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April 15, 2005
Three events this week took mortgage rates back down into the fives: release of the minutes of the Fed's March meeting, news that March retail sales caved-in to energy prices, and a painful and continuing slide in the stock market.
Many loud voices in the bond market had insisted that inflation was in the process of running out of control, and the Fed would begin to jack rates up a half-percent at a time, going to 4.50% or more by year-end. Whether this insistence was honest forecasting or phony herd-driving no longer matters: it was mistaken. The Fed's minutes contained this sentence: "Although the required amount of cumulative tightening may have increased, members noted that an accelerated pace of policy tightening did not appear necessary at this time...." Rates fell an instant later.
These minute-releases (for the first time this year only three weeks after each meeting) have become a dominant element in the bond-market calendar. The full texts are found at www.federalreserve.gov, and are worth at least one visit even by civilians, just to get a feel for style. Fed minutes never identify the speaker; they refer to "Many members said... A few members pointed out... Several committee members indicated...." This collective rumination is not useful; it is nine pages of cud-chewing edited free of any specific mention of interest-rate target. However, once in a while the authoritative call of the bell cow is clear: the long and convoluted sentence quoted above is unmistakably Mr. Greenspan's, hence its great weight.
Also its oracular message: "Required...cumulative tightening... increased...." From what to what? Where was the old target, and how much higher is the new? Is the Jupiter of PIMCO, Bill Gross, correct to announce 3.50% as tops from today's 2.75%? The bond market has clearly changed expectation downward: the 5-year T-note is trading near 3.90%, almost a half-percent below its peak last month.
Another clue in the minutes, and another obvious Greenspanism (in these minutes, declarative sentences near the end not attributed to a group of members are very likely to be The Word of The Man): "Monetary conditions evidently were still quite accommodative...." Evidently? How so? In standard, infuriating Greenspanese, he offers no evidence because it would show us what he is watching. Whatever: if he says they are still quite accommodative, then they have quite a ways to go, stocks and economy be damned.
Historically, the Fed continues its anti-inflation campaigns until something important breaks. This time, the economy obviously slowing, but the inflation threat from energy prices may force the Fed to choose between inflation and recession (trust me: this Fed, unlike the ones 1965-1978, will choose the latter). Two months ago, Mr. Greenspan's "conundrum" was interpreted as a bond-bubble warning; it was not and is not. A fall in bond yields during a spate of Fed tightening is always a warning of recession risk.
Some already argue that the stock market's disorderly retreat to 1999 levels is a sufficiently important break to force the Fed to cool it. I don't think so. Stocks have other troubles. First, a near-twenty P/E ratio for the whole market is sustainable only with a super-low Fed funds rate; a neutral rate near 4% is guaranteed to cut prices relative to earnings. Second, earnings are in question because of energy costs, and worse: the revelations of deceitfully "managed" earnings at Fannie Mae and AIG call into question the authenticity of all big-company earnings. Fannie and AIG are not like the serial collapses of technology comedy-business plans; these are regulated businesses in the core of the economy, CEOs and boards rotted through.
I think stocks are on their own, the Fed still coming, watching for energy-price ripples, and hoping to see a slowdown in housing prices in overheated markets.
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