The credit markets have concluded that inflation risk now forces the Fed into a sustained series of increases in its overnight rate, presently 2 percent.
Interest rates — all of them — spiked in the last 10 days. Lowest-fee 30-year mortgages to 6.625 percent (if you’re a shady character, FICO under 720, make that 6.75 percent), 10-year T-notes to 4.2 percent, and Fed-tied 2-year T-notes to 2.9 percent (up 0.55 percent this week).
The credit markets jumped to Fed conclusions after: oil hit $135; European Central Bank Chairman Jean-Claude Trichet indicated a tilt to tighten there; a string of inflation-centered speeches by Fed officials; and a rebate-bloated 1 percent pop in May retail sales.
It is folly to quarrel with a market move like this, but that’s what I’m going to do.
Think of the very first game of rock-paper-scissors, players uncertain whether scissors would cut paper, or paper would hide them; scissors would break on a rock, but not if stabbing the hand holding the rock. Which beats what?
In the last bad oil/inflation/housing wreck, 1979-82, the Fed did tighten (prime to 22 percent) into a contracting economy (unemployment to 11 percent), into the worst housing recession since the ’30s (mortgages 18 percent), and into the insolvency of the S&L system — all to break inflation running at 12 percent. The economy survived. Sort of.
However, we were then in an epic wage-price spiral, no way to break inflation without first breaking the rocketing growth of incomes. S&Ls then were a corner-pocket of the financial system, disconnected from banking and Wall Street. No major financial institution failed ’79-’82, and credit was easily available, just expensive.
Today’s incomes are contracting in real terms, wage growth stagnant. The "wealth effect" is running in reverse, Americans with no resource to tap to offset huge increases in the cost of energy, food and health care. The big end of today’s financial system is insolvent, broke, liquid but without capital, huge losses still to be recognized, and credit shortage is spreading to small institutions.
The rock-paper-scissors players in the credit markets have got three things out of whack — not necessarily wrong, but probabilities misunderstood. The first I just ran through: this is NOT like the last time. This is different.
Second. Inflation risk did reach a new plane with $135 oil, but so did damage to consumers. If you want the Fed to tighten, how deep a recession do you have in mind? You’re not pretending that rate-hike inflation-fighting is cost-free, and the economy has recovered, are you? (Same for the blinkered, one-track "strong-dollar" parade?)
The Fed’s "beige book" says the May economy was "generally weak"; the NFIB small business May survey says "recession" (it has never had a false reading), with surveyed earnings in a 1980 pit. May foreclosures are up 45 percent from last year (just getting started), and mortgage rates have jumped to the highest since 2000, jumbos at 8 percent a point higher than that, underwriting standards courtesy of Scrooge & Marley.
I’ve read all the Fed speeches in the last two weeks. The hawkish ones by regional Fed presidents are the worst collection of hack-jobs in my memory (Bullard, Plosser, Fisher…). The ones by Fed Chairman Bernanke, Vice Chair Kohn, NYFed’s Geithner — the three brilliant managers of the Fed’s finest-hour interventions since January — these speeches are inspired briefs on inflation measurement and theory, and markets. You must be an inventive reader to find interest-rate policy change in them.
The third thing missed in the credit markets: ’79-’82 conditions are present, but not here. There: China’s retail sales soared 21 percent last month, inflation 8 percent. Eurozone wages jumped 3.3 percent in the first quarter, the Continent drunk on an overvalued euro. Asian central-bank rates are on average 1.7 percent below inflation — that vastly undermeasured because of fuel subsidies. There’s a riot every night somewhere in Asia as those subsidies begin to fail; 30 percent of Malaysia’s government spending … not for long.
The Fed may have to snug in a dollar sop, and would lean hard into a recovery, but proper policy here is to wait for inevitable slowdown … over there.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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