The interest-rate rocket ride concluded at the middle of last week, the definitive 10-year T-note one night reaching 5.34 percent in Europe — versus 4.6 percent one month ago. The mortgage rate apogee did not quite touch 7 percent.
The 10-year on Friday was trading a hair under 5.2 percent, and I think there are excellent reasons for faith in stability near here, low-fee mortgages about 6.75 percent.
The week’s economic data were benign, inflation still above the Fed’s 2 percent target but ever-so-gradually abating. Overall economic activity is consistent with a second-quarter rebound from an awful first quarter, not upward-spiraling GDP: May retail sales shot ahead by 1.4 percent, but from a negative April; strong manufacturing reports slipped to flat in May, suggesting that passing strength was more pipeline filling than ramp-up.
This dead stop in long-term Treasury rates at 5.25 percent has two sets of fingerprints: the Fed’s cost of money is 5.25 percent, and the world’s investors are desperate for yield.
A little history: in 2004, when the Fed began to raise its rate from deflation-fighting 1 percent, long-term rates did not move upward, arguably the first time ever that long rates had stayed put at the beginning of a Fed cycle. “Greenspan’s Conundrum” was — is — the moniker for the phenomenon, now widely understood to have been caused by a global ocean of excess savings.
Long rates did ultimately rise from the mid-4 percent zone, but not until near the end of the Fed’s 17-hike campaign. When the Fed plodded to 4.5 percent, so went the 10-year T-note; a couple of months later, the Fed to 4.75 percent, so went the 10-year; then 5 percent, then 5.25 percent — the Fed bulldozed long-term rates tick for tick.
Stage two in the Conundrum followed: shortly after the summertime ’06 peak, long rates fell into an “inversion,” previously guaranteed to presage a recession. Not this time: rates fell because of misplaced hope for recession, and hunger for yield.
The heart of the Conundrum is “non-economic” buying of long-term bonds — non-economic because the buyers are forced to invest cash pouring into their hands, and result in no return whatsoever for the risks inherent in time.
These buyers are the Asian exporters, forced to buy U.S. securities lest their currencies become too strong, and wisely accumulating dollar reserves in their central banks to protect their currencies from another run like 1998. A marker: global central bank reserves have grown from $2 trillion to $5 trillion in a little more than five years. That’s a lot of money looking for investments, more money than there are good investments. Later to the game: the petro and commodity producers likewise awash in export winnings from the price spikes of ’04.
The hallmark of yield hunger: overpaying for poor investments. Markets everywhere today tend to bubble, and risk for time or credit brings negligible reward. The durable consequence of the Conundrum, I suspect: long-term rates staying very close to central bank rates. A bit lower if the economy seems to slow, as in the nine months past; a bit higher if the world economy seems to be running away from the central banks.
How might the Conundrum conclude, long-term rates returning to a proper, nonrecession 1 percent or so above the Fed? The rate rise thus far will do little harm to weak housing markets; however, should we fear a mortgage jump well into the sevens, and the killing damage sure to follow?
A change in Asian behavior has been forecast for a couple of decades, and isn’t going to happen soon. Petro/commodity winners are going to be cash fountains for a long, long time. Most episodes of underpriced risk end with cautionary accidents (we are due), but if there’s enough money chasing yield, it will just slosh somewhere else.
I think the Conundrum is still very much in action, that this long-term rate rocket is not the first in a series ahead, just a re-pricing of the Conundrum. The new pricing is still Conundrum crazy (all Treasuries from two years to 30 today are now trading in a 5.05 percent-5.25 percent band) and the 10-year is going to be tight to the Fed for quite a while.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
