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March 1, 2003
Changing prices in the financial markets reflect the continuous, minute-by-minute effort by investors to predict the future. Markets have frozen in a pre-war situation which transcends uncertainty; the future is now opaque and unknowable, and the ice is thick enough to roll a tank across. Only stocks could break through.
Mortgages are a perfect example. Fearful money is still buying, but even with that impetus, the tilt is only ever-so-slightly downward. Freddie Mac's survey has set a new record-low in each of the last six weeks: January 23's 5.91% gave way to 5.90%, 5.88%, 5.86%, 5.84%, and 5.79% (each with a partial origination fee).
Economic data are shaky, but not double-dipping. Orders for durable goods were the bright light, rising a strong 5.4% in January. However, claims for unemployment insurance are trending up again, and help-wanted advertising is mired at a 40-year low. Retail sales are down versus 2002, and sales of new homes crashed in January.
To no one's surprise, after the ludicrous duct-tape alert, consumer confidence fell by the largest monthly margin in 23 years (excepting September, 2001). April 1980 marked the failure of the Iran hostage rescue mission.
There is not the slightest wobble in the Bush administration's intention to go to war, nor any rising opposition in Congress. Our forces are still deploying, and war will not begin before the middle of March.
Today's veto threat by Russia confirms that we will not have the support of a new UN resolution, and it's time to drop the delusion that France is the sole opposition (and the offensive notions of French cowardice: difficult, certainly; cowards, no). The Turks are still not sure that they have been bought, or perhaps can be bought. Tony Blair is aboard, no matter what: despite media spinning of "big defections," this week's pro-Blair vote in the House of Commons was 434-124.
Danger in the world drives money to safety, and in the last two months has packed the usual shelters to the ceilings. Gold is way overbought for non-inflationary times. Oil at $40/bbl is trading at more than double the cost of production (as high as the price seems, it is less than half the inflation-weighted peak 1979-80). The Treasury's inflation-protected bonds have been bid so high that they won't make money without a sustained return of 5%-plus inflation.
If the shooting goes well, the fear-trades will unwind until we find out how the early stages of peace are going, and the mask of war falls to reveal the real condition of the US economy. I cannot imagine that even a Hollywood victory -- roses on tanks, grinning kids with GI candy bars -- would be a smooth process. Rates would rise out of the refi zone, but lurch back occasionally until the economy recovers.
Markets are probably prepared for the middle-case outcome: a real, not video-game war; bloody, even if short; protracted ethnic conflict among Iraqis, but civil unrest limited to Iraq; and Iraqi democracy beyond the visible horizon. Rates would swing wildly as this case developed, and as we learned the cost of extended involvement (some new deficit estimates top $400 billion).
In my opinion, markets have not begun to discount the potential for bad news. The real risk here is not just a longer, bloodier, or more expensive war, or even domestic terrorism. The real risk is a rending of the international fabric. We see ourselves as the good guys, the white-hats in the movie, and gravely underestimate the global anger rising at the perceived arrogance of the United States.
If this high-risk, maybe high-reward adventure goes badly, the world will turn against us in a way we cannot imagine. Then the financial consequence would fall to the dollar, and we cannot imagine that, either.
Meantime, Fridays are good days to lock, as rates have tended to slide in fearful anticipation of what could happen over a weekend.
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