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September 26, 1997
Bonds and mortgages survived some extremely strong economic news, but could not hold the lows of last week and the first half of this one.
You'll need to help clients with this week's Freddie Mac Fantasy. Headlines in this morning's newspapers: "Mortgages to 19-Month Low! 7.28%!" The 19-month part was right when Freddie completed its survey on Tuesday, but "7.28%" is Freddie's usual, two-point fable.
The strong news: Durable goods orders in August, supposedly suppressed by the UPS strike, exploded to a 2.7% gain -- a pretty good pop for any normal three month period; and existing homes sold at the fastest paceŠ ever.
Any time in the last couple of decades, a same-day durable goods and home sales surprise of this magnitude would have propelled traders into fifty-floor swan dives. This year, they barely squirmed at their screens.
The non-reaction to the durable goods report reinforces the point made here last week: the market believes that no evidence, sign, or signal of inflation pressure -- no matter how overwhelming -- will be enough to make the Fed tighten. The Fed will move only on the fact; the actual arrival of wage, commodity, or real estate prices in rapid motion.
So say the believers. And they're not just talkin', they're tradin' that way.
The Fed funds rate is the overnight rate set by the Fed for bank-to-bank trades. It is the benchmark cost of money in the financial system, and spreads above Fed funds for longer maturities compensate investors for future risks.
It is one thing for the bond market to get a little overconfident, and another for it to beŠ well, reach your own conclusion.
March, as Fed Tightens Wednesday Change
Fed funds 5.25% 5.50 +.25
90-day T-bills 5.38 4.92 -.46
Six Month T-bills 5.55 5.14 -.41
1-year T-bills 5.80 5.44 -.36
30-year T-bonds 6.72 6.30 -.42
30-year mortgages 8.375 7.625 -.75(!)
Two observations. First, a Fed tightening can be damn good news; and, mortgage rates are more excitable than Treasury yields.
Two trades. Found only in and near recessions (until now), Treasurys out to a one-year maturity are paying returns "below cost"; and, you get paid .86% for the 29 years of risk from one year to 30.
Those are lousy deals, unless you're a believer.
The Fed's next meeting is Tuesday, September 30; but the big deal next week is the employment report on Friday.
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