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July 14, 1989
The week's economic data were all released this morning and all were weaker than expected: Producer Prices fell .1%, Retail Sales fell .4%, Industrial Production dropped .4%, and Capacity Utilization fell to 83.5%.
The bond market reaction has been weak today, backwards from the usual response to evidence of a weakening economy. Today's trading pattern is a warning that mortgage rates may have gone as far as they are going to go for a while, and may back up if a bumpy landing doesn't materialize.
Borrowers (and even a Realtor or two) are having a hard time sorting through general predictions of falling interest rates. This last week is good evidence that "rates" do not move the same amount or in the same direction: mortgage rates stayed stuck, the prime rate started its long slide to come, the Fed eased only a little, Tbill rates hit sixmonth lows, and the 11th District COF index hit its highs of the year.
Particularly confusing to borrowers in the months ahead will be declines in the prime rate not matched by drops in mortgage rates. The prime rate is a commercial bank rate for short term lending, seldom fixed for more than a few months. Fixed mortgage rates are regarded as twelve year instruments whose bond market pricing has nothing to do with prime.
Prime will fall with more Fed easing as short term rates resume their normal position at levels below long term rates. As the Fed eases in pursuit of its soft landing, long term investors will resume their normal nervousness that the Fed will be too easy and cause inflation. Hence, sticky mortgage rates.
The COF index provides a more painful lesson in the individuality of interest rates. At 8.797% plus a typical margin of 2.50, this month's lucky ARM borrowers will get a payment change notice to 11.297% for the next year.
The last year's episode of high short term rates is exactly what ARMs were invented for. The invention is designed to protect surviving S&Ls, not as a charitable benefit to borrowers. Why would an S&L be so happy to lose money on a new loan for the first two years? Because it will make it all back later.
The next time somebody says "Rates are falling," be sure to ask which ones, how far, and how fast.
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