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June 20, 2003
Mortgage rates have held well, still in the 5.25%-5.375% band despite a huge reversal in the benchmark yield for ten-year T-notes, from 3.09% last Friday to 3.43% today.
There wasn't much hard data this week, except the .3% rise in the core CPI for May, which deflated deflation hopes among bond ghouls. Bonds sold also on the too-thin-to-matter news that the New York state index of manufacturing had improved, that the four-week average of new jobless claims fell by 3,000 (out of 425,000), and that the Philadelphia Fed index flipped from narrow negative to narrower positive.
When non-reports like these move the market, it shows the terrible vulnerability of the bond market to a dose of genuinely good news. Any consumer/borrower who backs away from a good deal now, expecting a better one soon, is crazy.
Yes, the Fed will cut its rate on Wednesday, but it's the most-telegraphed punch since the Bushies whacked Iraq. Everybody knows a quarter-percent is coming, and has known since the Chairman's May 9th line about "taking out insurance."
From there, Fedology (word root: "astrology") wandered off into chaos this week.
A lot of the upward move in Treasury yields came from abandoned hope that the Fed would cut a half-percent. The tip-off: the two-year T-note tracks expectations of change in the Fed funds rate; it traded at 2.01% last Friday, and is 2.31% today. A quarter is in the cake, but the half is out. Even if we get the half after all, it won't take mortgages below last week's all-time low; only a fading economy can do that.
What happened? A comedy of competing leaks from the Fed: on Thursday, an authoritative Fed-watcher reported for the Washington Post that the Fed would cut a half next Wednesday; today, the Wall Street Journal's Fedologist says only a quarter is for sure, but is coy about the half. The WSJ piece is undoubtedly the straight poop from close to the Chairman's office.
Why be cute about a still-standing chance for a half? So that if it came, it would be a surprise; and if it didn't it wouldn't disappoint. Though, of course, its potential absence already disappointed this week.
(At this point, you are right to wonder that adults who think this way are allowed to be in charge of the central bank, and others to trade trillions of dollars of securities. But there is more....)
Some Fedologers think the Fed won't go a half for fear of frightening the Nellies in the stock market, because a half would mean the Fed is really worried.
Then, there's been all this stuff out of the Fed itself about buying long-term bonds if it runs out of room to cut short-term rates (which it has -- anything below .75% could cause more harm in the money markets than good). The Fed is deflating that trial bubble, fast, as leaks now say that the Fed is not sure it knows how to buy the long end, does not know what effect it would have, and if it started to buy, how to stop. (It's way too late for the Fed to worry about an exit strategy. When the Chairman withdraws his jawbone support from the bond market, which he will one day have to, it will be one of the worst days in the history of that market).
The newest thing from the Fed is an enhanced jawbone, known as "pre-commitment", in which the Fed would promise not to raise its rate until inflation rises to a safely non-deflationary altitude (but safely non-inflationary, of course), or promises not to increase for a specific period of time, like a couple of years.
This theorizing looks like the Fed is wrestling in the net, more and more deeply entangled in high-risk, who-knows-what-benefit options. The Fed has shored up the economy, which will likely escape another recession, but the Fed hasn't the power to jack the economy back to 1990s growth. Knowledge that we are on our own might actually help, as the missing component in the bubble years was reality.
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