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February 23, 2001
Mortgage rates again reached their 2001 peak during this week, low-fee deals going as high as 7.50% despite deepening distress in the stock market.
Going back several years, bad stock market days were almost guaranteed to produce lower mortgage rates. Not this time... not yet. There are two explanations for the absence of interest rate follow through.
Theory #1. Energy costs have raised the threat of inflation; specifically, "stagflation."
Until the 1970's, no modern economy had for long suffered inflation and slow growth at the same time. Then and now, the condition is associated with a spike in energy costs which simultaneously acts like a tax increase, producing a stagnant economy, and triggers inflation. The Fed can't revive the economy by cutting rates for fear of making the inflation worse.
Stagflation is an unpleasant condition, and we are in some form of it; but the inflation component is minor, and energy prices aren't out of control. Even with transient energy distortions, the CPI will hold near 3% in 2001, and the energy distortions are transient. Natural gas prices have fallen to half their peak, and oil is under $30/bbl.
Theory #2. This one is more compelling. It holds that the economy's real problem is a still-imploding bubble in the stock market.
As of today, the Dow and broad market measures like the S&P 500 and Wilshire 5000 have reversed their January rallies, and are down more than 6% for 2001, while the Nasdaq is off more than 10%.
William H. Gross manages PIMCO, the largest and most successful family of funds investing in bonds. Mr. Gross is usually a cautious man, typical of a bond investor.
In the last 24 hours, Mr. Gross has announced his belief that the economy is "in recession." Further, he says that Fed Chairman Alan Greenspan faces the "dangerous" prospect of cutting rates in order to prop the stock market -- perhaps a full percent at its March meeting -- and that the stock market may nevertheless continue to implode.
Those of you well-trained in the metaphysics of bonds will be thinking... but recession and imploding stocks are supposed to be good for bonds and mortgages... right?
Yes, right, but: if the Fed begins a panicked series of stock-propping cuts, short-term rates will dutifully follow down, but long-term investors will be disturbed by the ultimately inflationary consequences of an easy-money Fed.
Richard Nixon, a hard-core budget balancer, in support of a 1969 budget deficit: "We are all Keynesians, now."
Well, in 2001, whether we own stocks or not, we are all invested in the stock market.
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