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July 15, 1993
New lows, he whispered, trying not to attract too much attention.
Thirty year rates are near 7.25% at par, which means it is economical to refinance every single mortgage loan created between 1973 and Christmas 1992. It's hard to be polite to that many people, let alone get their loans done.
The proximate cause of the newest new lows is good inflation news. The June Consumer Price Index held unchanged, while the Producer Price Index fell .3%.
The most extraordinary financial event of the last three years has beenŠ.not the stock market record, not the deficit, not the recession, not Clinton's tax increase, not low inflation, not the weak recoveryŠ.
It has been the yawning gap between short term rates and long term ones. At its widest last fall (30-year Treasuries at 7.75% and T-bills at 2.90% -- almost five full percent), the spread between short and long was easily the widest in the history of the country. For a recent comparison, in 1988 and 1989, there was no spread at all.
This spread has done fantastic damage to the economy in a slow, grinding fashion. Investors (banks in the lead) don't have to make loans, they just borrow short term money and buy some Treasurys. Few enterprises can afford to borrow at high intermediate or long term costs.
Financial mavens have known all along that this "steep yield curve" could not persist, and that the story had only three possible outcomes.
One, long rates become infinitely high as the country borrows and spends its way into bankruptcy. Two, the wide spread crushes the economy, we have a depression, and short rates fall below zero (in the Great Depression, T-bills bore negative returns: buy one for $100 and get $98 back at maturity. It was a good deal because nobody else could be counted on to pay the money back at all).
Three, the spread narrows in a happy ending as long rates come down, the economy recovers, and short rates rise a little. Banks actually have to make loans again.
Without much notice, Plan Three is underway. The spread has narrowed a full percent since November. Nice news, but the spread today (bonds at 6.55%, bills at 3.00%) at 3.55% is as high as any in the history of the country before about 1991, and has lots of room to narrow further.
The good news for mortgages and real estate is that the spread will continue to narrow by the long end coming down, not the short end coming up.
Long rates look as though they can decline another percent or more (gulp) before there will be signs of life from the economy, and the Fed won't raise short term rates until there is life to squash.
So don't get excited and wiggle, or make noise. The Fed's watchin'.
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