The credit markets have concluded that inflation risk now forces the Fed into a sustained series of increases in its overnight rate, presently 2 percent.

Interest rates — all of them — spiked in the last 10 days. Lowest-fee 30-year mortgages to 6.625 percent (if you’re a shady character, FICO under 720, make that 6.75 percent), 10-year T-notes to 4.2 percent, and Fed-tied 2-year T-notes to 2.9 percent (up 0.55 percent this week).

The credit markets jumped to Fed conclusions after: oil hit $135; European Central Bank Chairman Jean-Claude Trichet indicated a tilt to tighten there; a string of inflation-centered speeches by Fed officials; and a rebate-bloated 1 percent pop in May retail sales.

It is folly to quarrel with a market move like this, but that’s what I’m going to do.

Think of the very first game of rock-paper-scissors, players uncertain whether scissors would cut paper, or paper would hide them; scissors would break on a rock, but not if stabbing the hand holding the rock. Which beats what?

In the last bad oil/inflation/housing wreck, 1979-82, the Fed did tighten (prime to 22 percent) into a contracting economy (unemployment to 11 percent), into the worst housing recession since the ’30s (mortgages 18 percent), and into the insolvency of the S&L system — all to break inflation running at 12 percent. The economy survived. Sort of.

However, we were then in an epic wage-price spiral, no way to break inflation without first breaking the rocketing growth of incomes. S&Ls then were a corner-pocket of the financial system, disconnected from banking and Wall Street. No major financial institution failed ’79-’82, and credit was easily available, just expensive.

The Fed may have to snug in a dollar sop, and would lean hard into a recovery, but proper policy here is to wait for inevitable slowdown … over there.

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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