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April 26, 1991
Mortgage discounts are rising this morning on news of persistent inflation.
The 1st Quarter Gross National Product (JanuaryMarch 1991) fell 2.8% in a report this morning. A tandem report held the surprise: first quarter inflation rose 5.5%, a point or more higher than hoped.
March Durable Goods Orders plunged 6.2%, while Existing Home Sales rose .6%. After two good weeks, Initial Jobless Claims deteriorated again, up 47,000.
Wall Street Roulette has a particularly tense overtone these days. There is more clicking on empty chambers than usual, and more cylinders are turning closer to a bang.
The game is guessing when the Fed will switch from recession fighting back to normal: inflation fighting. The Fed has been progressively easy since last fall. Is there one more prerecovery ease ahead? Or is the next move to tighten? (Bang.)
This morning's GNP says the economy was still in decline in the first quarter. No surprise here: we knew January was a freefall month when we were in it. Next week is the first of May, and from a bond market perspective, the first quarter might as well be the Jurassic. All eyes are on current data, not ancient history.
The standard equation holds that the Fed must ease until the recession threat bottoms out. And all interest rates will follow the Fed because everyone knows that recessions reduce inflation.
But there is a missing piece in the old equation: the budget deficit. The continuous, massive overspending forces the Fed to be tighter than it otherwise would be. If the Fed fails to be sufficiently stingy, bond market investors will raise long term rates for the Fed.
Which is exactly what happened the last time the Fed eased. Then, 30year bonds yielded about 8.00%. This morning, investors demand and are getting 8.30%.
So, back to roulette. Will the economy stay weak because the Fed can't ease more? (Click.) Will further weakness help with inflation? (Click.)
Or will the economy begin a rebound with inflation still over 5%, and a $340 billion deficit? (Bang.)
The next spin happens May 79 when the Treasury will borrow $40 billion in three days. Rates will probably rise next week, the week before the borrowing. But, if the borrowing goes well (click), mortgages will come back down near 9.5% for a while longer.
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