The 10-year Treasury note blew through 5 percent for the first time in four years this week, and long-term mortgage rates have begun their approach to 6.75 percent.
The decisiveness of this week’s move was emphasized by an extraordinary departure from trading norm. Funny things happen in thin trading in holiday weeks (the bond market closed at midday Thursday for the Passover-Good-Friday combo); however, ever since Sept. 11, 2001, money has flowed to super-safe Treasury bonds before long weekends to protect investors against terror- or war-related “event risk.”
This time investors dumped Treasuries — doubly odd because the week’s geo-news was dominated by really ugly events involving Iran and a posse of generals trying to hang Defense Secretary Donald Rumsfeld. If the market feels safer without Treasury bonds than with them, then it is worried about some other event risk, the obvious one being the Federal Reserve.
Fed Chairman Ben Bernanke is still struggling to find a voice, but the two experienced pros still at the Fed (in an accident of terms and retirements, this is the first all-rookie Fed in modern times), Donald Kohn and Tim Geithner know what to say and how. Kohn’s speech yesterday was in the grand standard of Fed-speak – including pages of filler with only one paragraph to help the markets to find center ground. (This centering is terribly important, as the lurch-back in the markets from some misplaced emotional expedition can do considerable harm.)
Kohn made it deadly clear: any pause after the Fed goes to 5 percent on May 10 or 5.25 percent on June 29 will be a hair-trigger affair. The Fed’s contentment with inflation risk is now expressly conditioned on an expectation of economic slowdown soon ahead, and Mr. Kohn and the markets are painfully aware that no such slowdown is apparent. If anything, the economy is accelerating.
The expectation/hope of slowdown is based on notoriously unreliable forecasts from econometric models, the cumulative and lagging effect of the past two years of rate hikes, and the thus far imaginary effects of a housing slowdown (the economy may be so hot that mortgage-rate rises are just bouncing off stucco). March retail sales were fine, the job market is in excellent shape, and capacity constraints are showing up in several places, notably industrial capacity in use, now 81.3 percent, a five-year high and in the inflation zone.
The price of oil pushing $70 does nothing for the Fed’s peace of mind.
Beyond an accelerating economy and rising inflation risk, the Fed must be disturbed by the wild party in the commodity markets and the still-absent premiums for risk in the bond market.
The Fed does NOT like parties. Gold prices cruising through $600 makes some long-term sense, but not running up a hundred bucks in an eye-blink. Silver at $14, copper so high that money-chatter TV ran penny-meltdown skits… the whole commodity complex is out of control and trading beyond production cost. If it’s not an inflation warning, then it is a warning of too much money in the hands of too many drunks.
Observers think commodities are not showing inflation risk because inflation-indexed Treasury spreads versus ordinary Treasury bonds are okay; however, an alternate explanation would be drunks over-buying TIPs, too. They are sure as hell over-buying every other IOU on the planet. Bond risk premiums come in two forms: time and credit. The 10-year hit a five-year high, but still pays nothing versus overnight cost, hence no premium for time. Spreads between lousy mortgages and good ones, and between risky corporate bonds and Treasuries are far too low to compensate for risk.
This financial inflation — a form of bubble — may come from too much liquidity from central banks, or because we’re all getting rich in hot globalized trade, but either way, the Fed has to take away the punch bowl.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
