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June 26, 1998
Mortgage rates have not re-approached the maximum panic lows of Monday, June 15 (6.875% at "zero and zero"), and are close to 7.125% going into this weekend.
Japan-fright is still running strong, but the credit markets are on hold. There will be no Japan-related policy announcements while Mr. Clinton is in China, and last week's yen intervention bought time -- with luck until a new bank-bailout plan is announced after July 12 elections in Japan.
On the economic front, the credit markets are in a very well-armed standoff. Sudden, surprise weakness on either side will cause an abrupt, probably large-scale change in long term interest rates.
Those who believe that Asia's troubles are slowing our economy (at last...) were reinforced by news that orders for durable goods fell by 2.6% in May.
On the other side, 1st quarter GDP growth was revised up to 5.4%(!). While a Jurassic Park datum, it does beg a question: if the economy slows down, say all the way to a still-screaming 4.0%, does that mean the Fed will ease?
Not hardly, and that's the standoff: no matter how proper the anticipation of slowdown (New Paradigm Pollyannas aside), the Fed will not reverse to an easing stance until the slowdown is real, and deep.
It's easy to measure the Asian-money-flight-to-Treasury-quality:
Fed funds 90-days 180-days 1-year 2-year 10-year 30-year
5.50% 5.00 5.26 5.38 5.48 5.44 5.65
At first glance, this spreadless yield curve looks like the scores given to an especially ordinary skater (the Russian judge grading at 90 days).
In the last fifty years, "flat" yield curves have always reflected a market anticipation of an imminent drop in the Fed funds rate -- otherwise it's silly to own long term securities at overnight returns.
It's impossible to interview "the market" to determine its collective anticipation, but not even the Pollyannas think a Fed easing is imminent. This flat curve has been created by waves of money buying long Treasurys for safety.
Also buying because of high yield, spreads be damned. To an American, these yields are very low -- 1968-record lows. However, in Japan, a 10-year bond pays 1.54% in yen, which, going down like DiCaprio, means a net-negative return of 10-20% so far this year.
There are two reasons Japan must revive its economy: first to provide a market for other Asian nations' exports, and second -- more important -- so Japan can raise its interest rates. Unless Japan raises its rates, this wild, weird, yield-and-quality, yen-for-dollar chase will continue, and distortion will turn to destabilization.
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