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March 25, 1994
Long term interest rates fell after the Fed tightened on Tuesday, but the improvement lasted only 24 hours. On Thursday, mortgage rates hit their highs for the fourth time this month.
Two pieces of good news. Mortgage rates have not been able to pierce these highs, and the "high" here (8.125% at zero and zero) was the "low" reached last year for the first time in 20 years. Don't reach for the hemlock just yet.
Next Friday brings job statistics for March, which will set the rate trend for April. Next Friday is Good Friday, and many financial markets will be closed; closed markets on big news days add to pre-report anxiety.
Omen: next Friday is also April Fool's day.
Seconds after news flashed on CRT screens "FED TIGHTENS ONE QUARTER," bonds raced to their best gains in months.
There for a while, it looked as though the Fed's dream had come true: ratchet Fed funds from 3.00% to 3.25% to 3.50%, and bond investors would be reassured about future inflation. No such luck. Tuesday's temporary improvement came from relief that the Fed had only tightened a quarter point, not a full, half-point pop to 3.75%.
The cute psychology is over. Reality turns out to be that a tight Fed is a tight Fed. If the Fed is tight, nobody wants to buy bonds or mortgages unless yields are higher. The Fed has tightened only .50% since February 4, but yields on Treasurys and mortgages have risen twice that much since Christmas -- just what the Fed didn't want.
Though it is clear that the Fed's cautious tightening has hurt bonds, and not helped, the Fed has another agenda, and must continue. Believe Mr. Greenspan: he's said for a year that short term interest rates were "too low." He and his colleagues intend to rectify that situation.
In 1992, the Fed dropped the Fed funds rate all the way to 3.00% in an extreme effort to get the economy out of recession. The Fed doesn't want to crush the economy now, but must get Fed funds back to a reasonable level from which it could crush the economy if necessary. The current 3.50% Fed funds, or soon to be 4.00%, or even 4.50% won't noticeably slow the economy.
If inflation suddenly appeared, and the Fed really had to clobber the economy, it might take 6.00% or 7.00% Fed funds to get inflation back under control. The Fed can't move Fed funds from 3.50% to 7.00% in one swell foop. The gradual rise in Fed funds now in process is designed to position the Fed for future action.
More quarter-point rises to 4.00% or 4.50% seem likely, one every eight or ten weeks.
The weird, irrational part of our predicament is this: If the Fed gets more hysteria from the bond market with each rise in Fed funds, higher bond yields will clobber the economy before the Fed gets done with its tidy adjustment.
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