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December 20, 2002
Shortly after the words "material breach" left the mouths of American officials at the UN on Thursday, mortgage rates succeeded in their first material breach of 6.00% since October.
Handicapping war is a hell of a thing to be doing in the week before Christmas, but there are some useful and predictable aspects. The first to remember: war-related changes in interest rates will tend to be transient, lasting a few days or hours. For example, at this writing, yesterday's breach of 6.00% is reversing. The second thing to keep always in mind: the US economy will remain the dominant influence, and the stock market its proxy. An accelerating economy will mean higher rates, a weakening one, lower.
War is not imminent, but each progressive step toward war, like Thursday's, will exert downward pressure. Steps to come, perhaps: news that America has been joined by a coalition for war, or news that America has no coalition, but will proceed anyway; the announcement of each coming call-up of reserves (beginning soon after New Years); the UN inspectors' report due in late January, just before the President's State of the Union address; then the outbreak itself, unlikely before February or after March. First, a several-week-long air campaign, then ground forces, then Baghdad, then... then nobody knows.
Events which would push rates up: a pre-war coup in Iraq, or a decision by Hussein that exile beats death, or any other solid indication of peace, including a bitter, grudging stand-down by the US. Peace would mean an upward explosion in the stock market, and possibly an abatement of the risk-averse paralysis which plagues the economy. Peace could also come by winning cleanly, followed by a relatively stable Iraq. I think (in pure supposition) that our quick victory in Afghanistan was a central element in last winter's stock market rally.
Oil is a wild card. A surge in oil prices would be inflationary, a condition which should push rates up; but, on the other hand, high oil prices tend to crush Western economies, and recessions are good for rates. I'd bet on the latter force to prevail.
The standard bond-market equation: bad news pushes rates down. There is one worst-case exception in this situation: an American quagmire. Suppose war works in every way hoped, except Iraq turns into an immense Yugoslavia, with Kurds, Sunnis, and Shiites at each others throats, and ours. That outcome could produce a run on the dollar, and hurt the economy, and stocks, as well as push up rates. Despite many dollar warnings, it has remained sound, as global money has no better currency to run to (given the weakness in the economies supporting the yen and the euro), but a new Vietnam would change that calculus.
There it is: from a bond trader's point of view, episodic fear will generate temporary dips in rates, but in the background, the constant threat of peace.
And the economy. Mr. Greenspan delivered a speech yesterday in which he was anything but confident of "vigorous recovery," and indicated uncertainty about the "dynamics of bubbles," both during inflation and after implosion.
Well, I guess that makes all of us, now.
We won't get market-moving news on the economy until the reports due in the first week of the new year, and we will be back with the news on January 3.
Meanwhile, take time to watch all the versions of A Christmas Carol, revel each time in Scrooge's shutters thrown open, and fear not ghosts.
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