Four bad weeks in a row, this one the worst by far, yesterday the most abrupt bond-market move in two years. Mortgages are 6.75 percent, up a half-percent since May 14.
The 10-year Treasury: 4.6 percent in mid-May, 4.9 percent last week, 4.97 percent Wednesday, 5.13 percent Thursday, 5.24 percent in Europe last night, and semi-stable at 5.16 percent today.
Last time this high: summer ’06 at the 5.25 percent conclusion of the Fed’s two-year rate rise. Long-term rates quickly fell thereafter, all fall and winter looking for a housing or Fed-caused recession.
To measure the chances for a reversal of this rate move or a sustained rise ahead we have to look back a long way.
As a species we are engineered for getting the badger out of the cave today, not ruminating on wildlife of years past. Today’s big-media stories on the cause of this bond-market wreck range from the straight-faced “Surprise Hike By New Zealand Central Bank” (coincidence is not cause) to PIMCO’s Bill Gross, “Now I’m A Bond Bear.” Gross had a terrific, 15-year hot streak, and is now ice-cold, dead wrong for two years, still leading the media around by the nose in an unseemly promotional effort.
From 1963 to 2001, the mortgage-rate low was 7 percent. In that same span, the Fed got to a recession-bottom 3 percent in 1993, but was above 5 percent or going there quickly all the rest of the time. The first half of that 38-year interval was distinguished by the Fed’s epic error in tolerating inflation until it got out of control in 1979, and the inflation fight thereafter, victory in 2001.
Then the money world turned on its head (no, NOT 9/11): deflation became the problem, and the Fed eased to 1 percent (go back 50 years to find that). Mortgages to 5.25 percent, the low trade on the 10-year Treasury 3.13 percent. By 2004, the deflation danger was past, and over two years the Fed removed its emergency ease.
Today, the question on the table: Where the hell is normal? Can we expect a low-rate future, central banks vigilant, having learned their inflation lesson, or should we expect a return to constant inflation-fighting, and interest rates like the 1990s, mortgage centerline 8 percent? Where are the likely boundaries between boom top and recession bottom?
The authentic cause of this rate blow-out is this change in the inflation calculus: the entry of two billion subsistence-wage Asian workers has been the mother of all inflation suppressants, capping global wages no matter what happened to prices for or oil or commodities or food. Very suddenly — too suddenly — allegedly authoritative commentary chants the obit for the Asian suppressant, effects to conclude in a couple of years. Could be, sure … but, evidence, please?
I think the high-probability case is a return to a normal business cycle (even in the era of the “Great Moderation,” this recovery at six years is elderly), a normal yield curve (long rates back above short — Asian and Petro investors have too much cash, but are not stupid, and it’s stupid to buy bonds at yields less than cash), and traditional chances for central bank error near cycle-end (late to an inflation fight, then overdoing damage while playing catch-up).
As the world lurches toward normal, consider this change: as the Fed raised the cost of money ’04-’06, it was frustrated by the stimulus from artificially low long-term rates. Markets for everything tended to bubbles large and small. Now, the sudden run of long rates toward sensible levels is a powerful market tightening for the Fed, and the most natural business-cycle event of all. Long rates are supposed to rise into a hot economy and uncertain inflation future.
However, all segments do not return to normal at the same time, and incipiently bubbled markets are especially vulnerable. The bad stumble in American housing has knocked a point or two off GDP, but nothing worse; a 7 percent mortgage shove from behind … we’ll see.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
