A coulda-been-worse inflation report Friday gave us a morning-only breather, rates rising again now, as they will continue to do.
Bonds and mortgages on Wednesday broke through crucial levels: the 10-year T-note through 4.42 percent to 4.49 percent (higher Friday), lowest-fee mortgages through 6 percent to 6.125 percent (a move which Freddie Mac’s survey won’t “discover” until later this week).
The overall September Consumer Price Index rose 1.2 percent, the largest single-month gain in 14 years, now a 4.7 percent year-over-year increase. However, the “core” rate, excluding volatile food and energy prices, rose only .1 percent – just 2 percent YOY, down from 2.4 percent YOY in July.
Some have misunderstood the Fed, seeing it in a jawbone offensive against inflation, but not intending to raise its rate much farther because core inflation is under some control. Many others have mistakenly assumed that high energy prices would do the Fed’s work, slowing the economy. Give that up: September retail sales rose 1.1 percent excluding the collapse in SUV sales, and despite Katrina/Rita. There is some word of accumulating inventory of homes for sale, but no decline in aggregate sales, nor a decline in purchase mortgage applications.
Bonds and mortgages have not adjusted to the very great likelihood that the Fed will go .25 percent at each of the next three months’ meetings, putting Fed funds at 4.5 percent by Feb. 1. At that point, a lot of heavy lifting will have been done for the new Chairman (hope – pray – for Ben Bernanke or Donald Kohn), but any new Chairman faces market doubt about toughness, and the only way to demonstrate fortitude is to raise rates. Any flinch by the new Chairman will be interpreted as timidity, or execution of election-year instructions from the White House.
Fed politics aside, I don’t for the life of me know what is different about our economy now compared to 1994-1998, when the baseline for Fed funds was 5 percent-plus (mortgages at 8 percent), and I don’t see any reason for the Fed to stop short of 5 percent unless and until the economy slows markedly. Inherent economic strength aside, the grotesque budget irresponsibility in Congress and at the White House is working to stimulate the economy, not slow it.
There are some signs of an energy top: oil is falling toward $60/bbl, wholesale gasoline is down 14 cents to $1.68/gal, natural gas off almost two bucks to $12.85/hcf, and gold’s retreat from the $470s confirms the pattern. A sudden drop in oil to maybe $45/bbl would remove some inflation heat, but would also stimulate the economy, and a hot-running economy is the Fed’s fundamental problem.
Lagging behavior in mortgage rates is delaying the full effect of the Fed’s tightening. Fixed-rate mortgages are still below the 6.5 percent highs of the last three years, but the next .75 percent coming from the Fed is certain to push mortgages up toward 7 percent by spring. However, 7 percent was the low of the 1990s. Nobody knows or can know the level at which housing will crump.
Consumers are calling us, disturbed by the rate increases on their HELOCs, but are reacting to changes at least 45 days old. It seems to take a month-and-a-half for a rise in prime to make it all the way into payments, and consumers don’t have a clue that prime is already 6.75 percent, going to 7.5 percent by Presidents’ Day.
ARM indices are rising, with T-bill and LIBOR-based ARMs going to the high sixes right now. However, the lagging indices, MTA and COFI, will take a year to 18 months to fully reflect the Fed. If the Fed stops as low as 4.5 percent, the whole ARM universe will adjust above 7 percent.
This lagging mortgage action is one of many reasons that the Fed tends to overshoot its proper stopping point, and likely will this time, too.
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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