In an odd leap, long-term Treasury yields blew up, and Wednesday was the worst single day in nine months. The 10-year Treasury note stopped at 3.88 percent, a level touched for the fifth time since last June, but the violence of this move threatens upward breakout. Meanwhile, mortgages held fairly well, inside the 5.25 percent top that has held since August.
The peculiar part: Big sell-offs like this are driven by good economic news, but that’s not what we got. February sales of new and existing homes fell (new ones at the lowest pace since stats began in 1963, 303,000 annualized), and unsold inventory rose.
Unemployment claims fell to 442,000 last week, but must drop well into the 300s to mark new hiring. The U.S. Bureau of Labor Statistics says unemployment in February rose in 27 states, fell in seven, and was flat in 16.
California, at 12.5 percent unemployed, rather more than offsets North Dakota at 4.1 percent and Nebraska and South Dakota at 4.8 percent. Four states — Florida, Nevada, North Carolina and Georgia — set all-time highs for percentages out of work.
So, why the rate blow-up? Three theories so far. The first: the health care bill. Nobody in the credit markets believes its revenue assumptions, nor does anyone believe the expense forecast.
If you work in the credit markets and trust government promises, your career will be short. The centerline market estimate for health care’s annual deficit addition: $50 billion to $100 billion. However, no matter how accurate, that’s a long-term worry. Something short-term happened here.
Theory two: National debt of all kinds is in trouble, with budgets from Europe’s "Club Med" nations to Japan immensely out of balance, and all of them selling mountains of new paper. Maybe, but the Europeans seem to be kicking the Grecian urn down the autobahn, with no immediate crisis in prospect. Besides, that mess is pushing cash to U.S. dollars and Treasurys.
Theory three: The Fed is pulling the plug.
The Fed has been buying mortgage-backed securities and associated Fannie-Freddie debt for 15 months, the total roughly $1.4 trillion. This winter everyone wondered what would happen to mortgage rates when the Fed stops buying next week, but we’ve been watching the wrong market. …CONTINUED
The Fed bought those agency mortgage-backed securities (MBS) from super-cautious investors who buy only government paper. The Fed’s buys had three effects, one indirect: They did pull down mortgage-Treasury spreads, and the buys did provide "quantitative easing" (the Fed shooting money directly into the economy, bypassing busted banks that can’t make loans).
The third effect that most of us missed: The Fed’s buys soaked up last year’s entire federal deficit, pulling down Treasury yields themselves.
The mechanism: Lift $1.4 trillion in government paper out of that market, and investors then used the cash to buy other government paper. Treasurys.
Next week the Fed will stop, but the Treasury will not: It will continue to sell bonds at a pace near $150 billion per month. Who will buy those bonds, and the flood issued by governments from Athens to Tokyo, and at what rates? Those mysteries will soon find answers.
The Fed fears overdoing its quantitative easing: possibly inflationary, possibly generating backlash from excessive use of power, or worst of all, breeding accusations of round-heeled "monetizing" of government indiscipline.
If the Fed is out, the nightmare-dilemma end game has arrived. Cut the Keynesian deficit while the recession runs on? Or allow that spending to drive up interest rates, and maybe do more damage than fiscal discipline would do?
I think the Fed mistakes putting down panic for recovery, while we are still in a slow-motion landslide in asset values. Nothing but low rates will stop the slide. However, for the Fed to stay in the game awhile longer, a commitment to fiscal discipline by Congress and the administration would be mandatory.
How different all of this might look if President Obama had reversed priorities early last year: appointed a bipartisan commission on health care, and put all of his momentum and majority behind getting our books in order.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@pmglending.com.
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