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July 7, 1995
Surprise strength in the job market has offset some of the benefit of the Fed's quarter-point ease, and mortgage rates are holding in the high sevens at "zero and zero."
June non-farm payrolls doubled expectations with a 210,000-job gain, and the 100,000-job contraction in May was revised to only half the original drop.
Clients are suffering from the normal confusion caused by a policy change at the Fed.
Short term rates like "Prime" always follow the Fed. Mortgage rates are long term rates: when the Fed moves, long term rates may follow, do nothing, or go in the opposite direction.
See, long term investors worry about theŠ er, Š long term.
'Way back in December (a short while ago), everybody in the money business was convinced that sooner or later the Fed's tightening moves would slow the economy. "Sooner or later" was thought to be a year or two (not a long time, but much longer than a short time). Since a slow economy is an inflation-capping benefit to long term investors, long term rates began a gradual decline; by the end of April they had fallen more than a percent from December.
Suddenly, in the first week of May, all economic data turned sour. In the first week of June, they turned sourer. By the end of that first week of June, long term rates had fallen a whole additional percent from the December highs.
Then a funny thing happened. Long term investors began to reconsider the long term. They had been expecting a sour economy in the long run, but got one in the short run. "Sooner" had turned out to be two months, not two years.
Long term investors worry about all sorts of shadows all the time, but by the second week of June a single worry began to dominate. Since the economy had gotten sour quickly (short term), then the Fed would not tighten further (short term), and might even reduce rates (short term), which would mean that the economy was going to bounce back (long term).
If instead of two years of tightening (long term) followed by a recession (long term), I get a rejuvenated economy and maybe inflation (long term), why do I want to own mortgage investments (long term)?
I don't. Mortgage rates haven't returned to the early June lows, and won't -- unless the economy shows more weakness. If jobs continue to grow at 200,000-plus every month, we will be fortunate to have mortgage rates stay in the sevens.
Though the odds are lower for a big improvement in rates, there is no sign of an explosion upward. That would only happen if the Fed overdid its easing act (short term), and an economic rebound turned into a new boom (long term).
The Fed would never do a thing like that.
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