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August 1, 2003
Mortgage rates approached 6.50% late this week as selling by mortgage investors shifted from panic to hysteria.
Economic data confirmed a modest acceleration in the economy, but the driver in the rate explosion is institutions trying to get out of a couple of trillion dollars' worth of sub-5.75% mortgage-backed securities -- investments now likely to be under water for twenty years or so. Some institutions may be near financial failure.
2nd Quarter GDP posted 2.4% growth, a percent above forecast, and that news did most of the authentic, economy-based damage. The bond market ignored the other data, all of which came in below forecast, and was the newest stuff, for July: payrolls shed another 44,000 jobs; the purchasing managers' index just barely made it to positive, 50+ ground at 51.8; and July consumer confidence slumped to 76.6 from 83.5, versus an expected gain to 85.
There is only one question facing borrowers, Realtors, and mortgage bankers: How high will rates go before they stabilize? (Anyone asking how soon rates will go all the way back down should instead focus on an alternate career.)
It seems as though rates have risen a lot, but they really haven't, when compared to other cyclical reversals, and considering the true bottom of this cycle.
Where was the real bottom? Thirty-year, fixed-rate, low-fee loans traded at 5.25% during May, but that interval was a terrible misunderstanding between the Fed and the bond market. The market thought the Fed intended "non-traditional" intervention in long-term rates, and the Fed was slow to grasp the market's misplaced faith. When Mr. Greenspan explained that he had just been thinking out loud, rates went back to the Christmas-to-April 5.75%, the true bottom of the cycle.
Thus far in what looks like a new, sustained up-cycle, rates have risen barely .75% -- peanuts! It seems like a big rise to a market conditioned by three years and three percentage points of rate decline, but it is not.
The ultimate limit to any mortgage-rate rise is the threshold beyond which the rate rise begins to slow housing, and then the economy. The best measure of rate change, and potential for harm, is the magnitude of change from trough to top. The absolute level of rates -- whether fives, sevens, elevens, or fourteens -- matters little, because the housing market adapts so quickly to a new range of rates, and because any given range is tied to the rate of general inflation.
The most recent trough-to-top was short: mortgages went from 7.00% in January 1999 to 8.75% in May 2000 as the Fed tightened from 4.75% to 6.50%. Housing had not begun to suffer, but the technology economy fell of its own weight.
In the prior trough, the Fed had been record-easy in 1993 at 3.00% Fed funds, and mortgages were 7.375% in January '94. By May, they were 9.00%, as the Fed began a tightening cycle that would not stop until 6.00% Fed funds, and near-10% mortgages. That first, 1.625% rise in mortgage rates, January-May, didn't lay a glove on the housing market. In 2003, we haven't had half that rise.
In both '99-'00 and '94 we had a tightening Fed, and the Fed today is not close to a Fed funds hike. We have a super-low, 1.00% Fed funds rate, but equally super-low inflation, barely 1.00%. There is not the slightest sign of inflation rising from the 1.00% zone: excess productive and labor capacity litter the landscape, and the 3.50% gap between Fed funds and the ten-year T-note is enormous.
When inflation begins to rise toward 2.00%, the Fed will begin to toss in .25% hikes, but the mortgage market has already priced in the first of that, and the fact may be years away. The Fed's problem today is still too little inflation.
No guts, no air medals: I think mortgage rates are done here, until we can measure the strength and inflation potential of this "recovery."
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