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May 13, 1994
Good news. Sunshine, blue sky, and flowers.
Rumors of inflation and an economy growing out of control do not square with new data. April Retail Sales fell .8%, and over 350,000 new people filed for unemployment insurance last week.
The inflation news was even better. The Producer Price Index fell .1% in April, and the Consumer Price Index rose only .1%. There were no quirks in the reports, and the underlying "core" rates were under control as well.
Phew. Glad that's over. Low inflation and slow growth must mean that mortgage rates are back under nine, right?
AhŠ.no. They stopped rising, but there is no drop.
What is the market waiting for? For one thing, waiting for the Fed.
The Federal Reserve Board meets on Tuesday, May 17, and will raise its key rate, the Fed funds rate, that day. (We say "will raise," but they might not. If not, it will be a "Titanic Sinks Iceberg" story.) Guesses for Tuesday's move go as high as 4.50% all at once (from 3.75%), and the market is already prepared for a jump almost that big.
People are always saying a market is "prepared," or depressed or overjoyed or hysterical, as though there had just been some giant group press conference involving a mood vote by four or five million investors and brokers. "Prepared" is honest commentary here because the preparation shows in market prices.
For example, this week the yields on 90-day T-bills hit 4.81%, and the six-month T-bill is up to 5.00%. Those rates are consistent with a Fed funds rate of at least 4.25%. Those yields are also just about double where they were eight months ago.
(By the way, the yield on a one year T-bill, better known to Realtors and borrowers, rose to 5.50%. One year ARMs adjusting this week will go to 8.25%. Going higher.)
If there is some sign of softening in the economy, and inflation is under control, why is the Fed continuing to raise rates?
Ever since the first rise in February, the financial markets have been trying to psychoanalyze Mr. Greenspan and his colleagues. Many elaborate theories of Fed motivation have been advanced, and Mr. Greenspan hasn't offered a word since his first comments.
He said in February that the Fed "did not intend to limit the economy," but did not want to provide "excessive stimulus." Believe him.
After three years of stimulation, it is a terrible wrench to have to make long term investment decisions without help from the Fed. However, there is a pretty good chance that the extreme rise in long term rates has now fully anticipated the Fed's return to neutral.
Wait for Tuesday.
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