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May 31, 1996
Long term rates are just barely hanging on at the top of the last four months' range: mortgages at 8.50%, T-bonds at 7.00%.
This week's data kicked the last props out from under the optimistic theory that higher rates this spring would slow the economy, and rates would U-turn by Summer.
The news item doing the most damage was a 6.7% surge in new home sales for April. Housing is the most credit-sensitive sector in the economy, and higher mortgage rates were in full effect during April. Some home sales data are based on closings of old contracts ("lagging" indicators), but new home sales are tracked by contracts written, and are therefore authentic, new news.
If higher rates didn't slow the housing market in April, they didn't slow anything else, either. No U-turn.
While this week was merely grim, next week is scary. No slowdown is bad, but what if everybody was really wrong, and the economy is accelerating?
Monday brings the purchasing managers' index, which has risen in a straight line from 43% to 50% since January. Today's regional reports (Chicago 53%, New York 57%) suggest the national number will arrive in the mid-fifties, and the bond market is already deteriorating in anticipation.
Next Friday is "first Friday," and time for another employment report. A large rise in payrolls, or unusual increase in wages, and the Fed will tighten on the spot.
"The Fed can't do that; this is an election year, and everybody knows interest rates won't go up."
Please try to get across to clients that an election year is not some sort of force field which will protect borrowers from the real world. Neither candidate has the ability to muscle the Fed, let alone the markets.
From a market perspective, this election is the least relevant since Harding's, and has talent to match. Clinton won't touch entitlements, and Dole is in the grip of the tax cut wing nuts. Net deficit outcome, either way? Zip.
If the Fed feels the need to act, it will do so, and it has ample ability to generate its own political cover.
Which it began to do this week. Two Fed governors (Ms. Phillips and Mr. Broaddus), and the president of FRB Boston (Ms. Minehan) this Wednesday and Thursday gave speeches with substantially identical inflation warnings.
One speech? Routine. These Fed people warn about inflation even when they are easing. Two speeches on the same day? Coincidence.
Three speeches? Organized jawbone. Get ready.
Mortgages are at risk for nine.
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