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July 3, 2003
Mortgage rates are just barely holding below 5.50% in a loopy moment for the financial markets, one which is anything but resolved by the newest economic data. Top trading dogs are at the beach today, and not in a mood to resolve anything.
Within hours of the Fed's .25% cut last week, the same crowd that had insisted that the Fed should cut .50% because the economy was so weak suddenly announced that the economy was so strong that everybody should sell all their bonds. The market was poised to crater on the first June economic data, due Tuesday and today, because surely the news would show the start of the ramp up to 3.5%-4.0% GDP growth. Surely.
The June ISM data came Tuesday. This near-real-time survey is the old "purchasing managers' index", which for a quarter-century has been the best current-conditions guide to the economy. Long-term yields track its results on rails. A "50" reading divides a flat or shrinking economy from a growing one, and bond bears hoped for the first solid, 50+ reading since January.
Didn't happen. 49.8 was better than anything since February's 50.5, but way short of the Dec-Jan 55.2-53.9, and similar readings in the spring of '02. Nevertheless, the bond bears squeezed some signs of scary economic strength from the report, and markets were poised for the Bolshoi Skedaddle sure to follow the two employment reports today.
The weekly rate of newly unemployed people was supposed to drop below 400,000 for the first time in months. It did not: it rose by 20,000 to 430,000. Second, June payrolls were supposed to grow. They did not: they fell by 30,000, and another 70,000 jobs were revised out of May. These aren't recession reports, but they are not a ramp up to anywhere. Payrolls would have to grow by 120,000 per month through 2004 just to get the aggregate back to where it was in January 2001.
Meanwhile, bonds still sold off. When people really want to sell, they are going to find any rationale necessary. New "reasons" for selling: no buyers for new Japanese bonds (kabuki theater, not a real market), and a leap in a new ISM index of the service economy (every release in its short history has overstated economic growth).
Why is the market so determined to sell bonds?
At the yields to which highest-quality bonds fell last month, professionals can't make money. Pros make money when yields fall and prices rise, and a gain can be taken on sale. At last month's lows, there was no prospect of a further yield decline, or potential price-pop on sale. Among pros... "Baby, if they ain't goin' up, get short."
The pros have joined another huge seller out there, governments world-wide, and they may be wise to do so.
Famous pros... Byron Wien of Morgan: "...the bond market today is where the Nasdaq was at 5000." Paul McCulley of PIMCO: "A bubble in Treasurys is no longer a question...." Lee Thomas' two-word concluding sentence in PIMCO's newest posting: "Sell bonds." PIMCO's core business: offering bond funds to investors!
The only reason to buy and own bonds at last month's yield-low was for safety: to have as much money in the future, and a percent or two or three more each year. That's the way civilians and institutions think. Until there is new reason to pursue the safety of high-quality bonds, this bearish interlude will continue. If the optimists are at last correct about the economy, this sell-off will stop only when mortgage rates are high enough to crush refinances and hurt home sales. Six-something.
Safety money can come back, but only if low inflation trumps 1.00% Fed funds; if state and local strangling and saving by consumers instead of spending cancel the federal tax cuts; and if the newest stock market wealth effect runs in reverse.
Meanwhile, don't fight it. Get locked, and don't bet on lower rates soon.
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