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March 26, 1999
Mortgage and bond yields set a firm bottom early last week. Rates could neither break through to wintertime levels, nor hold their lows near 7.00% and 5.50%, respectively. At this writing, low-fee mortgages are trading near 7.125%, half way back up to the post-January high at 7.25%, and likely to stay within that 7.00-7.25% range until something big happens.
America's air assault on the Serbian remnant of Yugoslavia has had no effect on the bond market at all, which is most unusual. Historically, at the opening of hostilities -- no matter how thoroughly anticipated -- money races to American bonds in a classic "flight to quality", and interest rates fall for a few days. This time, on Wednesday afternoon, bond prices did not change at all. The absence of response begets several explanations. The most benign: Yugoslavia is the fourth sovereign nation to receive an American air strike in the last ten months (the others: Sudan, Afghanistan, Iraq), and the markets are bored with war. Or at least with surgical, antiseptic, cruise-war; casualty-free on our side. More ominous explanations include the following. Conditions in Kosovo appear much worse today than before the strikes, and the same is true for our relations with Russia. Yugoslavian anti-air is not sufficiently suppressed to allow air power alone to protect the Kosovars, and a choice between atrocities and ground troops is imminent. (At noon today, a White House spokesperson threatened the Serbs in Kosovo with legal action if they did not cease and desist. That'll fix 'em. Send in David Kendall and Ken Starr. By cruise missile, please.) Bad outcomes in Kosovo can tear up the bond market. If we get caught in a quagmire deep enough to require increased defense spending, budget assumptions will change for the negative. Quicksand aside, it is easy to see our increasing over-extension in the combination of the Balkans, Iraq, the rest of the Middle East, and North Korea.
Some very big borrowers also put upward pressure on rates. AT&T, a 500-pound gorilla if there ever were one, sold $8 billion in new bonds, the five-year maturity portion yielding 5.625%, only .64% above Treasury five-year T-notes, and the thirty-year AT&T bonds paid 6.50%, only .94% above Treasurys. Yesterday, Mexico sold $1 billion in ten-year bonds, but had to pay 9.75%, 4.49% above 10-year T-notes. There are two lessons here. First, American mortgage borrowers pay rates closer to Mexico's than AT&T's not because of foreclosure risk, but because of our right to prepay without penalty. Second, If AT&T thinks these are nice rates at which to borrow $8 billion, I wouldn't bet against them.
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