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May 30, 2003
Thursday marked the beginning of the third straight week in which low-fee mortgage rates held this tight, rock-bottom, 5.25%-5.375% range. To have held is remarkable in the face of more optimistic economic forecasts, mostly from the stock market, and the rest from right-side economists preening their new tax-cut plumage.
The week brought some terrible economic data, but it was all rear-view mirror stuff. We already knew April was bad, and it was: orders for durable goods fell 2.4%, down across all sectors, and personal incomes failed to grow at all.
In forward-looking news, retail chain stores reported May sales rebounding from the Feb-Apr pit to Dec-Jan readings. Polling of consumer confidence in May revealed dismal current conditions, but rapidly rising faith in the six-month future.
Belief in the second-half of '03 is nowhere stronger than in the stock market. Year-to-date, the Dow has risen almost 5%, the broader S&P 500 has gained more than 8%, the Wilshire 5000 about 9%, and the tech-heavy #78;asdaq more than 18%. This performance is easy to dismiss as exuberance, as it does not cross-foot with the current economy; however, it might be congruent with some unseen future economy. The stock market does get lucky from time to time.
Stocks are central to the economy going forward (and hence to interest rates) because of their unique positive feedback loop as prognosticator and propellant, as we enjoyed during the wealth-effect years, and came to fear during the ensuing reverse-wealth effect. In the next two weeks Americans will be opening envelopes containing the first big gains in paper wealth since the spring '02 fizzle.
It doesn't really matter if this rally is justified by the economy, by the tax cuts, by the Fed, or whatever; if it holds, it will contribute to restore faith, which will translate into economic activity. The reverse is true also.
In this latest leg of the Greenspan bond rally, interest rates have fallen out of the range of experience of everybody in the markets, which makes us mistake-prone.
Example. The yield on five-year T-notes has fallen to within a half-percent of the dividend yield on the S&P 500. To prefer the five-year here is to believe stocks will have no net price gain for the next five years. Ruddy-cheeked Neo-cons are cheering a coming global boom in which both bonds and stocks do very well. Paleo-cons like me figure one of the two markets will soon be a hood ornament.
Another. All adjustable-rate mortgages compute the new payment by adding a "margin" to an index. Since the first ARMs appeared in 1980, a standard margin has been 2.75% -- a piddling affair, then, on top of a one-year index value of 15.82% (true: March '80). Today's one-year index is 1.130%; given 2.75% margin, how much lower can ARM rates go? The downward pressure is so great that the FHA just dropped its margin to 2.25%. At that, should any investor buy an FHA ARM pool?
One more. The fixed-rate mortgage market is predicated on an average loan life of five-and-a-half years, which in turn is based on a reasonable probability at the moment of origination of a future fall in market rates leading to refinances, which would shorten the future average life from the nominal thirty years. As yields enter the fours, investors are buying loans which may be portfolio disasters for twenty years. No more "It's-time-to-refi" mail; instead, "Pleeeeease sell your house -- we'll pay your Realtor." Instead of mortgages at these yields, might as well buy stocks.
Next week's new data are a big deal: purchasing managers ("ISM") on Monday, payrolls on Friday. The bond market has discounted some improvement in May over April, but nothing more than a deceased-house-pet bounce. Any positive trend change in the job market, and sub-six mortgages are headed for the taxidermist.
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