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August 27, 1999
August's extraordinary drop in long term interest rates continued briefly after the Fed's tighter Tuesday, but could not hold. Bonds and mortgages are settling near 5.95% and 7.875% respectively. The exuberant mid-week dip to 5.83% and 7.75% was triggered by a greenspan sentence appended to the Fed's rate-rise announcement (soon after his retirement the Chairman's name will be used lower-case to describe complex, paragraph-long sentences): "Today's increase in the Federal funds rate, together with the policy action in June and the firming of conditions more generally in the U.S. financial markets over recent months, should markedly diminish the risk of rising inflation going forward." Trading desk translation: "We've whacked you twice ("policy action"), but your bond panic did the heavy work for us ("firming conditions"), and the inflation worry-warts can sit down." Further deconstruction: "going forward" to Mr. Greenspan means six months to a year, the interval necessary for "policy action" and "firming conditions" to take full effect... or not. That "should" in front of "markedly diminish" is NOT a guarantee.
The market is in pretty good balance on the way out the door, forward: six months of panic, a powerful correction, and a modest correction to the correction. Rate-watching going forward always begins with the rear-view mirror. Second-quarter GDP was revised down to modest 1.8% growth, but is misleading: the consumer spent as hard as ever, but the overall growth figure was suppressed by drawn-down inventories and imports. An inventory-building surge in the rest of the year has already turned up in orders for durable goods, up 3.3% in July, quadruple the forecast. And, the Chairman's confidence about "firming conditions" notwithstanding, mortgage rates higher than today's failed to suppress July home sales, which ran almost 5% ahead of last year's. Forward, forward.... Next Wednesday brings the purchasing managers' reports, and on Friday comes the big one, the payroll data for July. We already know from record-low (and falling) claims for unemployment insurance that the job market is still screaming; we hope for a silent, non-inflationary scream on Friday. If these reports repeat the rising-wage, falling-productivity pattern of the first week of August, we'll remember how we got to 6.30% bonds and 8.375% mortgages. It would take an economic-slowdown stunner for rates to fall below the best of this week. Advice stays the same: don't bet on big improvements.
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