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February 26, 1999
Tough week. T-bonds started the week at 5.32%, better than the 5.44% September-January high of the week before, and then... blew to 5.66% on Thursday, "improving" to 5.56% today. The mortgage damage has not been so dramatic. Treasury yields have risen almost a full percentage point from the 4.76% October '98 low, but 30-year mortgages on the lowest-fee terms have risen only to 7.125% from the 6.875% wintertime baseline. However, the sound of "seven" is a shock to many a client who thought 35-year record lows had become the natural order of life.
The damage was caused by Mr. Greenspan's testimony to Congress, emphasis provided by new economic data. On Tuesday, The Line: "The Federal Reserve must continue to evaluate... whether the full extent of the policy easings undertaken last fall to address the seizing-up of financial markets remains appropriate as those disturbances abate." The Fed eased last fall in three steps from 5.50% to 4.75%. If that easing is now not "appropriate" [background noises from traders gagging on salmon frisson croissants, spilling martinis to reach for phones], does that mean the Fed will quickly return the Fed funds rate to 5.50%? If those "disturbances abate", does that mean bond yields are merely pausing here [scattered angina and arrythmia at trading desks] on their way to the 6.10% prevailing before those "disturbances"? Mortgages to 7.75%? By Thursday, news added force to the Chairman's blow. Orders for durable goods, suppressed in '98 by overseas woes, put in a surprising 3.1% gain in December. Instead of a renewed decline, January orders leaped ahead at a 3.9% clip. Existing home sales, unemployment claims... everything supported Mr. Greenspan's description of an economy going "flat out". Fed chairpersons do not like economies going "flat out", even in a 1.00% inflation environment. "Flat out" makes the economy prone to inflationary accidents. Next week we get new reports from the purchasing managers and the Labor Department. If they are as strong as they are likely to be, we should assume the Fed will begin to reverse last fall's eases, the first reversal as early as their March meeting. Re-tightening or not, most of the damage has already been done. And, there are a couple of legitimate reasons for optimism later in the spring: rates may come down as tax receipts arrive in April and the Treasury starts to pay off debt; and there really isn't any inflation out there. However, there is no case at all for a near term return to the January lows.
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