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January 17, 2003
Mortgage rates slid back under 6.00% this week, aided by war fear and lousy economic data, but chances for a further drop are limited by the first large-scale Treasury borrowing in seven years, and the constant threat of peace.
The war-peace calculus: we're going to war as soon as we get a UN resolution, or decide to proceed without one by the end of March. We prefer February. Peace might break out in the form of exile for Hussein, or collapse of US resolve following a defeat at the UN, or something like the fall of the Blair government.
Everyone in the markets assumes long-term rates will rise instantly in the event of peace (or clean victory), in the belief that the threat of war has driven an excess of money to bonds and mortgages for safety, and is suppressing economic activity.
I'm not so sure. Having Iraq in the rear-view mirror would relieve a certain amount of anxiety, but post-bubble economic trouble is global, and the poster child for that trouble is the stock market. If it lets go again, there will be no shortage of money chasing bonds and pushing rates down anew.
The fresh economic data could be worse -- there could have been a clear signal of double-dip to new recession -- but any prognosticator who can look into a camera today and say the economy is in or is entering an acceleration phase is either drunk, or trying to sell you some stock.
The Fed's "beige book," a survey taken through last week, characterized the economy as "sluggish, soft, or subdued"; and the University of Michigan's consumer confidence finding fell (again), especially versus market expectations. In the newest hard data from December, both industrial production and capacity in use, expected to rise, fell. There are hints of a bottom in job losses (unemployment claims may be slowing, and temp hiring is up), but there is no sign of large-scale permanent hiring. K-Mart said it will close 326 stores and fire 35,000 workers; has anyone heard lately of a company planning to expand by a like number of stores and employees?
The inflation news is good -- incredibly so, in light of a 60% rise in oil prices in the last twelve months -- but zero inflation is a good-news, bad-news deal when you're worried about deflation.
The much-anticipated fourth-quarter corporate earnings results are arriving close to forecast, but all week long, every report reduced expectations for activity in 2003. The big engines of growth -- technology, earnings, capital spending -- are no better than holding their own, in no way justifying still sky-high price-earnings ratios.
In the land of political economics, the President's tax-free dividend proposal is falling flat. It does not have full Republican support in the Senate, there is no business support in new, large plans to pay dividends (Microsoft's point-three percent offer is insulting), and it fails fairness tests. Dividends are not truly taxed twice, as they are hardly taxed at all at the corporate level. And, as poor an economic idea as it is to tax dividends and capital gains, we do so for reasons of equity: these are the only ways for the truly wealthy to pay some share of the national freight.
Running a big deficit now -- whether by tax cut or increased spending -- is absolutely the thing to do, and the Democrats' fiscal carping has no foundation. However, there is a limit to deficit benefit: the point at which massive Treasury borrowing drives up long term interest rates, doing more harm to the economy than the excess spending helps. The usual crew disputes the notion that deficits can cause interest rates to rise, but that Frat-Boys-Take-Econ-101 bunch had better not run into a gang of bond traders after school. The Treasury will borrow $67 billion in February, and we will feel the upward pressure.
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