Will the drop in mortgage rates force the Fed to raise its rate?

In a time without precedent, benchmarks, or guardrails, we can claim just about anything and opposition will have to acknowledge possibility.

But this is serious, and we do have precedent. Tomorrow, the Federal Reserve will meet and decide whether to raise the overnight cost of money, which will have an effect on the economy.

Lessons from the ’90s

In 1997 a major debt and currency crisis began in Thailand with a run on the baht, and quickly became a global affair known as the “Asian Contagion.” The crisis peaked in August 1998 with the default by Russia on its debt. The Fed and Treasury feared the crisis would spin out of control, the rest of the world weakening and only the US able to pull the world out of a bad spiral.

The Fed’s cost of money (the Fed funds rate) was 5.5 percent. By the way, the stock market was booming, two years after Greenspan’s “irrational exuberance warning, but the Fed cut its rate three months in a row in fall 1998 to 4.75 percent.

In February 1999, Time magazine’s cover (remember magazines?) proclaimed the “Committee to Save the World:” Greenspan, Robert Rubin at Treasury, and Larry Summers at the White House.

History can be so inconvenient, and unkind. As it turned out, the global currency crisis sent a flood of cash to the U.S., and despite a strong economy here dropped mortgage rates to 6.75 percent by the end of 1998 from 8 percent in spring 1997.

That cash influx had even more force than the Fed’s rate cut, and the combination sent the stock market into new hysterics in 1999 — up another 2000 points to its unfortunate top one year later — also igniting inflation.

The Fed was forced to reverse field very fast, withdrawing all three 1998 cuts during 1999 and tacking on three more hikes in 2000. Recession the result.

The Fed remembers.

[graphiq id=”dySedCRxTuZ” title=”Fed Funds Rate vs. 30 Year Mortgage Rate Since 1971″ width=”600″ height=”628″ url=”https://w.graphiq.com/w/dySedCRxTuZ” link=”https://www.graphiq.com” link_text=”Visualization by Graphiq” ]

What’s the situation today?

This time the situation is different (they’re all different), but the same: the outside world is a wreck, the U.S. is the world’s only locomotive, and cash is pouring in here again and forcing long-term rates here back down, close to the 2012 all-time lows.

This time, unlike 1998, the Fed’s cost of money is still at an all-time emergency low, and the Fed owns nearly $4 trillion in Treasurys and mortgage-backed securities, bought to get our long-term rates down in the first place.

The Fed has been worried for nearly two years that it has been too easy for too long. It took its first, timid step up in December and got deeper overseas trouble as its reward, the major overseas central banks hosing cash in strengthening streams, a lot of that cash surfing right over here.

How housing matters

The Fed is trying to tighten, but mortgage rates here are now down from 4.25 percent closing on 3.5 percent in just six months — credit here easier than it was when the Fed started!

We do not have an overheated housing market, but it is recovering and its hot zones are on fire. The downward pressure on U.S. mortgages from overseas is still considerable, even after the drop so far this year — if anything, pulling down harder.

More tightening by the Fed runs the risk of making things worse overseas, but overseas events are easing for the Fed here when the Fed thinks it should be tightening. Should the Fed continue hikes to counteract unwanted foreign easing, to avoid the mistake of 1998?

Be glad you don’t have Chair Yellen’s job. Not this year.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.