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August 13, 1999
Good news this Friday-the-thirteenth... and the best in several months' unrelieved gloom in the bond market. The economic data were nothing special, but the market reaction to an ordinary -- very ordinary -- inflation report this morning indicates a change in psychology. The producer price index rose .2% in July ("core" unchanged), and T-bonds are enjoying an explosive rally, down from 6.27% yesterday to 6.12% this morning. A modest origination fee will re-introduce the word "seven" to mortgage conversations today.
Ever since February, when it was clear that the World Crisis was past and the American economy was racing ahead, the bond market has progressively anticipated a reversal of some or all of the Fed's three emergency eases last fall. Today's bond rally constitutes a confession among traders that they got ahead of themselves in Fed-fear. They were right for the first half of the year, and when right for long there is always a temptation to overdo things. The gradual rise from 5.00% bonds to 6.00%, and mortgages from high sixes to high sevens was good sense, accurately anticipating the July rise in Fed funds from 4.75% to 5.00%, and another .25% increase, as well. That's why the fact of the tightening in July did no harm, and neither will the one coming on August 24 (sez here). Things got out of control two weeks ago, when unpleasant wage, payroll, and productivity numbers appeared to hit Mr. Greenspan's tenderest spot. The bond crest near 6.30% and mid-eight mortgages were appropriate only for traders who expected a third tightening quickly as introduction to a longer tightening campaign. The numbers were bad, but did not deserve this nuclear accident treatment. The market needed to get a grip on the present likelihood, and stop flailing around in the worst case. Today, it got a good hold. The chairman fears a wage-price spiral flowing from a too-tight job market and a too-hot economy. It's worth worrying about, but there are other ways out of the worst case. The best one: when businesses run out of people to hire, instead of ruinous wage-competition, they stop hiring. The dominant form of advertising today is not on TV, and not on the internet; it is the "help wanted" sign in the window of stores and restaurants. The bottom of the labor barrel is near: while widespread opportunity is a good thing, recent hires behind some service desks resemble the cast from "Deliverance".
The likely case: the Fed goes to 5.25% a week from Tuesday, and that's it for the year. Mortgages passed their 1999 peak this week, and a slowdown in the economy can take us back into the sevens. No guts, no medals.
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