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March 5, 1999
Bond and mortgage yields have found a top: yesterday's 5.70% bond and 7.25% mortgages have fallen to 5.58% and 7.125% respectively. Consumers will be tempted to assume that today's improvement signals a decline to the September-January lows -- not a good idea, I think. This morning's payroll report calmed over-stressed traders only because it was the first report in weeks to arrive as forecast instead of much stronger than forecast. The bond market damage caused by reports earlier in the week was justified, especially by the second-straight triple-the-forecast leap in the Purchasing Managers' index. Long term rates spent the five months though January in a very tight trading range: for low-fee mortgages, 6.75-7.00%. It's reasonable to expect a new range now, with the old top serving as the new bottom, and the worst of this week setting the new top: call it 7.00-7.25%. Rate forecasting, done properly, is an effort to measure probability. In the near term -- a few weeks -- statistical probabilities favor "ranges" like the one described above. In the longer term, probability generates cone-shaped boundaries for future movements of rates, widening over time. The farther in the future we look, the less we can predict, and hence the ever-widening mouth of the cone. Despite the recent rise in rates, today's cone is remarkably narrow-mouthed (except in one respect -- I'll get to that). Fundamentals are favorable -- low inflation, and a tough-minded Fed -- and markets for money have enjoyed extremely low volatility for the last two years. By some measures, 1998 had the lowest top-to-bottom variation in mortgage rates in fifteen years. Big single-day leaps and drops, to be sure, but great stability overall. Low volatility tends to reinforce itself, until... well, an accident of some kind. You can't forecast accidents, except to be aware that you'll have a certain balance of good ones and bad ones over time. Last week, I said that our "'flat out' economy is accident prone". There are a couple of things out there that make me feel like I'm watching a brand new SUV whose exuberant driver is exploring his first snowstorm at the wheel. No, not the stock market. Instead, the remnant Asian contagion: overnight rates yesterday reached 45% in Brazil, .02% (point-oh-two) in Japan, and the euro is falling as fast as the European economy. As a collective accident, favorable for American rates. For upside risk, the oil patch; where in nine months the active "rig count" has fallen from over 1100 drilling to less than 500. Mighty reassuring, that cone is. Just don't fall asleep in it.
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