Last week’s hopes for a mortgage-rate top are still valid, but the location may be closer to low sevens than high sixes. The latest over-target inflation report (May CPI core plus .3 percent) will likely force the Fed from 5 percent to 5.25 percent on June 29, and short-term Treasurys are beginning to price a 5.5 percent Fed in August.
The Fed must proceed until the economy slows substantially, but the global unwinding of stock markets that began two weeks ago caused bonds to get ahead of themselves. The catalyst for the stock crater was Federal Reserve Chair Ben Bernanke’s first tough speech, not an actual economic slowdown; when stocks reached technical support this week and rebounded, the 10-year T-note rose rapidly from its 4.97 percent low back to 5.1 percent and mortgages to 6.75 percent-plus.
The consumer is showing some softening, evident in slower housing markets, and in this statistic: the gain in retail sales since February is entirely attributable to gasoline sales increased by higher prices. However, business conditions remain superb, earnings solid — so solid that corporations are actually paying taxes. Widespread assertions that the economy is slowing are contradicted by tax revenue: Federal tax payments in May were 26 percent ahead of last year, and corporate payments are up 30 percent year-to-date. Individual receipts are up 14 percent, the biggest gain in “non-withholding” revenue — bonuses, capital gains and such (National Enquirer headline: “Big Biz And Fat Cats Pay Taxes!”).
Volatility in the markets is perfect expression of their discomfort with knowledge that the economy will slow down and awareness that it has not yet.
As we approach the Fed’s June 29 meeting, the behavior of the 10-year will have some slowdown predictive power. If the 10-year T-note again mechanically moves with the Fed, on the day or in anticipation, it will say to me that the market believes that the economy is no closer to a substantial slowdown. If so, we’re vulnerable to more hikes. However, if the 10-year doesn’t make it to 5.25 percent, or does but then retreats below the Fed’s rate, then we’ll have another inversion. The one last winter was a head fake; an inversion now, with the Fed a full percent tighter than last winter, would much more likely portend a nearby slowdown.
The media today are stating as fact that Bernanke’s speech yesterday on energy prices and inflation caused the last, strong leg of the stock rebound. He did say (text as always at www.federalreserve.gov) that high energy prices to date have not done much harm to overall inflation, but those who interpret his remarks as satisfaction with inflation and backing away from his price-stability speech are mistaken. The speech had different tone (breezy, Faculty-Club-dinner style), but its whole point was that neither he nor anyone else should expect a drop in energy prices, and an increase from here would be real trouble indeed.
Vice Chairman Kohn’s speech today should correct any misimpression: the Fed has rate-hike work to do, and will do it.
The deepest part of the global stock crater last week coincided with concerted action by foreign central banks, but the tea leaves this week say they’re nowhere near as tough as ours. China’s central banking efforts to get lenders to cool it have been plaintive, like the driver of a car who has inadvertently parked in neutral on a hill. A 30 percent year-to-datesurge in capital spending and growing inflation testify to ineffectiveness. The Bank of Japan appears to have signaled the local stock market that it means business, but only a little, its interest rate still zero; and the ECB at 2.75 percent is hardly tight, and has no political support to be so.
This central bank divergence shows up in the dollar, its spring slide halfway reversed. When the globe slows, it will be our Fed’s work. If anybody sees it actually begin to slow, please shout loud, as bonds and mortgages are eagerly waiting.
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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