|
March 25, 2005
The Fed shifted emphasis at its meeting on Tuesday, indicating elevated concern for inflation "pressures", if not the fact. Long-term interest rates instantly blew up to the highest level since last summer: the 10-year T-note traded above 4.60% (it had been as low as 4.00% last month), and the lowest-fee 30-year mortgages touched 6.25% at maximum panic, now back to 6.125%.
New economic data didn't add much to the picture; next week, especially Friday brings a blizzard of market-moving reports.
To make sense of the powerful reaction to a minor change in Fedspeak, and to measure the new how-high-how-fast bracket for interest rates, we have to look back three years.
2002 marked stage one of a two-part Fed campaign to save us from the aftereffects of a blown bubble; in stage one the Fed had to intercept what it called an "unwelcome decline in the rate of inflation." Inflation had fallen below 1.00%, a pre-deflation danger zone threatening credit and economic collapse, and the Fed set out to get inflation safely back above 1.5%. All through 2002 and early 2003 the Fed fire-hosed cash into the system, and dropped the overnight cost of money to a fifty-year low 1.00%.
The economy began to show signs of life in June 2003, and long-term rates rocketed off, higher than they are now in premature expectation that the Fed would choke off the cash pump. It did not; instead, still worried about too-low inflation, the Fed offered the markets its "considerable period" reassurance of low rates.
Stage two began in the spring of 2004 when inflation reached the 1.5% mark, the economic expansion was entrenched, and the Fed needed to begin to close the hose -- "to remove excessive accommodation." Long-term rates exploded again, 10-year T-notes approaching 5.00%, mortgages 6.50%, again a premature reaction. The Fed dampened that panic by predicting a "measured" reversal of too-low interest rates (an estimation still present in this Tuesday's troublesome statement) -- that, and persistently slow growth in payrolls, and down again went long-term rates.
The Fed's stage-two plan seemed in good shape through seven .25% hikes since last June toward a 4.00%-ish neutral -- in good shape until we drew a plan-crushing wild card: $50-plus oil. Now we and the Fed are in some difficulty.
The Fed's problem all along has been this: if you set out to goose the inflation rate above 1.5%, how can you be sure to stop before it gets beyond 2.00%? If inflation threatens to go beyond 2.00%, how firm with the brakes do you dare to be?
We do not yet have the fact of higher inflation (the latest producer and consumer "core" prices rose only .1% and .3%.), but the oil spike is now raising costs in the economy beyond the ability of businesses to absorb them. One short analysis of oil-driven cost increases this week mentioned airlines, cargo, military tents, shoes, weed killer, Barbie dolls, plastic, rubber, trucking, fabric, fertilizer, pesticides, polyester, pharmaceuticals, paint, pant liners, and diapers (presumably including soon-to-retire Alan Greenspan's Depends). Wages are 75% of costs in our economy, and they are flat, but jack the cost of the other 25% far enough and we have an inflation problem.
Enter unwelcome stage three. The two premature rises in long-term rates are past, and this one is real. The Fed's statement on Tuesday puts us on notice that the Fed may have to get us to neutral quicker, and once there may not be able to pause. Post-panic trading this week made very clear that the only thing between us and much higher mortgage rates is the Fed's evident resolve not to let inflation out of the box, no matter how high it may have to take its short-term rate.
Those of you with mortgages nearing adjustment, or with large balances on lines of credit... don't miss this chance for fixed-rate safety plays.
|
