a long time, but if the Fed is in tightening mode, the day of reckoning tends to come sooner.”

“We think the party stops by mid-2005. A series of rate hikes will cause a reassessment of likely future house price risks and its associated debt, thereby triggering housing’s fall,” he says, predicting that, “Fed funds may not reach “neutral” before trouble comes knocking.”

While short-term interest rates are very low, Morrison says that mortgage rates are close to normal. “Coupled with record-high debt servicing, a moderate rise in rates has bite,” he says. “ Consumer hard landings are typical in housing busts because wealth effects from real estate are more powerful than from stocks. Lost wealth is replenished the old fashioned way – saving from income, rather than betting on asset inflation. Moreover, sectors worth 20% of GDP would initially feel profits squeezed. Hiring, and hence income growth, would then stumble.”

“As the hangover hits around mid-2005, monetary pain-relief in the form of Fed easing will eventually have to come to the rescue again. Only this time, the medicine will not prove as potent as in 2001-03,” he warns.