More than two weeks ago, in an apparently sustained and explosive rise, the 10-year T-note traded at 4.4 percent, and low-fee mortgages were 6 percent. Today, Treasurys reached 4.15 percent, and mortgages 5.75 percent.
There is no consensus explanation for the decline.
Yes, these are the quietest weeks of the year in the bond market (all the heavies are on Hampton beaches, kicking sand at lightweights), and weird stuff happens when nobody is home.
Nothing seems to have changed at the onward, upward Fed. Chicago Fed prez Moskow on Thursday delivered merciless remarks: “…Continue to reduce accommodation…core inflation higher…” and said 5 percent unemployment [where we are now] is “about as low as it can go on a sustained basis.”
One predominant bond-market theory: high energy prices are more likely to slow the economy than produce inflation. So, new highs last week (oil $67/bbl, and all-time high natural gas at $9.50/mbtu) may be pressing down long-term rates. But…how is it possible for these prices not to produce some inflation?
Trading on Tuesday and Wednesday gave a very clear picture of the markets’ mind. First thing Tuesday, news of weakness in sales of existing homes took down the stock market and brought happiness to bonds, long-term rates down. Then on Wednesday, rapid-fire: news that orders for durable goods had crashed 4.9 percent in July brought a big bond rally; then strength in sales of new homes reversed the rally and got the stock market excited; then energy prices hit their new highs, collapsing stocks and re-igniting the bond rally.
Who is in charge? What is the predominant force?
Energy prices, sure, but that’s an established pattern. The New Thing: I’ve never seen the stock market trade on housing sales numbers, not tick-for-tick, days running. It’s as though the markets have at last begun to believe that the Fed really is targeting asset prices, specifically housing and bonds.
There is nothing wrong with rising home prices, so long as sustainable – not just in current conditions, but in a variety of less pleasant eventualities (inflation or recession). There is nothing wrong with low long-term rates, unless they reflect an unwise faith in reduced future risk of all kinds – not just economic, but geo-political.
Federal Reserve Board Chairman Alan Greenspan on Friday morning gave his farewell address to the annual convocation of central bankers in Jackson Hole (several were seen without neckties!), and in an offhand way confirmed increased emphasis on asset-price targeting. Newsies have spent the morning trying to put things in his speech that aren’t there (text at www.federalreserve.gov): it is a basic, routine recital of his belief that the Fed’s job is to manage risks at hand, and for the moment risks include asset prices.
As commentators and traders thrash for explanations for Fed policy, asset-price structure and economic future, it seems to me that we are missing the obvious. The Fed is cornered: it must not allow energy prices to invade consumer prices, and it must not allow housing prices to continue to compound at a double-digit slope. It would like to get these things done without breaking crockery, but…first things first.
The Fed will keep going until housing slows markedly, and will go farther if inflation appears. If that’s all there is to it, then owing bonds in the low fours and mortgages in the high fives is the soul of prudence. You don’t have any inflation risk because the Fed won’t allow it, and if the Fed has a recession accident, you have the chance to make a ton of money in the ensuing yield decline. It also makes sense to trade stocks with housing; if it fades, so will the economy and earnings.
There is still the “neutral” thing: it doesn’t make sense to own 4.15 percent bonds if cash-neutral is going to be 4.5 percent. However, there is a great deal of money voting with bond ballots, saying that sustained neutral is no higher than the 3.5 percent today.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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