Here at the turn of the year,
days getting shorter, time to look ahead — which I am reluctant to do, unable
to predict the future. But we can bracket probabilities, and apply a little
history. Seven wagers on the future follow below.
New economic data this week were
limited, but positive. Sales of existing homes in May rose 9.2% year-over-year,
and prices with them, up 7.9%. Personal income gained .5%, and spending surged
.9% (possibly suspect); and the core personal consumption expenditure deflator
(PCE, the Fed’s favorite measure of inflation) stayed at 1.2% year-over-year.
Only new orders for durable goods were tepid, up .5% for May but down 2.2%
year-over-year, clearly suppressed by the hot dollar.
The Bureau of Labor Statistics
has an odd protocol for releasing the all-important employment statistics each
month: the program calls for release on the first Friday each month, but often
delayed if the first day of a month falls on Friday. However, the BLS is
oblivious to holiday weekends, like next week: we’ll get June data next
Thursday, which in thin pre-holiday markets guarantees an explosive response to
a surprise in the data. Only the very brave should float a mortgage rate into
Thursday.
Which leads to the future. Which
is already here: the 10-year T-note today trades at 2.48%, up more than a
half-percent from last winter’s lows. Mortgages always follow 10s, which have
pushed vanilla 30-year loans with low fees to about 4.25%.
The only meaningful questions for
the rest of the year are versions of “How high is up?” How much of the
long-term rate jump in the last 90 days is front-running Fed liftoff? Or is the
bond market behind, just now catching up?
Then the painful branch of
inquiry: At what point will higher mortgage rates slow housing? And will that
pinch then constrain the Fed?
It has been so long since the Fed
tightened that the young have no feel for mechanics. From here forward, as the
Fed normalizes, think “yield curve.” Every day. The yield curve is the graphic
description of the spread between the Fed’s overnight cost of money and the
10-year. The two move together only by temporary accident, and changes in the
slope of spread are the best single guide to the future.
Historically, long-term rates do
front-run the Fed, rising before it begins a tightening cycle and then rising
through the cycle. The volatility in long-term rates in the up-cycle is
directly proportional to uncertainty about the speed of tightening and its
ultimate extent. Bet on this, first: most of the long-rate jump since March has
been a correction of an overdone drop, and bonds are just beginning to
anticipate the Fed.
Bet on this, second: the Fed is
coming. September is in the can unless economic data weaken a lot. The Fed will
not wait for inflation to rise to target, nor for further increases in incomes.
Third bet: volatility will be big because nobody including the Fed knows how
hard they’re coming. Their first marker: the reaction to liftoff. If
hysterical, they’ll cool it. If routine, they’ll proceed. No way to know in
advance, especially as bond-market capacity for self-deception is European in
extent (sidebar: this week’s pop in the 10-year tells me that Greece is off
market radar, an unspeakably silly exercise which will not stay the Fed’s
hand).
Fourth bet: bond-market
complacency at this moment is epic. The US economy appears self-sustaining. The
developed world is also heating — a reckoning someday for extreme central bank
rescues, but at the moment the rescues have traction.
Long-term rates must enjoy a
positive spread versus the cost of money during any economic expansion phase,
if only as a buffer to further tightening. The end of every tightening phase is
marked by an “inversion,” short rates over long, as bond investors bet on a
recession — hardly likely, now, although the Fed does always overshoot.
Fifth bet: mortgage rates are
going up with the Fed, tick for tick, overshooting and then falling back to the
Fed’s slope. Sixth: only the strongest housing markets will stay so through
next year. Seventh: after its second hike, mortgages 5.00%, the Fed’s life will
be very complicated. Lucky seven.
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