You can watch markets for a long time and not see a one-week reversal in psychology — and reality — as large as this. Mortgages are pulling back slowly from 6.75 percent, but the immediate threat of 7 percent has disappeared altogether.
One week ago, bond and stock markets were drowning in the depressing soup of an obvious inflation problem and a Fed too timid to do anything about it. Then it got worse: Tuesday’s CPI affirmed the fear, the core rate rising .3 percent for the second month in a row, way over the Fed’s 2 percent-annual ceiling.
Then things got weird. Investors dumped stocks and bonds by the bale after the CPI news, but late in the day, long-term bonds, the most inflation-sensitive products in the financial universe, began to rally. By late Tuesday, light had dawned that a CPI report this bad would force the Fed to react, and therefore the odds had risen for the bond market’s dream of Christmas, a Fed overshoot on the tight side. There’s nothing like a recession for increasing the value of bonds.
Then the Fed did react. Just jawbone, but it was first-class ‘bone. First the announcement that Donald Kohn had been named vice chair of the Fed.
Next, a rookie piped up. Fed rookies are prone to saying really silly things (upon appointment as Dallas Fed president last year, Richard Fisher offered an apparently official leak that the Fed’s rate hikes would soon end; he hasn’t been heard from since). Not this guy: new Richmond Fed President Jeffrey Lacker, a man to watch, said just what the markets needed to hear. Just the truth: “Inflation is at the borderline of acceptable, and perhaps even beyond. I have been disappointed by the last two rounds of inflation reports…and containing inflation has to be our primary focus. A pause [in rate hikes] is less likely.”
Why Fed Chair Ben Bernanke has been unable to find simple words like these is beyond everyone in the markets. He spoke after the CPI report, and looked not so much deer-in-the-headlights (he does have some personal substance) as bland, wandering and totally unable to communicate the heart of the matter. If he can’t talk, that’s OK; but don’t make things worse by trying. Give Lacker the mike.
OK, confidence restored, where the hell are we, really? Old hand William Poole, St. Louis Fed president, said that for all he knew about the Fed’s June 29 meeting, it might raise rates a quarter-point, jump them an inflation-pre-empting half-point, or cut its rate. He wasn’t kidding: bet on uncertainty and volatility here.
The Fed obviously believes the economy is about to slow. Bernanke may be helpless as a public leader, but he is a fine economist with the best intentions and fears that the Fed may already be too tight. The most senior Fed watcher, David Jones, said today that the Fed is substantially on the tight side of neutral.
The problem has been very strong real-time economic data, and oil at $70 stubbornly maintaining inflation pressure. At the end of this sea-change week, oil is still there, but other strong-economy and speculative indicators have reversed even more strongly than long-term rates and Fed confidence.
Stocks are down 200 points in two weeks, and shaky worldwide. Gold has collapsed from $728 to $655 in 10 days. Natural gas in the last 48 hours has traded under six bucks, down 60 percent from last winter. And, the Fed is not the only tightening central bank: the Bank of Japan is still maintaining a zero percent cost of money, but it is sucking cash out of the system at an amazing pace, the monetary base in Japan down 9 percent since January.
If the economy cools, quickly, then the pause-leaning Bernanke is a hero; if not, the Fed has to play catch-up and over-do us into recession. For the moment, either way the calculus favors a top in long-term rates.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
