Credit markets are dish-rag limp at the end of this week, exhausted in the aftermath of the Fed’s surprises on Wednesday. The resulting drop in the 10-year T-note has taken lowest-fee mortgages back below 4.00%, and the Fed has given important guidance to consumers.
The markets should not have been so surprised. This column avoids blue-sky predictions (Peter Drucker: “Nobody predicts the future; the idea is a good grasp of the present”), but last week we had it right. After describing the Fed’s decision-making, the last three paragraphs nailed the economic headwinds and the Fed’s need to knock down expectations of the pace of future rates hikes.
Chair Yellen’s Wednesday post-meeting statement opened, “…Economic growth has moderated somewhat,” dropped use of “patient,” and concluded, “…Even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”
Yellen is doing an inspired job of communication, using achingly exact English. Many on Wall Street want the Fed to telegraph every punch, but it cannot: it must watch our own economic decisions made free of Fed influence. Otherwise the Fed would just chase its tail. It must occasionally surprise markets, but not shock them — that’s the purpose of its inexact guidance to the public.
Everybody has the idea that we’re headed for an extended period of interest-rate volatility. “Volatility” by itself is no help. That’s the word your stockbroker uses when you’ve lost your shirt. Here’s the useful modifier: we’re in for upward-tilted volatility.
Yellen did not say, as Bernanke was forced by circumstances to say, that rates will stay down. She said very carefully that rates will not rise as quickly as they otherwise might. But they are still going to rise. Slope is the argument, not direction.
Ever since the financial world ended in 2008, we have had the luxury of continuously downward volatility. Slow to lock your rate, no big deal. Rate lock expires, usually a shot at an extension. Miss your chance altogether, still a succession of chances to refinance from one impossibly low rate to another even more impossible. Few people would have bet that we’d now be refinancing last year’s 4.50% loans. Build a new house, no big deal to float your rate until close to completion.
In upward-tilted volatility we CAN still go lower, even touch the all-time mortgage lows near 3.50%, but less and less likely. A beautiful trader-term describes our predicament: asymmetric volatility. Today mortgages are less than a half-percent above the all-time low, but 14% below the all-time top in 1981. At any given moment the chance of up or down is 50-50, but the magnitude of risk is unbalanced.
Two caveats. First, as detailed in last week’s issue, the Fed has lost its predictive ability. The tidy cycles 1945-2000 have since been without precedent. To say the Fed is “data dependent” does not begin to describe how quickly big surprises will arrive. The main data point to watch: the first Friday of every month we get the prior month’s payroll report. If wages suddenly begin to rise, the Fed will come hard and fast, no matter what calming assurances it may have issued just the week before. Don’t leave a rate unlocked before one of these reports.
Second, all of those upside warnings notwithstanding, a self-sustaining and upward-spiraling US recovery is in doubt. Not for domestic reasons, but global ones. The main problem the Fed has with its models: none of them have experience with a world in which China is running a $700 billion net trade surplus, and Germany another $200 billion. Nowhere in econometric look-back do we find overseas central banks with negative costs of money, nearly all aggressively devaluing against the dollar.
It is possible that the Fed will have to suspend altogether plans for liftoff from 0%, and mortgages re-touch the record. But don’t play with matches. And don’t blame yourself or your banker if you lock and rates slip a bit.
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