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December 12, 2003
Mortgage rates have settled (again) at 5.75% in a week punctuated by two exclamation points from the Fed: the first caused an abrupt rise in rates on Tuesday, and the second cancelled the first, and then some.
This back-and-forth is not a sign of disarray at the Fed. Grownups are in charge of this branch of government. Mr. Greenspan may not have known the exact extent of market movement that each of these press releases would cause, but he knew in advance the direction of each, and knew which of the two would predominate.
Going into Tuesday's Open Market Committee meeting, everybody knew the Fed would leave the Fed funds rate at 1.00%. The only question was the post-meeting statement -- to what degree would the Fed acknowledge the economic acceleration underway, thereby hinting at how soon we will kiss goodbye 1.00% overnight money. The Fed left in "...a considerable period....", but said "The probability of an unwelcome fall in inflation has diminished" and is now equal to the risk of inflation.
Mortgage rates rose .125% or more immediately after the press release, and futures markets priced a rate hike as early as March.
Then on Thursday afternoon, at the end of a ho-hummer, the Fed released the details of its October meeting. Markets regard one-month-old news as pre-trilobite strata. Traders already decoded the October post-meeting statement; the minutes would make a nice doorstop, if anybody bothered to print them.
WHAZZAT?! Junior traders snorted awake, seniors got yanked from post-market martinis... "Looking ahead, members generally anticipated that an economic performance in line with their expectations would not entirely eliminate currently large margins of unemployed labor and other resources until perhaps the latter part of 2005 or even later." Two thousand... FIVE! Mortgage rates fell .125% and more.
And would be falling still, along with bond yields, were it not for the stock market's absolute belief in the Promised Land, the consensus elsewhere that the economic expansion is now durable, and in the growing worry in bond circles that the Fed is creating conditions precedent to inflation.
The stock pushers and recovery rocketeers don't want to hear it, but the Fed is leaving the funds rate at 1.00% because it's still worried. On Tuesday, the Fed said prospects for future economic growth were "balanced", not tilted to strength. They know full well that this recovery is based on a Social-Security-revenue-inclusive deficit of $650 billion, a trade deficit of $500 billion, and a dollar that has lost a quarter of its value in a year. Unsustainable, all.
Further: the recovery has holes, as-is. The jobs we're picking up now are low-wage, in no way a replacement for the high-wage (and options!) ones lost. Tip-off: in that miraculous 8.2% GDP 3rd quarter, state-level tax revenue for the US as a whole grew by point-six percent. That's a classic sign of a binge: run the economy on borrowing and cheap cash, and nothing sticks to its ribs.
The Fed's Herculean effort has unintended consequences: the Dow has soared 37% --2,700 points -- since the Fed went down to 1.25%. The wealth effect is nice, but a new bubble is trouble. What happens when it comes clear that the only way to reduce the twin deficits to sustainable levels is a tax increase and spending cuts?
The Fed knows that if this recovery falters, it is in real trouble, out of ammo. We usually muddle through, and will again, but this is an abnormal muddle.
Light a candle for another grownup back on the scene. Dubya has sent James Baker, Poppa's consigliore, on a mission to pull our ex-allies back together and help in Iraq. Baker has a world view that coincides with the world as it is, and has a shot at rescuing our foreign policy from the Neo-con fantasy. Wish this man luck.
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