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August 26, 1988
Though yesterday was scary, the bond market is doing better today, and seems to have established a trading range. Expressed in mortgage terms, the trading range appears to be between 1.00 and 2.50 discount at 10.5 note rates: days with quotes at the bottom of that range are locking opportunities which should be taken advantage of with some urgency.
The credit markets continue to react to older economic data showing a strong economy, but I don't expect substantial movement until the markets get a read on how the economy is responding to higher interest rates. Our bad day this week can be traced to Second Quarter GNP revised up a little to plus 3.3%, and the Second Quarter GNP Deflator revised up to a very high 5.1%. But this is ancient history: the second quarter ended 60 days ago, and the Fed has hit us hard twice since then.
Other news may show the first signs of deceleration in economic growth: the Consumer Price Index rose .4%, about as expected, but certainly less than feared, and Durable Goods Orders fell 7.0%. The best news for us was a 5% decline in Existing Home Sales; the east and west coast markets are softening.
Economic data in the next month can tell us a lot. The Fed is unlikely to tighten overtly before the election, but it has several wellcamouflaged means of raising rates. The economy needs to show a slowing or topping out by the end of September, or mortgages are headed into the 11% range. Maybe it's just from living near a troubled economy, but I have the feeling that the national economy and inflationary pressures are not all that strong.
The Fed's job is to create recessions in order to head off inflation. The job will probably be easier this time than before because of the appearance of ARM mortgages. Until this upcycle in rates, all home mortgages were fixed rate (ARMs were illegal until late 1978, and uncommon until 1982). Until now, Fed tightening had little impact on a homeowner, but each month hereafter, ARM homeowners will be getting notice of 15% increases in their mortgage payments. Not only will they get those notices, but they have reason to expect another increase next year. The Fed may be surprised at how fast the economy responds to tightening.
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