Long-term Treasurys are sliding down in yield again, holding low-fee mortgages in the high-threes.
This improvement has been caused by several things, all reinforcing each other, and is likely to continue. However, in the background lies an enormous contradiction that is clearly troubling long-term markets.
First things first. Way back in my ill-spent youth, during an exciting day I asked a veteran trader why bond prices were rising and rates falling. Dead pan, no grin before or after: “More buyers than sellers.”
The herd … always think first of the herd.
Despite unanimous forecasts from important people that rates would soon rise, the 10-year T-note 2.3 percent at year-end in the next five weeks crashed to 1.65 percent. A violent move begets a violent reversal, which crested this week at 2.15 percent and has now re-reversed to 2.06 percent. The 2.15 percent crest held a yearlong downtrend.
Most of us are still arguing about the cause of the big January move in the first place. The dominant explanation: Bonds followed the price of oil. No matter what stimulus lower prices may bring (looks thin to me), lower oil means lower inflation.
For how long? Oil forecasts cover a range from $10 (silly work by a better man, Gary Shilling) to a rapid run back to $80 (several investment-pickers who should know better). The likelihood is a several-year centerline near $60, maybe with 20 bucks’ worth of spectacular volatility either way. That’s enough to hold inflation down.
The Fed is, of course, the source of contradiction, desperate to get above zero for fear of financial bubbles, but every bit as fearful of pulling the plug. It knows that oil does crazy things up and down, and tries to strip that out by looking at “core” rates of inflation.
However, this oil drop is so big and durable that it is already pulling down prices of other things — paint, fertilizer, anything carried by a truck. Also, every economic competitor on the planet has devalued its currency versus ours, which pushes down on global dollar prices of everything, including wages.
Thus the Fed’s meeting minutes released on Wednesday:
“An earlier tightening would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound.”
The Fed is fully aware that premature or overdone tightening, even 0.25 percent, could get them right back to 0 percent, the situation they are desperate to escape.
Off into the murky metaphysics of the Fed. All central bankers want to be in front, pre-emptive. This time, deeply unsettling to them, the proper course may be to follow wages and inflation as they rise. If they rise, heh-heh.
Then the geopolitical rundown. As I am writing, noon on Friday, the Germans have allowed another Band-Aid to Greece, keeping its cash supply going but fixing nothing. The 10-year T-note instantly jumped from 2.06 percent to 2.1 percent. Buying time is better than running out, but no big party.
Break down Greece into two pieces, financial and political. A Grexit would — will — roil markets and push down interest rates. But given five years to prepare, especially banks and central banks have circuit breakers in place.
The big risk is political. Not that a Grecian escape would embolden Italy to do likewise, but instability. Many places many times, severe economic repression breeds political extremism: Europe in the 1930s, ISIS today, and the dangerous lefties who won the Greek election.
Which brings us to Russia. For reasons I don’t understand, markets have stopped trading on news from Ukraine. Thus far, sanctions seem only to have cornered Vladimir the Rat. The hunch here last week that he had used the Minsk conference to pull the pants off Merkel and Hollande? Correct. Perhaps markets sense that Ukraine has been written off, and so they do the same.
The most important thing is the trajectory of the U.S. economy, and its breadth. That is, if we continue to improve, how inclusive the improvement?
If wages begin to rise for all, then the Fed should tighten, and we should be glad to see it happen.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
