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January 4, 2008
Long-term rates have fallen to the mid-December lows, and show almost every sign of going lower. The 10-year Treasury has reached 3.83%, and the lowest-fee mortgages are 5.875%.
The immediate drivers of decline: nosedives in brand-new data for December. $100 oil got the ink on Wednesday, but the bond-market mover was the purchasing managers’ manufacturing survey at 47.7 -- a five-year low, below the “50” breakeven level into contraction, still a hair above the 44 level marking recession. Today’s payroll data... maybe a hair above recession, maybe not: December unemployment jumped to 5.0%, the .3% leap the largest single-month in twelve years; and payrolls gained a meager 18,000 jobs, government-heavy, the private sector declining.
Not quite off the table-edge: hourly earnings actually increased at a 5% annual slope; and the service-sector purchasing managers’ survey is still positive at 53.9.
I don’t see any market mechanism that would intercept a significant slowdown, now. A recession might or might not ensue -- technically two consecutive quarters of negative GDP growth -- but the December pattern is not likely to reverse. The credit crunch is still in place, clenching gradually tighter and tighter, more than counteracting the Fed’s rate cuts thus far.
So, for mortgage rates, what’s with the “almost” in the lower forecast?
The one thing that could mess up a drop in mortgage rates to the low fives, maybe breaking the 5.25% ’02-’04 bottom: a rescue. There is only one that would work: the asset-firewalling bailout of the financial system recommended here for months, but the public is still far too angry at bad actors for that. Which leaves bad ideas for rescue.
Today Chairman Bernanke and Secretary Paulson will meet with Mr. Bush at the White House. Oh, to be a fly on the oval wall. Will the visitors tell Dad what happened to the family car, or will equivocation and procrastination prevail? This administration leans to market solutions or tax cuts. Fiscal stimulus might be in order, following Larry Summers “Three T’s” rule: timely, targeted, and temporary. Quickly cutting FICA taxes to zero below a certain income limit is a reasonable, never-tried idea, but Dubya and this Congress will never get a tax cut done in time, or properly.
The only other non-bailout rescue is monetary policy. Translation: BIG cuts in the 4.25% overnight cost of money, and going inter-meeting -- the January 30 and March 18 schedule is a long time to wait.
Here is the compound and circular problem with that rescue: the bond market won’t like the inflationary consequences. The economy and especially housing need lower long-term rates; if the Fed appears to abandon discipline, long rates will rise no matter how far the Fed cuts. As morning trading wears on today, that very thing is happening: bonds are losing early gains.
I have struggled to understand the Fed’s silence since August, and its apparent failure to comprehend the magnitude and consequences of the credit crunch and to act accordingly. Re-reading the testimony, plowing through recent meeting minutes leads to an alternate theory, down William of Ockham’s road to simplicity of hypothesis (“Ockham’s Razor”). Mr. Bernanke is neither blind nor passive. When the Fed said in October that risks to growth and inflation were balanced, he meant exactly that. Both risks were awful, still are, but inflation is the more dangerous of the two.
The appropriate Fed policy cannot be discussed in public. No Chairman can tell the American people: “We will be slow to ease on purpose, following the economy downhill, making no effort to pre-empt recession until inflation is clearly under control.” A Chairman can embark on a public fight against inflation only when the public feels its pain; Bernanke must engage in brinkmanship to hold inflation below the 2% bound -- a priority on nobody’s screen except bond investors.
It’s the only way to get long-term rates down, and to achieve a durable rescue.
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