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August 20, 1999
More good news... two whole weeks in a row. T-bonds rallied another eighth of a percent, staying near 6.00% all week, and mortgages picked up even more ground, to 7.875% at mid-week for the lowest-fee 30-year deals.
Commentators should be cautious when announcing a decisive change in a market, but the last ten days' trading in T-bonds and mortgages looks exactly the way a turning point is supposed to look. One of the oldest rules in Fed-watching holds that an episode of Fed tightening is finished when T-bonds rally at the prospect of another tightening. It's been a lead pipe cinch for three weeks that the Fed will tighten next Tuesday, and bond yields have fallen from 6.30% to 6.00%. This concept -- bond traders pleased with higher rates from the Fed -- is lost on most of the media. I shouldn't be too critical because the concept confounds common sense. When the Fed first begins to tighten, the bond market hits the windshield; however, further tightening ultimately reassures the bond market, confirming that the inflation threat has been pre-empted. In the last stage, traders are thrilled that the Fed might overdo things, causing an economic slowdown or stock market mini-crash. (Thinking like that is how you get known as a "bond ghoul".) Your customers are going to hear only the "bad" news from the media on Tuesday: GREENSPAN ON WARPATH!... HOME MARKET TO CRASH UNDER HIGH RATES! Instead, mortgage rates are likely to hold right where they are today, the lowest in a month, until the market gets more economic data.
The bond rally is good news, but nobody should confuse it with prospects for a further drop in bond and mortgage rates -- not now, anyway. While the market fully anticipates a tightening move by the Fed, a .25% raise in the Fed funds rate to 5.25% puts a floor under 6.00% T-bonds. The Fed funds rate is an overnight cost of money, and long term investors rarely accept returns less than .75% above short term cost. There are two exceptions: panic, like last fall, when investors worldwide raced to U.S. Treasurys for safety, ignoring yield spreads; and during a deepening economic slowdown, when narrowing bond-to-Fed-funds spreads reflect anticipated easing. We may get little panic dips (China/Taiwan, a stock swoon, Russia...), but there is no evidence whatever for an economic slowdown. Home sales are cooking along at a steady, high pace, ignoring the one percent rise in mortgage rates since winter. And, in another sign of a too-tight job market, new claims for unemployment insurance this week reached a 26-year low. We need that slowdown to get mortgages farther down in the sevens, whenever, however.
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