Inflation data and deepening worries about the Fed’s intentions have taken mortgage rates higher again.
A one-point loan fee (whether called “origination,” or described in plain English) will still get a 5.87 percent 30-year rate, but the low-fee deals are almost to 6.25 percent, up from the March low at 5.37 percent. The adjustable-rate-mortgage market is worse: a point will buy a Fannie/Freddie 5-year at 4.62 percent now, more than a percent north of the March low. The largest purveyor of “portfolio” 5-year hybrids (Washington Mutual) appears to be pricing defensively, as a one-point fee produces a rate approaching 5.5 percent.
We should have gotten some relief on word that 1st Quarter GDP rose only 4.2 percent versus expectations of near-6 percent, but the GDP internals included a further up-ramp of the best measures of inflation. The sub-1 percent, 1 percent-ish era has concluded, and given way rather briskly to a 2 percent annualized increase in the “core personal consumption expenditure deflator.” Just rolls off the tongue…”PCE” for short.
Today, anybody who indicates concern for inflation is dismissed as a fight-the-last-war fuddy-duddy. It took years to run the technology New-Agers out of town, and it may take just as long to shoo away the Newer-Ager, excess-capacity deflationists. Inflation is always a possibility. All it takes is a central bank that gooses the economy too hard for too long.
The whole world of money is trying to figure out where the Fed is going, and at least one voice at the Fed (Bernanke) wants it to say so. So long as Greenspan is in charge, it will not. Greenspan believes (correctly) that the Fed must gather insights from the bond market; if the market knew the Fed’s cards, then it would know how to play, and the Fed’s market-based information would be polluted by tail-chasing.
Specifically, the bond market is trying to figure out what the Fed thinks is a “neutral” cost of money (neither “accommodative” nor “tight”), how fast the Fed will go from wacky-easy 1 percent to neutral, and whether the Fed’s view of neutral will be correct. Traders and investment managers cannot know the answers to those three questions, but they have to place their bets (if they flinch, new Princeton button-downs and SUNY deeze-and-dozes are itchy for their seats.)
There is no absolute guide to neutral. “Easy” is a Fed funds rate at or below the inflation rate – on the newest data, the Fed’s 1 percent cost of money is at least 1 percent underneath. Traditional Fed theorizing puts neutral a couple of percent above inflation. Therefore, the Fed’s 1 percent may be as much as 3 percent too low (2 percent inflation plus 2 percent = 4 percent fed funds) – a hugely uncertain calculation and range. Then you have to consider the speed with which the Fed should get to neutral. Is the economy still fragile? It looks less so every day, and the only missing piece is wage growth. Or, is the economy in the process of racing away from the Fed, and we should be thinking about how far above neutral the Fed should be?
That’s how you get a staggering stock market, and weird prices for ARMs.
The bond market has now built in the first .5 percent of increase, but we are very much at risk of rolling anticipation, in which the fact of each .25 percent hike begets pricing-in of the next. The Fed meets on Tuesday, and we will get April job data next Friday. We need some help: we need a weaker-than-expected job number, a deceleration in China, fiscal reality and a tax increase from the Bush Administration…something to take the heat off the Fed.
If you’re the Fed, you don’t dare to get behind. If you do, to slow the economy you have to slow the housing market, and to do that – as hot as housing is – you would have to get mortgage rates well up into the sevens. That’s the process that produces recessions. The Fed is so far below neutral that it can and should err on the sooner-and-higher side, .25 percent maybe as soon as Tuesday.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
