The US 10-year T-note made it just above 3.00% before pulling back, and mortgages stopped rising short of 5.00%, today about 4.75%. However, today is odd. 1st quarter GDP data was released this morning, growing 2.3% annualized, probably distorted to the downside, but inflation-related aspects moved up.
Rates should have moved up farther but have not — not long-term ones, and not the Fed-predicting 2-year T-note. Some observers think the economy will push the Fed to three more hikes this year instead of two, but market data says “uh-uh.“
For the moment, housing is safe. When mortgages do cross above 5.00% the psychological impact is likely to be greater than the change in payments.
Under normal circumstances, any common ones in the last fifty years, we would now enter the predictable Fed phase: continue to ooch upward until the economy slows, which the Fed accidentally overdoes and we have recessions.
Looking back a half-century, the rocket in oil prices guaranteed the ’73 recession no matter what the Fed did. The long, double-sink ’79-’82 affair was the intentional work of Paul Volcker. However, the next ones, ’91, ’01, and ’07 were all surprise events during gradual Fed rate-hiking. That’s the model. Only once in that whole span did a string of Fed hikes produce a soft landing (1994), and that was a close miss of recession.
But today is not normal. Patterns recur, but today is today, not yesterday. Perhaps the largest “not normal” is the global economy outside the US, allegedly in a strong and synchronized expansion which should exert even more upward pressure on rates. In the warm afterglow of the visit of Emmanuel Macron and icy welcome to Angela Merkel, start with Europe.
Macron is an exceptional player of poker, tilting the table his way even when holding no cards. He is charming, brilliant, and tough, the model of French leadership (graduates of Ecole Nationale Polytechnique, known as “énarques” run the place no matter who is president). Macron’s immediate predecessors were the worst since the 1958 founding of the 5eme Republique: Sarkozy a crook, Hollande a laughingstock.
France has never been as productive as Germany and will not be, despite Macron’s exertions toward a market-based economy. French public debt is just shy of 100% of GDP and packed into French banks. Its annual budget deficit is down to 3% of GDP, but growing faster than GDP, which in this very good year may reach 2%. Its trade deficit is 2.5% of GDP.
Rather worse, France must pay its bills in euros, whose value is based on the German economy and anti-inflation mania. Germany’s debt is only 65% of GDP and falling because Germany’s budget is in surplus by 1% of GDP. Germany’s trade surplus at 7% of GDP is the largest of any major nation and hurtful to all. No state dinner for Angela.
The empty hand played so well by Macron is based on elegant double-talk (French is ideal; even German poetry sounds like giving orders). Salvation for France is based on a duet with Merkel: “Europe’s problems can only be solved by more Europe.” But the two are off-key. To Merkel, more Europe means everyone to behave like good Germans, budget and trade surpluses devastating to the outside world including Euro-others, but good for Germany. To Macron more Europe means fiscal and banking union, mutualized taxes, debt and deposit insurance — a transfer union in which Germany picks up the tab for the others’ deficient productivity. Nein. Wird nie passieren.
Europe is exactly where it was ten years ago, stifled by the German euro, and the ECB playing for time. This week the ECB again flinched from any pullback in emergency measures, its overnight cost of money minus-.4%. The Fed will be at least 2.25% by the end of this year. Our 10-year Treasury note pays 2.96% today. The German version pays 0.57%, and even flat-broke France can borrow at 0.79%. European fragility shows in Italy’s 10-year cost at 1.73%, and Spain’s at 1.25%.
These yields expose Europe’s recovery as a rag doll animated by the central bank — as long as it can. So long as inflation stays below 2%, it can, but when the ECB stops then all of the Euro fissures will reopen. Japan is the same, sustained by its central bank, but its fundamentals far worse than Europe as evidenced by its 10-year yield today at 0.05%. China’s economic miracle acts as a tax on the rest, its over-production a heavy burden — which if anything will increase as China attempts to restructure away from debt-based growth.
That external pattern explains our domestic mysteries. Given the tax bill and doubled deficit spending the US should be rocking and the Fed pulling away the punchbowl. We are growing well, especially jobs, but not accelerating.
All credit market eyes are on the narrowing spread between the Fed-sensitive 2-year T-note, today 2.48% and the 10-year, as above at 2.96%. When 2s pushed up by the Fed cross over 10s we have a recession. But, this time we might invert only because the outside world is the same jar of pickles it was the last time long-term US rates hit all-time lows.
Those of us in housing and mortgages certainly hope so.
The US 10-year T-note in the last year, tip-toeing across 3.00% and then scurrying back:
The 2-year T-note… no tip-toeing, no scurrying, just marching up in advance of each Fed hike:
The ECRI has settled in an okay place, but not hot, and as above is not accelerating:
Mortgage interest rates flat despite stronger than expected economic data. Economic data stronger than expected included March Existing Home Sales, the February FHFA House Price Index, the February Case-Shiller Home Price Index, March New Home Sales, April Consumer Confidence, Weekly Jobless Claims, March Durable Goods Orders, the March U.S. Trade Deficit, the first look at Q1 GDP, the Q1 Employment Cost Index, and the University of Michigan Consumer Sentiment Index. Weekly Jobless Claims fell to a new low dating back to the inception of the report in 1969. The Fed is expected to increase the Fed Funds rate at least two more times this year with some calling for three rate increases. The Treasury auctioned $96 billion of 2 Year Notes, 5 Year Notes, and 7 Year Notes which were met with just okay demand. Global tensions have lessened slightly as North and South Korean leaders met at the DMZ for the first time since the war began in 1950. The European Central Bank left its benchmark rate unchanged.
The Dow Jones Industrial Average is currently at 24,237, down over 200 points on the week. The crude oil spot price is currently at $68.08 per barrel, down slightly on the week. The Dollar strengthened versus the Euro and Yen on the week.
Next week look toward Monday’s Personal Income and Outlays, Chicago Purchasing Managers Index, and Pending Home Sales Index, Tuesday’s PMI Manufacturing Index, ISM Manufacturing Index, and Construction Spending, Wednesday’s FOMC Meeting Announcement, Thursday’s International Trade and Weekly Jobless Claims, and Friday’s employment report for April as potential market moving events.
In any normal year in the last half-century, this would be the week in which markets and media became pre-occupied with the Fed — especially housing market participants, and even politicians.
This is the week in which the Fed’s new hiking cycle began to bite. Mercifully for new chair Jay Powell, fog and smoke billowing from other parts of government make perfect cover for the Fed, for a little while longer. The Fed’s hikes have not yet affected the real economy, but when mortgage rates pierce 5.00%, a whole lot of people will notice.
The Fed’s ideal public profile is irrelevance, if not complete invisibility. It dropped the overnight cost of money to “0%-.25%” ten years ago. Five years ago it began to threaten rapid hikes which never happened, a combination of hold-us-back and “Wolf!” which gradually bored markets into not paying attention.
The Fed did at last begin to raise the cost of money at the end of 2015. By .25% to 0.50%. And then waited a whole year to go to 0.75%. Yawn.
Last month it went to 1.75% — and promises to be at least 2.25% by the end of 2018. So help me, markets did not react until this week, and at that only in the most sophisticated way (yield curve slope). A few civilians are snorting to wakefulness, their ARM-reset letters this month jumping to 5.00% for both Libor- and T-bill-based adjustable mortgages.
“Well! Harrumph. I’ll just refinance.” Uh-huh. How does 4.75% sound — while it lasts?
Historically, housing is central to Fed cycles. We are the first to overheat, the first to faint when the Fed hikes a lot, which marks the onset of recession, and the first to recover. Today, only one problem: we have no recognizable housing cycle. Housing overheating is one of the good reasons for the Fed to tighten — overbuilding makes recessions deep, and Fed interception is a good idea. However, today we have no overbuilding, except apartments in a few markets.
Is it in the Fed’s or the nation’s interest to thump housing while in a state of chronic under-supply? The Fed’s standard down-the-nose: “Monetary policy is unable to assist individual segments of our economy” Um… not even the sector most sensitive to interest rates? Unfortunately, down-the-nose is correct. Feels lousy, though.
Traditionally and accurately, its rate “hikes” are synonymous with “tightening,” as in credit harder to get. Not this time, not yet. The Fed has already made cash the most expensive in ten years, but no sector reports that loans are harder to get.
Here’s the fun part. How high will the Fed have to hike before it is “tight?” Nobody knows. To slow the economy to a sustainable pace (GDP growth sub-2%, less than 100,000 jobs monthly), will the Fed have to choke credit, or just hike far enough? The most basic calibration of Fed altitude is the cost of money relative to the “neutral rate of interest,” known in econ-ese as r*, spoken as “r-star.” Higher than r*, the Fed is tight.
Where is r*? We Fed economists don’t know, so we say that r* is “not observable.” But when we went to 1.75% in March, we said we were still “accommodative,” meaning below r*, wherever it may be. Get your Ph.D, and then you can sound authoritative while guessing by saying “not observable.”
If all is so hazy, how do I get off with announcing in paragraph two, above, that this week the Fed’s hikes have begun to “bite”? On that we have good, solid data. The Fed has been oh-so-gradually pushing up on the cost of money, an overnight rate, but only this week has that up-pushing (from “underneath” as traders would say) moved long-term rates, specifically the 10-year T-note, which defines mortgages and a lot else.
Long-term rates go up and down with inflation. For the Fed by itself to alter long-term rates in the absence of material shift in inflation requires a lot of effort. To push down required an immense QE program. To push up gets a grudging response. In the months before and after the Fed’s last hike, both the Fed telltale 2-year T-note and 10-year froze — even though everyone heard the Fed’s intention to hike farther. 2s began to move up just ten days ago, to price-in the next hike. The 10-year did not move until two days ago. That lag is the marker of the Fed pushing up — nothing else happened to cause the move, just the Fed. That is a form of “tightening,” and the first in this cycle.
During that lag the spread between 2s and 10s reached the most narrow since the last recession, 2s at 2.32%, 10s at 2.73%. In this last week, 2s rose to 2.44% and 10s to 2.94%, the spread opening a bit. At some unknown moment 2s will rise above 10s — an “inversion” — and we’ll have the next recession.
I am a card-carrying Fed Fan. It is a lot of fun to tease them about unknowns, in the black humor of trading desks. Little that they do gets under my skin.
However. Overconfidence is intolerable. Powell and new vice-chair Clarida are first-class appointments who are fully aware of how little they can know for sure.
My current least-favorite is John Williams, who got himself slid sideways from the San Francisco Fed to New York president, much higher prestige, will now vote at every meeting and is supposed to be the watchdog over markets. Williams on Tuesday exceeded all of my poor expectations, and invited fate to the party:
“The flattening of the yield curve that we’ve seen is so far a normal part of the process, as the Fed is raising interest rates, long rates have gone up somewhat — but it’s totally normal that the yield curve gets flatter. My own forecast would be that interest rates are going to move up gradually, smoothly. It’s going to be like a 747 landing and people don’t even realize that they can turn their phones on.”
The gods of money are not pleased. He spoke the day before Southwest 1380.
The Fed funds rate since 2007. Anybody would get sleepy:
Since 2013, the 10-year T-note in red, Fed funds in blue, the yield curve “flattening:”
In fine timescale, the 10-year in just the last year. The post-February stall is clear, as is the re-touch of the 2.95% February top. We’re back on alert for breaking 3.00%, and 5.00% 30-fixed mortgages:
To watch the Fed, watch the 2-year T-note (NOT, not ever, the Fed funds futures market). 2s also stalled into April, but the last ten days are unmistakable, and ahead of 10s:
Mortgage interest rates increased this past week on increased inflation expectations. Commodity prices have moved higher as the economic outlook has improved. Economic data was mixed. Economic data stronger than expected included March Retail Sales, March Housing Starts and Building Permits, and the April Philadelphia Fed Business Index. Economic data weaker than expected included the New York Empire State Manufacturing Index, the April NAHB Housing Market Index, and Weekly Jobless Claims. February Business Inventories, March Capacity Utilization, and March Leading Economic Indicators were in line with expectations. Global tensions have subsided recently as it appears that the U.S. and North Korea will meet in June at a summit for the first time in 30 years. The European Central Bank may remove its current stimulus and increase its benchmark rate. Corporate earnings are now the focus of equity markets with strong earnings expected.
The Dow Jones Industrial Average is currently at 24,527, up about 160 points on the week. The crude oil spot price is currently at $67.90 per barrel, up slightly on the week. The Dollar strengthened versus the Euro and Yen on the week.
Next week look toward Monday’s PMI Composite Flash and Existing Home Sales, Tuesday’s Case-Shiller Home Price Index, FHFA House Price Index, New Home Sales, and Consumer Confidence Index, Thursday’s Durable Goods Orders, International Trade, and Jobless Claims, and Friday’s first look at Q1 GDP, Employment Cost Index, Chicago Purchasing Managers Index, and Consumer Sentiment Index as potential market moving events.
- One-unit principle residence (including condos and PUDs; manufactured housing is not eligible)
- Fixed-rate mortgages with a maximum term of 30 years
- Reserves (if required) may be gifted
“Stranger and stranger,” said Alice. As peculiar as markets have been, we are overdue to return to some version of normal, reacting to actual economic events instead of shock-politics and related speculation.
This week had the feel of concluding crescendo. The offices of the personal attorney of the president were searched by warrant approved by his own Department of Justice. Then markets improved in response to a reassuring speech on trade by a world leader, Xi Jinping (I have no memory of any prior speech by any foreign leader moving US stocks so much).
Speaker Ryan will retire, not until January despite helpful shoves from behind by his friends. With apologies to Winston Churchill and Clement Atlee, the object of Winston’s spear: “An empty limousine arrived at the Capitol, and out stepped Paul Ryan.” Congress needs help at the top of both parties; add McConnell, Pelosi, and Schumer as empties in the limo. Ryan’s announcement, the introduction of Mueller-protective legislation, and Mike Pompeo’s charm offensive all calmed markets.
On alternate days markets were upset by Syria. To strike or not to strike, how soon or how hard, but at least intersection with the real world: oil this week broke to its highest prices in three years. The new Middle East is pure and unstable power play beyond the ability of the US to control. Iran versus Saudi Arabia, the former allied with Russia and Syria, the latter aligned with Israel, and Turkey a wild card. Now a common event: in the sky above Riyadh, the Saudis shooting down Iranian missiles launched by Yemeni rebels.
All of that conspired to keep US interest rates down. For two months the 10-year T-note has traded within an inch of 2.80%, holding mortgage rates close to 4.50%.
To hold long-term rates down like this while the Fed intends at least two more rate hikes this year… that requires a great deal of contrary force. And rates stayed down despite this week’s Treasury auctions of $64 billion in new bonds.
Pushing down: rising oil prices will slow the global economy, which is not accelerating despite hopeful foreecasts. The prospect of trade war is already slowing economies, if only by tamping down upon risk-taking. Dallas Fed prez Kaplan in Beijing said that few if any of the proposed US tariffs will happen. “I think it’s so clearly in the interest of both countries that we have a constructive trading relationship and substantive talks.” There are no talks underway.
Markets had a bright day after Trump said we may re-join the TPP, but fizzled when learning that we intend to renegotiate it, too. We will not be able to renegotiate in our favor every trade agreement outstanding, and the effort will burn good will. Franz Kafka: “In a battle between you and the world, bet on the world.”
The US economy is showing odd signs. The rate of growth in total bank credit began to fall in half early in 2017, and this past February fell to zero. That dearth of borrowing may be the result of the new tax and spending bills loading potential borrowers with cash, but the trend began long before those took shape late last fall.
The Fed released minutes of its March meeting on Wednesday, and given everything else going on, nobody but professionals noticed. The bulk of the minutes were straight down the fairway, the Fed staff saying that risks are “balanced.” However, discussions among the participants are shifting toward end-of cycle thinking.
These minutes are tricky to read as “participants” include the Fed governors and all of the regional Fed presidents. A good half of the regionals are unqualified, and all opinions in the minutes are anonymous. But there are patterns:
“All participants agreed that the outlook for the economy beyond the current quarter had strengthened in recent months. In addition, all participants expected inflation on a 12-month basis to move up in coming months.” Do not look for a pause in rate hikes.
“Participants agreed that, even after [the March .25%] increase in the target range, the stance of monetary policy would remain accommodative.” The Fed’s hikes have not even reached neutral.
"Tax changes enacted late last year and the recent federal budget agreement, taken together, were expected to provide a significant boost to output over the next few years. However, participants generally regarded the magnitude and timing of the economic effects of the fiscal policy changes as uncertain.” The tax and spending bills may not stimulate the economy, but sure as hell will not slow it.
“Several participants expressed the judgment that it would likely become appropriate at some point for the Committee to set the federal funds rate above its longer-run normal value for a time.” There it is, for the first time in this cycle. Not a switch to increased hawkishness, just a statement of fact: if the economy does not slow to a sustainable pace, below 2% GDP growth and jobs 100,000 per month or less… then we, the Fed will see to it.
"A strong majority of participants viewed the prospect of retaliatory trade actions by other countries, as well as other issues and uncertainties associated with trade policies, as downside risks for the U.S. economy.” Or maybe we’ll slow down by some other means.
The US 10-year T-note in the last two years… in the last two months, stuck:
The US 2-year T-note is ultra-sensitive to the Fed, but in the last two months almost as stuck as 10s — very odd, considering the Fed on the march:
A tale of psychology in two charts. The National Association of Independent Business has surveyed its small-business members for 45 years. Since the 2016 election its overall optimism has reached all-time highs. Is the survey still a good proxy for the economy, or a political statement by its conservative membership? Optimism in the top chart, actual component-by-component economic performance in the second:
The Atlanta Fed’s tracker has flattened at exactly 2.0% for the first quarter after weakening throughout:
The ECRI has had a perfect forecasting record since 1965, except for one false-recession call in 2011. Its brilliant chief economist then is still on duty now, Lakshman Achuthan — and he is worried again. Chart weakening but still intact:
Mortgage interest rates increased slightly as economic data continued to be mostly weaker than expected. Economic data weaker than expected included the March NFIB Small Business Optimism Index, February Wholesale Inventories, the March Consumer Price Index (CPI), the March Treasury Budget, Weekly Jobless Claims, March Import Prices, the University of Michigan Consumer Sentiment Index, and the February JOLTS Job Openings report. While weaker than expected, Wholesale Inventories reached their highest level since October 2013. Economic data stronger than expected included the March Producer Price Index (PPI) as well as the core PPI, excluding the food and energy components. PPI was up 3.0% year over year and core PPI was up 2.7% year over year. CPI was up 2.4% year over year and core CPI was up 2.1% year over year. The Treasury auctioned $64 billion of 3 Year Notes, 10 Year Notes, and 30 Year Bonds which were met with okay demand. Trade tensions with China have subsided slightly and tensions with Syria have not increased today.
The Dow Jones Industrial Average is currently at 24,429, up almost 500 points on the week. The crude oil spot price is currently at $67.27 per barrel, up over $5 per barrel on the week. The Dollar weakened versus the Euro and strengthened versus the Yen on the week.
Next week look toward Monday’s Retail Sales, Empire State Manufacturing Survey, and Housing Market Index, Tuesday’s Housing Starts and Industrial Production, and Thursday’s Weekly Jobless Claims, Philadelphia Fed Business Outlook Survey, and Leading Economic Indicators as potential market moving events.