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February 16, 2007
Mortgage rates have stabilized near 6.25%, the 10-year T-note providing gravity in a range near 4.70%. The bond market has done a lot of intra-day bouncing, trying to find a level after a two-month straight-line run-up in rates, then a downward correction, then the Fed Chairman’s annual testimony to Congress.
Bouncing was a sensible thing to do.
Reading Alan Greenspan’s prose was a confusing but elegant stroll through the hedge maze in a full-blooming Victorian garden. Perfesser Bernanke writes a concrete sidewalk straight across a salt flat.
He led with a “... The predominant policy concern is the risk that inflation will fail to ease...”, but I think that line is the result of his painful learning experience last year: the Fed Chairman must always indicate that inflation is the primary concern. Later on he was more descriptive, but gave only a dry -- desiccated -- recitation of the Fed-staff forecast: GDP 2.5%-3% in 2007, inflation to retreat gradually.
Two things in the Perfesser’s testimony might be considered revealing. The Fed’s forecast for unemployment for the next two years is for the rate to stay right where it is: 4.5%-4.75%. All preceding Fed fights with inflation required a run-up in unemployment (the Fed, of course, denied any role in those run-ups), and it is useful to know that low unemployment per se will not cause the Fed to tighten, or to stay on hair trigger. That said, it would be foolish to interpret the Fed’s tolerance for strong employment as indication of easing soon ahead. From the Fed’s perspective, the job market is in a sweet spot: employment is good enough to keep politicians off the Fed’s back, but foreign wage competition is clamping a lid on the inflation potential of strong employment.
The second modest surprise was the Perfesser’s risk assessment. His prepared remarks had this direct, un-Greenspan sentence, qualifying the growth and inflation forecast: “The risks to this outlook are significant. To the downside... housing. To the upside, output may expand more quickly than expected.” In Q&A, I think he tipped his hand, emphasizing the chance for a stronger economy.
The chance for outsize growth makes good sense, as the whole world is enjoying growth at or above any pattern in the last twenty years. Japan’s last quarterly GDP gain was 3.5%, the same as ours, and Europe is approaching 3% results, all of that with inflation low and falling. The cause is clear: the rapid increase in world trade is making everybody rich.
Housing is a wild card. There isn’t anything for the Fed to do about it, as the global-dollar-recycling machine has suppressed mortgage rates at least a percentage point, way below their normal growth-cycle position above the Fed’s cost of money. What better housing safety net could there be?
The housing worst is obviously not over, not with today’s news of a 14% crater in January new-home starts, and the Realtor association report that median home prices fell in 40% of metro areas in the fourth quarter last year. Yes, weather was lousy in January, and yes, median prices are distorted by changes in the mix of homes sold, cheaper houses always selling better in weak markets. Yes, all that, but these numbers are lousy.
I think the real wild card transcends housing itself: follow the money. It is clear now that the broad class of “sub-prime” loans was priced, originated, bought by Wall Street, black-box derivatized, and sold all over the world on default assumptions that were foolishly optimistic. If credit-quality assumptions were also mistaken for higher-quality loans, the economic risk ahead is not so much the traditional one to consumers and housing-related workers, but the threat of a financial accident in global markets. Investors don’t like to be fooled by salesmen, in pin stripes or not.
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