Here at the turn of the year, days getting shorter and it’s 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 percent year over year, and prices with them, up 7.9 percent. Personal income gained 0.5 percent, and spending surged .9 percent (possibly suspect); and the core personal consumption expenditure deflator (PCE, the Fed’s favorite measure of inflation) stayed at 1.2 percent year over year. Only new orders for durable goods were tepid, up 0.5 percent for May but down 2.2 percent 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 it is 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 preholiday 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 percent, 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 percent.
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 that will not stay the Fed’s hand).
Fourth bet: Bond market complacency at this moment is epic. The U.S. 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 at 5 percent, the Fed’s life will be very complicated. Lucky seven.
The 10-year T-note in the last week: tough week. As above, I suspect that Greece has suppressed rates here, but markets have finally figured out that Greece does not matter.
The 10-year T-note in the last five years: This is an exceptionally weak chart. Some fair support from here to 2.75 percent, then a very serious battle at 3 percent (mortgages just under 5 percent). Take out that nifty double-top and there is no support at all, an invitation to wild volatility and mortgage rates at the housing-abort level.
The 2-year T-note (below, two years back) is the best Fed-predictor, but is now nearly Fed-defiant. The yield tops have been steady for six months, only the bottoms ascending. There’s a 50-50 chance the Fed will hike twice by Christmas, and it’s crazy for a 2-year note to pay the same yield as the likely overnight rate in six months.
One of the splendid charts from Calculated Risk: The chart is new single-family homes, today “recovering” to prior levels of recession. We certainly overbuilt from 2002-2007, but that is worked off now. Considering the wear-out rate of older homes, and the huge increase in U.S. population, and new-home construction is very thin.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
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