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May 20, 1994
The Fed dropped the other shoe, and along with it mortgage rates fell almost a half percent in 48 hours.
The drop in mortgage rates is due more to temporary relief than a change in economic fundamentals. We should get a month or two of relative calm (mid-eights to nine), but it would be a mistake to expect stability beyond that time.
Industrial production had its 11th straight rise, but only a little one, and capacity utilization held steady at 83.9%, just below the danger zone. Retail sales flattened out, as did housing starts, down 2.5% in April.
The Fed will not toss around any more footwear until the economy declares itself, a process which will require about two more first-Friday-of-the-month payroll reports.
If the economy is clearly slowing, the mortgage highs of the year are past. If the economy shows more signs of strength, practice saying "ten" to clients.
Have the Fed's moves put a brake on the economy? The answer will surprise as many people as did Fed funds up, discount rate up, prime up, mortgages down -- all on the same day.
The Fed's moves so far will have little impact on the economy. (Higher long term rates may be slowing the economy, but they are a market function, not a Fed one. If the Fed had not moved at all, mortgage rates might be just as high or higher than now.)
Raising short term rates a percent, or two, or three is the least possible application of Fed power, and tends to merely reshuffle the money deck. Retirees earn more on their CD's (stimulus), while borrowers pay a hair more (drag). Within a wide range, the net effect is nil.
Higher rates don't bite into the economy until they exceed the benefit of the borrower's return. If I've got a project which I expect will return 12%, a rise in prime from 6.50% to 7.25% is a non-event. Even mortgage borrowers theoretically priced-out by much higher long rates simply change strategy: go adjustable, get help from family, or buy down -- but still buy.
Recall the 1979-82 period, and the economy that would not die: prime was at 22%, and mortgages near 17% for three years before the economy and inflation finally cracked.
The Fed has a steel-toed boot which it saves for difficult moments. Technically, "tight" doesn't refer to manipulating short term rates. Tight means putting the toe to the supply of money and credit, and creating the "credit crunch" which usually precedes recessions.
There is not the slightest sign that the Fed is "tight" in this serious sense. So far, the Fed has only sent signals that it's paying attention. Strength in the economy would put us right back into will they, won't they, and how much; and for keeps, next time.
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