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August 18, 1995
On Friday afternoon last week, bond yields broke through the top of the July trading range, and took mortgages along for the ride. 30-year Treasurys reached 7.00%, and mortgage rates spent the week between 8.25% and 8.375% at "zero and zero." Breaking out the top of an established range is not good news.
However, economic data brought no big surprises which might explain the rise in rates. Industrial production rose for the first time in five months, but gained only 0.1%. Housing starts put in a strong July, up 6.7%, but from a very low base. The trade deficit set a single-month record, but the cause was Mexico's inability to buy our exports, not an inflationary import binge by Americans.
So, why are mortgage rates rising, ever so gradually?
There are times when the bond market is fearful of inflation, and a tightening Fed is reassuring, as it was all last winter. There are other times when the bond market has built in an expectation of easing from the Fed, and then realizes it isn't going to happen.
Like now.
Early July August 17
Fed Funds (lowered .25% on July 6) 5.75% 5.75%
One-year T-bills 5.56 5.85
Two-year T-notes 5.65 6.12
Five-year T-notes 5.89 6.38
Ten-year T-notes 6.09 6.56
Thirty-year T-bonds 6.95 6.96
Note the note action. Bills and bonds are little changed, but from two to ten years, the market has given up an expectation of .50-.75% in additional easing. Since mortgages have a presumed life of roughly three to seven years, they have suffered the same damage as the notes.
It's surprising that more damage has not been done. In June, the standard argument went like this: the Fed doubled the Fed funds rate in 1994, from 3.00% to 6.00%, and the soft economy meant that the Fed would soon begin to ease back towards 3.00%.
However, just as the Fed began to ease, the economy began to recover on its own.
Maybe the 3.00% funds rate was excessively low, and necessary only to get the economy out of the last recession. Maybe the current economy needs no stimulus at all. What if the Fed eased prematurely, and the economy gets a little hot along about December? The Fed wouldn'tŠ they couldn'tŠ tighten?
Thus does a market slowly abandon happy expectations.
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