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May 27, 1988
The Fed tightened again this week (Fed Funds to 7.5%) in response to a stronger, exportled economy. However, there was no hard evidence of renewed inflation, and money supply growth has slowed sharply.
First Quarter GNP growth was revised up from 2.8% to 3.9%, while perversely the GNP Deflator was revised down to 1.7% from 2.4% (indicating sharply lower inflation). Durable goods orders rose .8%, and Existing Home Sales rose 4.5%, but still remain well below last year's levels. Early this morning, the bond market looked like it was ready for a very bad day, and then three more pieces of data were released, all far weaker for the economy than expected: Personal Income rose only .1%, Personal Consumption was unchanged, and after tax Personal Income fell .9%.
This data just does not support the Wall Street public relations campaign that we are about to have an inflationary replay of the late 70's. Wall Street is quite panicky because it is not selling enough securities to maintain its lifestyle, and there is nothing like a little customer panic to make the phones ring.
However, a defensive mortgage strategy may be called for. We have a loan product which is a fixedtofloatingtofixed reconvertable appropriate for uncertainty of the kind we are now enduring. It starts out as a five year fixed rate loan priced with a note rate about a point under the 30year rate with equivalent discount, and at the end of five years converts to a 1year ARM. After the conversion to floating rate, the borrower still retains the right to convert back to fixed rate for $250.
This loan protects against a potential high rate period in the near future, is substantially cheaper than 30year, will adjust down at five years if rates have fallen, has tremendous flexibility to avoid refinancing costs, and even if rates rise over five years, will have bought time and appreciated equity to help cope with higher rates. One of the secrets of why it is such a good deal is that discount points buy more rate relief on a five year loan than they do on the estimated 12year prepay life of a 30year loan.
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