Fed caught in economic tug of war
By Lou Barnes
Consumer Real Estate News
Inflation data and deepening worries about the Fed's
intentions have taken mortgage rates higher again.
A one-point loan fee (whether called "origination," or
described in plain English) will still get a 5.87 percent
30-year rate, but the low-fee deals are almost to 6.25
percent, up from the March low at 5.37 percent. The
adjustable-rate-mortgage market is worse: a point will buy a
Fannie/Freddie 5-year at 4.62 percent now, more than a percent
north of the March low. The largest purveyor of "portfolio"
5-year hybrids (Washington Mutual) appears to be pricing
defensively, as a one-point fee produces a rate approaching
5.5 percent.
We should have gotten some relief on word that 1st Quarter
GDP rose only 4.2 percent versus expectations of near-6
percent, but the GDP internals included a further up-ramp of
the best measures of inflation. The sub-1 percent, 1 percent-ish
era has concluded, and given way rather briskly to a 2 percent
annualized increase in the "core personal consumption
expenditure deflator." Just rolls off the tongue…"PCE" for
short.
Today, anybody who indicates concern for inflation is
dismissed as a fight-the-last-war fuddy-duddy. It took years
to run the technology New-Agers out of town, and it may take
just as long to shoo away the Newer-Ager, excess-capacity
deflationists. Inflation is always a possibility. All it takes
is a central bank that gooses the economy too hard for too
long.
The whole world of money is trying to figure out where the
Fed is going, and at least one voice at the Fed (Bernanke)
wants it to say so. So long as Greenspan is in charge, it will
not. Greenspan believes (correctly) that the Fed must gather
insights from the bond market; if the market knew the Fed's
cards, then it would know how to play, and the Fed's
market-based information would be polluted by tail-chasing.
Specifically, the bond market is trying to figure out what
the Fed thinks is a "neutral" cost of money (neither
"accommodative" nor "tight"), how fast the Fed will go from
wacky-easy 1 percent to neutral, and whether the Fed's view of
neutral will be correct. Traders and investment managers
cannot know the answers to those three questions, but they
have to place their bets (if they flinch, new Princeton
button-downs and SUNY deeze-and-dozes are itchy for their
seats.)
There is no absolute guide to neutral. "Easy" is a Fed
funds rate at or below the inflation rate – on the newest
data, the Fed's 1 percent cost of money is at least 1 percent
underneath. Traditional Fed theorizing puts neutral a couple
of percent above inflation. Therefore, the Fed's 1 percent may
be as much as 3 percent too low (2 percent inflation plus 2
percent = 4 percent fed funds) – a hugely uncertain
calculation and range. Then you have to consider the speed
with which the Fed should get to neutral. Is the economy still
fragile? It looks less so every day, and the only missing
piece is wage growth. Or, is the economy in the process of
racing away from the Fed, and we should be thinking about how
far above neutral the Fed should be?
That's how you get a staggering stock market, and weird
prices for ARMs.
The bond market has now built in the first .5 percent of
increase, but we are very much at risk of rolling
anticipation, in which the fact of each .25 percent hike
begets pricing-in of the next. The Fed meets on Tuesday, and
we will get April job data next Friday. We need some help: we
need a weaker-than-expected job number, a deceleration in
China, fiscal reality and a tax increase from the Bush
Administration…something to take the heat off the Fed.
If you're the Fed, you don't dare to get behind. If you do,
to slow the economy you have to slow the housing market, and
to do that – as hot as housing is – you would have to get
mortgage rates well up into the sevens. That's the process
that produces recessions. The Fed is so far below neutral that
it can and should err on the sooner-and-higher side, .25
percent maybe as soon as Tuesday. Friday April 30 4:37 PM ET |
