Friday, March 20, 2015
Capital Markets Update
By Louis S. Barnes Friday, March 20, 2015
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.
Friday, March 13, 2015
Capital Markets Update
By Louis S. Barnes Friday, March 13, 2015
Long-term rates came down a hair this week from the prior three-week spike, but there is no sign of another flirtation with the February lows. The third-straight monthly slide in retail sales and oil to $45/bbl might have taken the edge off of Fed-fear, but did not. Lowest-fee mortgages are 4.00%-ish, the 10-year T-note well above 2.00%.
Everyone assumes the Fed next Wednesday will remove “patience” from its post-meeting language, opening the door to its first rate hike since 2006. Many in markets think it’s coming in June, fewer think September. But it’s coming.
The Fed’s purpose is to protect us from extremes in the business cycle. Capitalist economies tend to self-reinforcing spirals up or down with violently bad endings.
When the Fed sits down to talk about action, the entire internal conversation is based on the mathematics of the business cycle — equations, charts, and models. All of necessity backward looking, vulnerable to truly changed conditions. Each cycle from 1945 to 2000 was carbon-copy — each expansion, tightening, recession, easing, and recovery. A perfect world for models.
But, beginning in 2001, a jobless recovery, a burst stock bubble, a false recovery based on undiscovered (incredibly) credit and housing bubbles, six years at 0% cost of money, and today’s uneven and iffy recovery — nothing in the last 15 years resembled back-look models. Add to that uncertainty: the Fed and markets assume that changes in monetary policy take most of two years to take full effect.
The Fed’s mathism and models are honestly the best it can do, but also provide a mask beneficial to the Fed. Better that complexity conceals from civilians the reality: its decisions are a collective dampened thumb stuck into the breeze.
The mathism and thumbs are directed at two questions: first, what is the capacity of the economy to grow without inflation, expressed as the Non-Accelerating Inflation Rate of Unemployment? NAIRU, pronounced like the jacket. If too many are unemployed, our spiral sinks into deflation and the Fed can and must spew invented cash; too few unemployed, and the Fed must tighten long before wages grow too fast.
The second question: Where do we set the Fed funds rate? Lowering or raising on what slope? Found in every numbing Fed paper today, this notation: r*. Beaten to death in a speech by the new Prez of the Cleveland Fed, Loretta Mester, r* is the “equilibrium Fed funds rate,” the result of this equation:
The unintended(?) black comedy in Mester’s speech: “The big issue is that the equilibrium real rate, r*, is unobserved. Incidentally, so are the level of potential output and the natural rate of unemployment.” Translation: we’re guessing at the values of the variables. In a heating economy we’re going to jack Fed funds somewhere above inflation… but r* looks scientific and precise. Really cool equation.
Back to the business cycle. Two things drive the spiral: unemployment, as above assuming it translates into wage gains, and second the credit cycle, in a hot economy when new loans, the rising value of collateral, and wages all chase each other.
Today we have very little wage growth. John Williams, sensible Prez of the San Francisco Fed in a speech last week says he knows the unemployment capacity limit is 5.25%: tighten now, and gradually higher rates in two years will offset the wage effects of full employment. But, this time looks very different: global competition, IT effects, predatory exports (China, Germany), and a hyper-dollar all push down on wages. Our job growth is in low-wage sectors not subject to competition or IT. Waiting tables.
There is no up-winding in the credit cycle. Mortgage rates returned to 70-year lows without any up-tick in purchase applications. Very good and tough new bank regulation, run-proofing the system and intercepting bad ideas (subprime car loans, “leveraged loans”…) have already tightened credit.
The bond and mortgage markets fear a Fed “normalization” marching upward mindlessly to levels appropriate before 2000, 3.5%-4%. I hope next Wednesday the Fed tamps down that view of normal, and how long it should take to get there.
Long-term rates came down a hair this week from the prior three-week spike, but there is no sign of another flirtation with the February lows. The third-straight monthly slide in retail sales and oil to $45/bbl might have taken the edge off of Fed-fear, but did not. Lowest-fee mortgages are 4.00%-ish, the 10-year T-note well above 2.00%.
Everyone assumes the Fed next Wednesday will remove “patience” from its post-meeting language, opening the door to its first rate hike since 2006. Many in markets think it’s coming in June, fewer think September. But it’s coming.
The Fed’s purpose is to protect us from extremes in the business cycle. Capitalist economies tend to self-reinforcing spirals up or down with violently bad endings.
When the Fed sits down to talk about action, the entire internal conversation is based on the mathematics of the business cycle — equations, charts, and models. All of necessity backward looking, vulnerable to truly changed conditions. Each cycle from 1945 to 2000 was carbon-copy — each expansion, tightening, recession, easing, and recovery. A perfect world for models.
But, beginning in 2001, a jobless recovery, a burst stock bubble, a false recovery based on undiscovered (incredibly) credit and housing bubbles, six years at 0% cost of money, and today’s uneven and iffy recovery — nothing in the last 15 years resembled back-look models. Add to that uncertainty: the Fed and markets assume that changes in monetary policy take most of two years to take full effect.
The Fed’s mathism and models are honestly the best it can do, but also provide a mask beneficial to the Fed. Better that complexity conceals from civilians the reality: its decisions are a collective dampened thumb stuck into the breeze.
The mathism and thumbs are directed at two questions: first, what is the capacity of the economy to grow without inflation, expressed as the Non-Accelerating Inflation Rate of Unemployment? NAIRU, pronounced like the jacket. If too many are unemployed, our spiral sinks into deflation and the Fed can and must spew invented cash; too few unemployed, and the Fed must tighten long before wages grow too fast.
The second question: Where do we set the Fed funds rate? Lowering or raising on what slope? Found in every numbing Fed paper today, this notation: r*. Beaten to death in a speech by the new Prez of the Cleveland Fed, Loretta Mester, r* is the “equilibrium Fed funds rate,” the result of this equation:
The unintended(?) black comedy in Mester’s speech: “The big issue is that the equilibrium real rate, r*, is unobserved. Incidentally, so are the level of potential output and the natural rate of unemployment.” Translation: we’re guessing at the values of the variables. In a heating economy we’re going to jack Fed funds somewhere above inflation… but r* looks scientific and precise. Really cool equation.
Back to the business cycle. Two things drive the spiral: unemployment, as above assuming it translates into wage gains, and second the credit cycle, in a hot economy when new loans, the rising value of collateral, and wages all chase each other.
Today we have very little wage growth. John Williams, sensible Prez of the San Francisco Fed in a speech last week says he knows the unemployment capacity limit is 5.25%: tighten now, and gradually higher rates in two years will offset the wage effects of full employment. But, this time looks very different: global competition, IT effects, predatory exports (China, Germany), and a hyper-dollar all push down on wages. Our job growth is in low-wage sectors not subject to competition or IT. Waiting tables.
There is no up-winding in the credit cycle. Mortgage rates returned to 70-year lows without any up-tick in purchase applications. Very good and tough new bank regulation, run-proofing the system and intercepting bad ideas (subprime car loans, “leveraged loans”…) have already tightened credit.
The bond and mortgage markets fear a Fed “normalization” marching upward mindlessly to levels appropriate before 2000, 3.5%-4%. I hope next Wednesday the Fed tamps down that view of normal, and how long it should take to get there.
Friday, March 6, 2015
Capital Markets Update
By Louis S. Barnes Friday, March 6, 2015
Brace thyself.
Mortgage rates are above 4.00% for the first time since December, taken up by an overnight rout in the 10-year T-note (and a lot of other markets). 10s last night were hanging on to chart support at 2.11%, and are now 2.25%.
As always here, take it one piece at a time. First of all, the dive in 10s from 2.35% at Christmas to 1.65% in early February — one-third in six weeks! — was a tad peculiar. Most of us thought the cause was exceedingly low yields overseas, and every major central bank trying to devalue its currency versus the dollar. I still believe that, and believe foreign conditions are a strong counterweight to Fed tightening. The Fed thinks so, too, which may force it to tighten harder, right or wrong.
Charts aside, the overnight driver was an up-side surprise in February payrolls, another 295,000 jobs. Despite claims of a “strong” report and violent market reaction, the thing is shot full of holes. One-third of the jobs were hospitality and retail, protected from foreign competition, but dead-end, unstable, and poor-paying. Average hourly earnings rose $0.03, 0.01% for the month and decelerated to 2.0% year over year. More people at work even at lousy wages means more national income, but at this rate of change, increasing inflation is impossible.
Trading in every market today says they are worried about the Fed, not inflation. Every market has interpreted the February job data as conclusive impetus to fed tightening. Every market has been slow to take the Fed at its word, day after day for many months that it is aching to lift off from 0%. Six years-plus at 0%, every Fed economic forecast wrong on the happy side, disbelief has been good business.
The stock market usually rises on good economic news. This winter it began to counter-trade. Good news means the Fed is comin’, so sell. Midday today, the Dow is off 238 and looks worse.
The currency complex confirms. The ECB next week begins $60 billion per month QE, flooding the world with euros, last-ditch uber-easing. The Fed is about to tighten. Hence the euro just this morning lost 2% of its value, trading at $1.08, the lowest in 13 years. QE helps economies three ways (Wonder Bread helps 12 ways): portfolio effect, pushing investors to take risk, a silly thing to do in Europe; forcing down long-term rates, which in Europe are already down, in Germany below zero beyond 7-year maturities; and weaken your currency. ECB QE will bring only the last, a euro weak enough to help Club Med (absurdly low for Germany).
Currencies are odd stuff. A low euro does not help versus any other country also devaluing, which every competitor has except China, which will soon be forced to, and except the US. The US is in then position of Club Med at the outset of the euro. In part we feel rich: everything we buy from overseas has gotten cheaper. But that’s a hollow and fleeting victory. The wage component of everything produced overseas — goods and services — has fallen in value, pushing down on US wages. Zero-sum is in play:
Brace thyself.
Mortgage rates are above 4.00% for the first time since December, taken up by an overnight rout in the 10-year T-note (and a lot of other markets). 10s last night were hanging on to chart support at 2.11%, and are now 2.25%.
As always here, take it one piece at a time. First of all, the dive in 10s from 2.35% at Christmas to 1.65% in early February — one-third in six weeks! — was a tad peculiar. Most of us thought the cause was exceedingly low yields overseas, and every major central bank trying to devalue its currency versus the dollar. I still believe that, and believe foreign conditions are a strong counterweight to Fed tightening. The Fed thinks so, too, which may force it to tighten harder, right or wrong.
Charts aside, the overnight driver was an up-side surprise in February payrolls, another 295,000 jobs. Despite claims of a “strong” report and violent market reaction, the thing is shot full of holes. One-third of the jobs were hospitality and retail, protected from foreign competition, but dead-end, unstable, and poor-paying. Average hourly earnings rose $0.03, 0.01% for the month and decelerated to 2.0% year over year. More people at work even at lousy wages means more national income, but at this rate of change, increasing inflation is impossible.
Trading in every market today says they are worried about the Fed, not inflation. Every market has interpreted the February job data as conclusive impetus to fed tightening. Every market has been slow to take the Fed at its word, day after day for many months that it is aching to lift off from 0%. Six years-plus at 0%, every Fed economic forecast wrong on the happy side, disbelief has been good business.
The stock market usually rises on good economic news. This winter it began to counter-trade. Good news means the Fed is comin’, so sell. Midday today, the Dow is off 238 and looks worse.
The currency complex confirms. The ECB next week begins $60 billion per month QE, flooding the world with euros, last-ditch uber-easing. The Fed is about to tighten. Hence the euro just this morning lost 2% of its value, trading at $1.08, the lowest in 13 years. QE helps economies three ways (Wonder Bread helps 12 ways): portfolio effect, pushing investors to take risk, a silly thing to do in Europe; forcing down long-term rates, which in Europe are already down, in Germany below zero beyond 7-year maturities; and weaken your currency. ECB QE will bring only the last, a euro weak enough to help Club Med (absurdly low for Germany).
Currencies are odd stuff. A low euro does not help versus any other country also devaluing, which every competitor has except China, which will soon be forced to, and except the US. The US is in then position of Club Med at the outset of the euro. In part we feel rich: everything we buy from overseas has gotten cheaper. But that’s a hollow and fleeting victory. The wage component of everything produced overseas — goods and services — has fallen in value, pushing down on US wages. Zero-sum is in play:
Friday, February 27, 2015
Subscribe to:
Posts (Atom)