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March 13, 1998
The bond market got the benefit of two out three big stories this week (oil and Japan), and is not in a mood to pay attention to the negative one (strong economy).
At the best of this week, bond yields fell back under 6.00%, and low-fee mortgages were available at 7.125-7.25%. Rates are now smack in the middle of the range between January's low and last week's high. I continue to believe that a return to last week's highs is more likely than revisiting -- let alone breaking through -- the January low.
Benchmark oil prices fell below $14/bbl from time to time during the week. Cheap oil in the pipeline to refiners, and in turn to utilities and gas pumps, guarantees favorable reports on inflation for the next two months at least. Bonds are so pleased by low inflation reports that the market tends to forget the difference between a permanent change in condition and a temporary aberration.
In 1996, oil prices fell to $9/bbl (roughly the same as today's $14/bbl in constant dollars), bond and mortgage markets were overjoyed, leading to the first great, post-70's refinancing boom. Temporarily low oil prices distort inflation statistics, and also distort the economy: cheap oil acts like a tax cut, and over-stimulates the economy.
Mortgage rates bottomed at 8.00% in 1986; and after an April, 1987 reversal in oil and bonds, mortgages rose back above 10%, and crested at 11.5% in 1989. That isn't going to happen now, but neither is 6.00%. Whether because of oil prices orŠ whatever, retail sales are exploding on the upside. February rose at a strong, .5% pace; while January was revised from plus .1% -- presumably an early sign of Asian flu -- to plus 1.0%. Some revision, that: tenfold. (Winston Churchill, after a tour as Chancellor of the Exchequer: "I simply could not keep track of those damned little dots.")
It's amazing what a decimal point will do for an economic forecast. Every serious forecaster is now aware that first quarter economic growth is far stronger than anyone thought going in, and is accelerating, not slowing.
Asian flu may get us later, but not sooner.
Then there's Japan.
Imagine that Ken Starr is out to dinner at some fancy Washington joint, and notices the chairman of Chase Manhattan Bank picking up a big dinner tab for a Fed governor. Next day, his investigation spreading ever-outward, he raids the offices of the Fed, the governor hangs himself, and a humiliated Alan Greenspan offers to resign.
We thought we had it bad. The "government" of the world's second-largest economy is paralyzed; and every time Japan's sun appears to be sinking, T-bonds have a good day. However, it's not good news.
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