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March 30, 2007
Upward pressure continues on long-term rates: the 10-year T-note at 4.65% has jumped the March range, and mortgages are at risk to lose the 6.25% level.
The economy has slowed to growth near 2%, but shows no sign of serious impact from the housing recession. This morning, personal income and spending each rose by .6% in February. Construction spending, expected to drop, instead rose .3%.
Weekly applications for mortgages are holding in a steady band. If a mortgage credit crunch were beginning to bite, we would see a decline by now. Refinance apps are running stronger than would be explained by interest-rate-advantage models, indicating that large numbers of ARM borrowers are successfully escaping their upward resets.
The corporate sector is showing some stress: earnings are falling, many estimates calling for mid- to low-single-digit growth, a small fraction of performance in the last several years. Capital expenditures are unexpectedly weak, orders for durable goods in a sustained decline. However, balance sheets are strong, and after a long run the downshift could be no more than a cyclical wobble.
The consumer is king: if spending and job growth continue (the payroll numbers next Friday are crucial), then GDP growth will continue. At a subdued rate, but given the Fed’s hope for gradually declining inflation, the ideal outcome.
If growth and inflation behave, fine. However, what if inflation does not “gradually decline”, as in Fed forecasts since summer 2006? Will the Fed have the courage to choose inflation-fighting over GDP preservation?
The immediate answer is not so hot: long-term rates broke upward during Perfesser Bernanke’s Wednesday testimony to Congress.
Messrs. Greenspan and Volcker are all-time tough acts to follow, but were tough guys. The Maestro was tempered by thirty years on stage and in back-office Presidential administration combat before taking his seat in The Chair, and “Tall Paul” learned to break ribs in an equally long span of New York City banking. Both men were at home in the no-prisoners world of markets.
Perfesser Bernanke is very bright, and an economist with few peers, but there is no power in his presence: he looks like a furry escapee from the cast of Wind In The Willows. Determined and firm, but bookish, diminutive, and easily startled.
He may have monetary policy exactly right, and may have the courage when the time comes to sacrifice the economy to keep inflation in the box. That time will certainly come, as it does for all Fed Chairs. However, whenever the Perfesser talks about the subject he appears to believe that he can have it both ways.
When asked to clarify last week’s post-meeting statement -- did it mean neutral or still biased-to-tighten -- he said it meant “flexibility”, and a groan rose from every bond-trading desk in the land. Then, in an off-hand, don’t-bother-me way, announced that there will be no more “advance guidance” after Fed meetings, no statement of bias or neutrality. That change deserved formality.
In response to Senatorial questions about Fed regulatory efforts in mortgageland, the Perfesser gave vague, harassed answers, insisting that the Fed is on the job, apparently unaware that the industry has completely ignored the Fed’s formal guidance of last September, tightening underwriting standards for “exotic” loans.
The worst of it... Last month, Mr. Greenspan suggested that the economic expansion was long in the tooth, nearing the end of its natural lifespan. Some say the Chairman Emeritus should cool it, but the Perfesser couldn’t leave it alone, saying, “the data does not support” a finite life span for economic expansion.
Bond people are terrified by central bankers who believe their skill can produce infinite expansion with controlled inflation, and so long-bond yields rose.
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